Politically, the UK's Spring Budget may be most remembered for the U-turn the government made within one week on its measure regarding social security contributions payable by the self-employed.
In order to introduce greater parity between employees and self-employed people, the Budget had said that social security contributions (known as national insurance contributions in the UK) for self-employed people (Class 4) would rise by 1 percent from next year (and 1 percent the year after).
The conservative party which leads the government had, however, said in its election manifesto that it would not raise certain taxes − national insurance being one of them. Although this was not a binding legal promise, the government bowed to pressure (not least within its own party) to withdraw the proposed measure to show its commitment not to raise income tax, VAT or national insurance during the life of this Parliament (which will probably end in 2020).
Overall, this budget, presented by the Chancellor of the Exchequer on March 8, is relatively low key. But this should be welcomed by many businesses operating in the UK, given the volume of changes introduced recently, including more which are due to take effect this year. A few measures are good news for business and are highlighted below.
Corporation tax rate: the Budget did not change the planned corporation tax rates. In line with expectations, the rate of 20 percent will fall to 19 percent from April 1, 2017 and there will be a further reduction to 17 percent in April 2020.
Non-UK resident companies chargeable to income tax and non-resident capital gains tax: the government has published its eagerly awaited consultation on bringing non-UK resident companies, who are currently chargeable to income tax on their UK taxable income, and to non-resident capital gains tax on certain gains (relating to residential real estate), within the scope of corporation tax. The government's main target is the income of non-resident companies which own UK real estate which is currently subject to income tax rather than corporation tax.
Following this reform, these companies will be subject to the rules which apply generally for the purposes of corporation tax, including the (BEPS Action 4) limitation on interest expense deductibility, the anti-hybrid rules and new rules which the government is introducing on the use of tax losses. Although the new rules on tax losses enable more flexibility regarding the types of profits against which companies can set their carried-forward losses, there is also a new restriction under which only 50 percent of a company's profits in an accounting period can be sheltered by carried-forward losses. The 50 percent restriction is subject to an annual allowance per group of £5 million profits, which can be relieved in full.
The consultation envisages the grandfathering of unused losses which have accrued to non-resident companies before the reform takes effect. Such losses would be available to be carried forward and used against future profits of the UK property business carried on by the non-resident company. The losses would not be subject to the new rules referred to above restricting to 50 percent the amount of profit which can be sheltered. The losses would not however be available to be surrendered to other group companies.
Some had feared that the reform might alter the long-standing position that gains made by non-resident companies disposing of UK commercial real estate held as an investment rather than as part of a trade are outside the scope of UK tax. The consultation document however suggests that this will remain the case and that only disposals of residential property by certain non-resident companies will be (as now) subject to UK tax.
A benefit of the reform will be that non-resident companies will be subject to tax at the rate of corporation tax which is due to fall to 17 percent from April 2020 (in comparison to the income tax rate of 20 percent) and may be able to access group relief.
Implementation of BEPS Action 4 - restrictions on interest deductions: the UK government is implementing BEPS Action 4 with effect from April 1, 2017 so that each group's net deductions for interest will be restricted to 30 percent of taxable earnings in the UK. An optional group ratio rule, based on the net third-party interest-to-earnings ratio for the worldwide group, may permit a greater amount to be deducted in some cases. The draft legislation also provides for repeal of the existing debt cap legislation (enacted in the UK in 2009) and its replacement by a modified debt cap which is intended to ensure that the net UK interest deduction does not exceed the total (third-party) net interest expense of the worldwide group. All groups will be able to deduct up to £2 million of net interest expense per annum, so groups (or single companies) below this threshold will not need to apply the rules.
There will also be a Public Benefit Infrastructure Exemption (PBIE) that will apply to qualifying infrastructure companies. The intended beneficiaries include not only private finance initiative companies which undertake large-scale projects for the government, such as building new hospitals, but also, subject to various conditions, property owning companies letting property on leases of 50 years or less duration. For companies within the PBIE, their qualifying third-party interest expense will be removed from the scope of the new interest restriction rules.
Following representations made by stakeholders, amendments are being made in the following key respects:
- to remove certain unintended restrictions arising from the modified debt cap that could prevent deductions for carried forward interest expense
- to remove the so-called comparative debt test from the PBIE, which would have required groups to compare the level of debt within their companies seeking the benefit of the exemption with the level of debt of non-qualifying companies of the group carrying out similar activities (such as non-UK companies)
- to provide for a transitional period to enable businesses to restructure to meet the stringent terms of the PBIE and
- to limit the impact of related party guarantees. Where debt is guaranteed by a related party, interest payments are treated as related party interest, even where the lender and borrower are unrelated. This can impact both the group ratio rule (which only looks to net third-party interest) and the availability of PBIE (which is only applicable to third-party interest). The rules are to be amended such that interest will not be treated as related party interest in the case of certain performance guarantees and all guarantees granted before March 31, 2017 or intra-group guarantees in the context of the group ratio rule. This was subject to significant lobbying by the property industry and will be welcome.
Withholding tax on interest
- Extension of double tax treaty passport scheme: This scheme was introduced by the UK tax authority in 2010 to reduce the administrative burden for foreign lenders and borrowers paying UK source interest by making it easier for them to access the UK's network of tax treaties. The use of the passport scheme is currently restricted to non-UK corporate lenders and corporate borrowers paying UK source interest.
From April 6, 2017, these restrictions will be removed and the passport scheme will apply to all types of overseas lenders and all borrowers paying UK source interest (so partnership and unit trust borrowers can now use the passport scheme). Transparent entities (including partnerships) will be admitted to the scheme as lenders where all of the "constituent beneficial owners of the income are entitled to the same treaty benefits under the same treaty. This will be particularly good news for sovereign wealth funds, pension funds and partnerships wishing to break into the UK debt market and, therefore, for borrowers too. The use of the passport scheme may also become more prevalent in the context of portfolio transfers involving individual UK borrowers.
- New exemption from withholding tax on interest on debt traded on a multilateral trading facility: the UK government has also announced the introduction of a new exemption from withholding tax for interest on debt traded on a multilateral trading facility (MTF) (such as Chi-X Europe and LMAX Exchange) and is consulting on its implementation. This move follows on from the introduction of the qualifying private placement exemption and is also aimed at removing barriers to the development of UK debt markets and platforms. The new exemption will extend the existing quoted Eurobond exemption (QEE) which applies to debt which is "listed" on a "recognised stock exchange." As the listing requirement of the QEE applies by reference to local regulatory arrangements, debt traded on MTFs in Luxembourg or Ireland currently fall within the QEE whereas the same securities traded on a wholesale UK MTF would not. The new exemption will apply from April 2018.
All in all, the major measures discussed above and coming into force have all been consulted upon for many months. It is clear that the underlying strategy of the government is to proceed with BEPS implementation while making the UK attractive to international business and investment in preparation for Brexit.