This special issue of our UK Tax Bulletin includes a summary of the main Budget proposals announced by the Chancellor of the Exchequer this afternoon. The Budget included a number of items which had already been announced (although that did not prevent him announcing them again) but there are other measures which were unexpected.
HMRC and HM Treasury have issued a large number of press releases and other documents relating to the proposed Budget changes. Many of the matters considered are highly technical and further details are available on request from our London office.
The Chancellor has confirmed that the £30,000 charge will be introduced on 6 April 2008. Foreign domiciled individuals who are resident in the UK are eligible for the remittance basis of taxation – that is to say, they pay tax on their UK income and gains but not on their foreign income or gains, unless it is remitted to this country. For those foreign domiciled individuals who have been resident in the UK for 7 out of the last 9 years they will only be able to continue to benefit from the remittance basis if they pay £30,000 a year for the privilege. Those who do not pay the £30,000 will be chargeable to tax on their world wide income – subject to the normal double taxation relief for tax paid in other countries.
Those who have not been resident in the UK for 7 out of 9 years will continue to benefit from the remittance basis without charge and so will those who have unremitted foreign income and gains of less than £2,000 per annum. However, where somebody claims the remittance basis (whether they pay the £30,000 or not), they will forfeit the right to their personal allowance and their capital gains tax annual exemption. The charge will not apply to anybody under the age of 18 who will continue to benefit from the remittance basis without any supplementary charge.
An individual will be able to claim the remittance basis each year (on payment of the £30,000 charge) but any income not taxed by reason of a claim in one year which is subsequently remitted in a year when the remittance basis is not claimed, will continue to be taxable here.
It is confirmed that remittance of funds to pay the £30,000 charge will not be taxable although this would appear to be a very restrictive relief; it will only apply where the £30,000 is paid direct to HMRC from an offshore source by cheque or electronic transfer.
The £30,000 charge will be very different in principle from that which was originally announced. It will no longer be an entry fee for the remittance basis but will be an actual tax charge on unremitted income and gains. Individuals will be able to specify the particular unremitted income or gains to which the £30,000 will relate. This means that the charge will become income tax or capital gains tax and therefore eligible for double taxation credit in other countries – particularly the United States. The position has not been confirmed by the IRS but the prevailing view seems to be that this change will be sufficient to enable credit to be granted.
Now that the £30,000 will be a tax payment, it is confirmed that it will be also eligible to frank a Gift Aid payment. The multiple opportunities which have emerged from these changes indicate that the £30,000 payment could prove to be much less burdensome than anticipated.
The Pre Budget Report set out a large number of changes to the way in which the remittance basis will operate in the future and some intrusive information requirements for notifying details of foreign trusts to HMRC. The notification requirements have been abandoned but the changes to the remittance basis have been broadly retained.
The definition of a remittance is being widened considerably to encompass the use of any property in the UK or the benefit of any services provided in the UK. At the moment a chattel can be purchased with relevant foreign income outside the UK and then brought to the UK; that does not represent a remittance of the income as it does not represent a sum of money. From 6 April, the new definition of a remittance means that bringing a chattel or using other assets in the UK will represent a taxable remittance.
There will be an exemption for personal effects, assets costing less than £1,000, assets brought into the UK for repair and assets in the UK for less than 9 months, purchased out of relevant foreign income. In addition, any asset purchased out of untaxed relevant foreign income which is owned on 11 March 2008 will be exempt from a charge under the remittance basis – unless of course it is sold.
Source Ceasing Rules:
No tax liability can presently arise if the source of the income which is remitted does not exist in the tax year. A common example is a bank deposit or shareholding which gives rise to interest or dividends. If the account is closed or the shares are sold and all the accumulated interest and dividends are remitted in the following tax year, no tax arises because, in the year of remittance, the source of the income would not exist. This rule has not applied for some years in respect of employment income nor in the case of some trust income, and the draft legislation now specifically provides for all such income to be taxed in the year it is remitted whether or not the source exists in that year.
