The UK’s 2016 Budget, presented earlier today, introduced several significant reforms to the UK’s tax system. Key points of particular interest to the private equity market include the following highlights.
Taxation of Carried Interest:
Although the introduction of the recently proposed “income based carried interest” regime, taxing certain carried interest proceeds as deemed UK source income, has been confirmed, at the time of writing the final details are yet to be confirmed. We may not have those details until the Finance Bill publication date, 24th March. The new regime is expected to apply from 6th April 2016.
Capital Gains Tax:
The top rate of personal capital gains tax (CGT) will fall from 28% to 20% from 6th April 2016. However, importantly, carried interest is excluded and will continue to be taxed at 28%. This increases the importance of qualifying returns as co-investment rather than profit-related “carried interest” to the extent possible. Residential property is also excluded, with taxable gains remaining subject to the 28% rate.
The “Employee Shareholder Status” (“ESS”) CGT exemption is to be capped at £100,000 of lifetime ESS gains per person. However, shares acquired under the ESS scheme up to today (16th March 2016) are grandfathered. Many private equity houses have used ESS schemes to incentivise management in recent years. Although historic implementation is not affected, benefits for future transactions are now limited. This isn’t entirely surprising, as the exemption has long been considered “too good to be true”.
Corporation Tax Reforms:
The UK corporation tax rate will fall to 17% from April 2020. (The rate is currently 20%. It had already been announced that the rate would be cut to 19% from April 2017 and to 18% in 2020.)
As anticipated, UK relief for interest costs will be capped from April 2017 at 30% of UK EBITDA, following the recent OECD BEPS recommendations. There will be a de minimis threshold for interest costs of up to £2m, and an exception for public-benefit infrastructure projects. Groups with a higher external gearing ratio may also be permitted a higher level of deductions. OECD BEPS anti-hybrid rules will also be introduced from 1st January 2017.
The tax loss consolidation rules for losses generated in a group from April 2017 onwards will be relaxed. This is likely to reduce the problem of trapped finance costs in leveraged UK acquisition companies, but only for interest cost accruing from April 2017.
Relief for carried forward tax losses will be limited from April 2017 for profits above £5m (on a group basis). Relief over that threshold will only be available on half of the excess profit. The accounting value of deferred tax assets may be impacted adversely. The use of carry forward losses by banks is even more severely restricted.
The top rate of Stamp Duty Land Tax (“SDLT”) on commercial property is rising to 5% from 4% from 17th March 2016. Changes to the application of rate thresholds mean that the new 5% top rate will only give rise to higher SDLT on chargeable consideration of £1.05m and above. SDLT on the grant of leases is also being reformed.
The use of offshore structures to develop UK property whilst keeping development profits outside of the UK tax net is being closed down, with an extension to the UK tax charge on property dealing and development. The change, to be effective at some time later in 2016, establishes a clearer charge to UK tax on non-residents even where there is no UK tax presence. There are related changes to the UK’s tax treaties with Jersey, Guernsey and the Isle of Man, which are the jurisdictions most commonly used for these structures.