Remittances from a fund which contains a mixture of income, capital and capital gains have always been problematic, with different rules and practices applying to income and capital gains. A statutory rule is being introduced on 6 April 2008 to determine how much of a transfer from a mixed fund is treated as income or gains and how they are chargeable to tax. This at least has the advantage of certainty because the previous rule was of doubtful authority. The practical effect may be limited because nobody in their right mind made distributions out of a mixed fund anyway but reorganised it first to avoid the problems. The only uncertainty here is that the Budget Day press release says that the rules will be more comprehensive than those set out in the draft legislation published in January – but we have no further details.
It has long been established that for income to be taxed in the UK, it has to be remitted by or on behalf of the person entitled to the income. A gift of income to a third party (an outright and absolute gift completed outside the UK) could be remitted by the donee without any charge to tax. The amount remitted would not be the income of the donee and therefore not taxable; nor could it be taxed on the donor as it did not belong to them.
New provisions will apply from 6 April 2008 to provide that where foreign income and gains are alienated by a transfer to an offshore vehicle or close relative, the donor will be taxed on the remittance basis if the donee brings the money to the UK. The original proposal was extremely wide but it will now be limited to spouses (etc) and their children or grandchildren.
It is understood that HMRC have accepted that this only applies to transfers after 5 April 2008 so that alienation prior to that date should continue to be effective – but there is nothing in the press releases specifically confirming this point.
At the moment, where a foreign domiciled individual has taken out a foreign loan for use in the UK, perhaps to buy a house in the UK, and pays the interest on that loan outside the UK from foreign income, that is not treated as a remittance. With effect from 6 April 2008 the payment of such interest will represent a remittance. However, these rules will not apply where interest is paid on existing mortgages secured on a residential property in the UK. However, if the terms of the loan are varied or any further advances made now, this grandfathering provision will cease to apply.
Capital Gains Losses:
Foreign domiciled individuals obtain no relief for foreign capital losses as the remittance basis only applies to gains. However, from 6 April 2008 individuals will be able to elect in and out of the remittance basis year by year and a measure of loss relief is now provided. For 2008/09 it will possible to elect for relief for foreign losses in the years in which they are taxed on the arising basis, but it will be necessary to provide details of the assets giving rise to the loss, and of unremitted gains.
Segregation of Capital and Income:
This particular technique is unaffected by any of the changes. The charge to tax remains on the remittance of income or capital gains. There is no charge on a remittance of pure capital – unless it is mixed up with income and gains. Accordingly, the strict segregation of income from the principal will continue to enable the principal to be remitted free of tax.
Works of Art
Under the new remittance rules, where a work of art is brought to the UK, it will represent a taxable remittance if it was purchased out of foreign income. However, this will not apply to works of art purchased overseas from unremitted income if it is brought to the UK for public display at an approved establishment. This exemption, combined with the change in the proposals for offshore trusts, will deal with many of the criticisms levelled at the proposed rules at least as far as they would have applied to works of art.
There is no reference anywhere to the proposal for temporary non residents who remit income during their absence and it remains to be seen whether this idea has been abandoned
The taxation of offshore trusts is being changed as far as foreign domiciled individuals are concerned – and the changes are considerably different from those originally announced. Under the present rules, there is an exemption in respect of gains made by offshore trusts where the settlor is UK resident but not UK domiciled. There is also an exemption from capital gains tax in respect of gains of a non resident trust where benefits are provided to a UK resident but foreign domiciled beneficiary.
The settlor exemption will continue but the beneficiary charge will apply to all foreign domiciled beneficiaries (including the settlor if he is a beneficiary) on the basis of capital payments or benefits received from the trust where the trustees have made capital gains. The proposed transparency rules whereby the remittance basis would apply to the beneficiary only if the asset on which the gain was realised was situated outside the UK has been abandoned. The beneficiary charge will continue broadly as at present, with the exception that the foreign domiciled beneficiaries will not be completely exempt but taxable on the remittance basis in respect of benefits from the trust received or enjoyed in the UK.
Trust gains made before 5 April 2008 will not be taxed even if distributed to a beneficiary in the UK unless the beneficiary has become both resident and domiciled in the UK.
A new matching rule is to be introduced on a LIFO basis applicable to all beneficiaries, not only those with a foreign domicile. This is particularly welcome, especially when it is combined with the significant reduction in the rate of capital gains tax on stockpiled gains from 64% to 28.8%.
The controversial notification requirements proposed for foreign domiciled settlors of foreign resident trusts have been completely abandoned. There will be no change to the existing notification provisions of schedule 5A TCGA 1992 although it is acknowledged that HMRC are entitled to enquire about foreign income and gains in the course of an investigation if it is relevant to the liability to UK tax.
Trustees will be able to make an irrevocable election to rebase all assets held by them at 6 April 2008. This will have the effect of washing out all the accrued gains arising to that date and securing an effective exemption from capital gains tax on foreign domiciled beneficiaries.
The election will apply to assets owned by the trust on 6 April 2008 and assets owned by any underlying company on that date providing that any gain on such asset would have been apportioned to the trust under section 13 TCGA 1992.
There seems to be no requirement for the trustees to notify HMRC of all the assets to which the rebasing election applies, at least not until such time as it is necessary to consider whether capital payments are to be made to beneficiaries in the UK.
Offshore Income Gains
Offshore income gains accruing to non-resident trusts are attributed to UK beneficiaries under a mixture of the capital gains tax and income tax rules. The attribution follows highly complex provisions which can have capricious effects. There is to be some reform from 6 April 2008 and the attribution will be along the following lines:
(a) An offshore income gain will primarily be attributed to beneficiaries under the section 87 capital payment rules in the year in which the gain is realised;
(b) If it cannot be matched in this way in that same year, it will then be treated as income and permanently removed from the section 87 capital gains pool. However this will not be the case if the motive defence to the transfer of assets abroad rules applies in that year (because the relevant transfer satisfies the bona fide commercial not to avoid tax test). In that event the offshore income gain will remain in the section 87 pool.
These general rules will be universally applied, but the new rules relating to non domiciliaries receiving capital payments from offshore trusts will be adapted to apply in a similar manner to offshore income gains, i.e. a remittance basis will apply after 6 April 2008, but not in so far as the offshore income gain was realised or accrued (by election) before 6 April 2008.
It will remain the case that gains of this type are charged to income tax and not to capital gains tax.
The above changes will not apply to non resident companies. The present rule is that capital gains made by a non resident company can be apportioned to the UK resident participators who have more than a 10% interest in the company – unless they are foreign domiciled. This exemption for foreign domiciled individuals is being removed so that UK participators of foreign companies will be taxed on the chargeable gains of the company irrespective of their domicile.
There will no rebasing to April 2008 in respect of the gains of such companies; rebasing applies only in respect of companies owned by trusts to which the companies’ gains would be attributed under section 13.
It is tempting therefore to consider transferring such a company to a trust before 5 April 2008 so as to secure rebasing of the company’s assets. This does need to be considered in the light of the uncertainty over the alienation rules because there is a possibility that the subsequent enjoyment of the trust funds in the UK could be regarded as a remittance after 5 April 2008.
Residence: Day Counting Rules
Under the present rules, an individual will be resident in the UK if he is present in this country for more than 6 months in a tax year. This is interpreted to mean more than 182 days and while HMRC generally (as a matter of practice) disregard days of arrival and departure in this calculation, they are strictly entitled to calculate the period on the basis of hours and minutes on the authority of CIR v Wilkie.
There is also the HMRC practice whereby an individual will be regarded as resident in the UK if he is present here for more than 90 days per annum on average over 4 years; he becomes resident at the beginning of the fifth year. However, if it becomes clear that his pattern of visits is such that he will breach this test he will become resident from the beginning of that year. Again, in calculating the 90 day figure, HMRC practice is to ignore days of arrival and departure.
The Pre Budget Report suggested that the day count would be revised for both the 182 days statutory test and the 90 day practice to include days of arrival and departure with effect from 5 April 2008. However, this has been modified and only a day when the individual is present in the UK at midnight will be counted as a day of presence for residence purposes.
There is to be an exemption for passengers who are in transit. The exemption previously proposed was very narrow (only if you stayed airside) but it has been extended to include people who have to change airports or terminals when transiting through the UK – and it will also allow people to switch between modes of transport so they can fly in but leave by ferry or train. Days spent in transit which involve being in the UK at midnight will not be counted as days of presence for the purposes of determining UK residence. If however the individual takes the opportunity during this transit to “engage in activities that are to a substantial event unrelated to their passage through the UK” they will not get the relief.
It must be emphasised that these day counting provisions only apply in respect of non resident individuals who visit the UK. They have no application whatsoever under current HMRC practice to individuals leaving the UK. HMRC presently take a very firm view (explained in HMRC Brief 01/07) that to become non resident the individual has to leave the UK and these day count figures have little or nothing to do with the determination of whether he has left the UK. This is of course highly controversial and is the subject of litigation at the present time.
Capital Gains Tax: New Rules
The Chancellor confirmed his proposal to abolish taper relief and indexation allowance (and the share identification rules) on 6 April 2008 and for capital gains tax to be charged at a flat rate of 18%. This will apply to individuals and trustees; companies will not be affected by any of these changes.
Following extensive representations he announced a new relief called Entrepreneur Relief which is available in respect of gains made on the disposal of all or part of a business, or shares in a trading company, by those who are involved in running the business. The first £1million of gains will be charged at an effective rate of 10% and the rest will be chargeable at the new flat rate of 18%. There are some resonances with retirement relief and also with taper relief but it is not quite the same as either of them.
The relief will only apply to gains arising on the disposal of all or part of a trading business owned by the individual for at least one year, or on the disposal of shares in a trading company (or the holding company of a trading group) providing that the individual (of any age) making the disposal has been employed by the company and has held 5% of the shares (or more precisely, shares which have 5% of the votes) for at least one year. It will not apply to employee shareholders unless they hold at least 5% of the shares. This will exclude a huge number of people who previously qualified for taper relief – inevitably including the smallest employee shareholders.
Trustees will be able to benefit from this relief – providing that a beneficiary with an interest in possession in the relevant assets is involved in carrying on the business or is an employee of the company. Where a business is not disposed of as a going concern but ceases, the relief will be available on disposal of the assets within 3 years of cessation of the business.
There will also be a relief for “associated disposals” of assets which are used in the business – e.g. a director who owns the company premises or a member of a partnership who owns the partnership premises.
Some relief is provided to those who have been trapped by the abolition of taper relief – for example where somebody has disposed of their shares for loan notes which will not be redeemed until after 5 April and will therefore be caught by the new regime. They will lose the taper relief and indexation and have the effective rate of tax approximately doubled. However, the availability of the Entrepreneur Relief (and it only applies to the first £1million) will depend upon whether the loan notes are QCBs or non QCBs. When QCBs are redeemed the Entrepreneur Relief will apply to the gain arising on that occasion if the original shares would have qualified at the time of their disposal. Unfortunately, those who exchanged their shares for non QCBs have to continue to satisfy the conditions for Entrepreneur Relief – that is to say for the period of at least one year prior to the redemption of the loan notes, the individual must own at least 5% of the company and be employed by the company. That is hardly very likely – who would have sold their company and received cash and loan notes but have retained a 5% interest in the company?
The nil rate band is being increased from 6 April 2008 to £312,000.
The Chancellor has also confirmed his previous proposal to allow the nil rate band unused on a person’s death to be transferred to their spouse. This does not completely eliminate the need for nil rate band trusts but is certainly very helpful where no such provision has been made.
There are some consequential revisions to capital gains tax valuations because section 274 TCGA 1992 provides that where the value of an asset in a deceased persons estate has been ascertained for IHT purposes, that value is also applied for the purposes of capital gains tax.
As a result of this change, the value of the assets in the first estate will need to be recalculated to determine how much of the nil rate band applies and if that differs from the value previously agreed for CGT purposes, it would all have to be recalculated. Accordingly, in these circumstances, the requirement to use that value for section 274 purposes will not be necessary.
Transitional Serial Interests
Last September a controversial view was expressed by HMRC concerning transitional serial interests in trusts. They suggested that where a pre 22 March 2006 life interest comes to an end and is replaced before 5 April 2008 by another life interest in favour of the same life tenant, section 53(2A) IHTA 1984 required this event to be treated as an immediately chargeable transfer. This view was not thought to be correct (see the SSD Tax Bulletin for September 2007). The matter is now to be dealt with by retrospectively repealing section 53(2A) and replacing it with a new provision which makes it clear that there is no chargeable transfer in such circumstances.
A useful extension to the transitional serial interest provisions is also to be made. Under the Finance Act 2006 provisions, where a person had an interest in possession in settled property at 22 March 2006, the interest could be terminated in favour of a continuing interest in possession, either for the same or another beneficiary; the old inheritance tax rules would apply to the continuing interest. In other words, the settled property would be treated as being part of the inheritance tax estate of the beneficiary with the continuing interest.
This provision was due to expire on 5 April 2008, following which it would no longer be possible to substitute one interest in possession for another without a chargeable transfer arising, otherwise than on death of one of the spouses. It has now been announced that the 5 April 2008 deadline is now to be extended to 5 October 2008, giving a useful further period for reorganisation of pre 22 March 2006 life interests in trusts.
Overseas Pension Schemes
As announced in the Pre Budget Report, legislation is being introduced to restore IHT protection to pension savings which have had UK tax relief and to all savings in certain overseas pension schemes. The relief will apply to funds in schemes that are tax-recognised and regulated in the country in which they are established, or, if unregulated, contain funds which must be used to provide a pension income for life.
This is an important issue for individuals who have made (or are contemplating) a transfer of a UK pension fund to an offshore scheme and the detailed draft legislation is awaited.
Rates of Tax
The main rate of corporation tax will be reduced to 28% from 1 April 2008 where profits exceed £1.5m. Where profits are below £300,000 the rate will be 21%. The marginal rate where profits are between £300,000 and £1.5m will be 29.75%.
These bands are divided by the number of associated companies which are broadly companies under common control.
A change is proposed to the definition of an associated company for small companies relief purposes. To determine whether one company controls another or is under common control, it is necessary to attribute to a person any rights or powers held by his business partners. It is proposed that a business partner’s rights or powers will only be attributed to a person where some tax planning arrangement is in place which results in a tax advantage being obtained under the small companies tax rules.
Controlled Foreign Companies
Anti-avoidance measures are introduced to block a number of schemes which involve the use of a partnership or trust to escape or reduce tax charges under the controlled foreign companies rules. Broadly, HMRC’s concern is that offshore trusts or partnerships have been used in order to avoid companies being treated as controlled by UK residents, and to avoid income being treated as that of a company.
Intangible assets regime
It is to be put beyond doubt that the “related-party” rules for the relief on intangible assets will not be affected by the administration, liquidation, or other insolvency arrangements in which one or both of the parties are involved.
Writing Down Allowances
The standard rate of writing down allowance is reduced from 25% to 20%. The corresponding rate on long-life assets is increased from 6% to 10%. From April 2008 unrelieved expenditure on longlife assets will be allocated to a new “special rate” pool, on which an annual writing down allowance of 10% will be available. Somewhat complex transitional provisions apply where an accounting period spans April 2008.
In addition, from April 2008 expenditure on certain “integral features” of buildings, which do not normally qualify for capital allowances under present rules, will qualify for the above mentioned “special rate” pool, and thus for an annual writing down allowance of 10%. The legislation will include a list of what constitute “integral features”.
Changes are also made as regards the costs of thermal insulation. Currently, such expenditure only qualifies for capital allowances in the case of industrial buildings. In future, thermal insulation costs for all buildings (except residential buildings) will qualify for capital allowances, albeit only at the 10% rate.
Capital Allowances: Annual Investment Allowance
The current 50% and 40% rates of first year allowance for expenditure on plant and machinery by small and medium sized businesses are abolished as from April 2008. Instead, businesses will be able to claim an “annual investment allowance” at 100% on the first £50,000 of expenditure on plant and machinery (which includes long-life assets and “integral features” of certain buildings, but does not include cars). Expenditure above £50,000 will qualify for capital allowances in the normal way. Related companies or businesses will qualify for only one amount of annual investment allowance.
First-year Tax Credits
Where a company makes a loss attributable to 100% first-year allowances for expenditure on certain designated energy-saving or environmentally-beneficial plant and machinery incurred after April 2008, it will be able to “surrender” that loss and claim a cash payment of 19% of the loss from the government (to be known as a “first-year tax credit”). The amount of credit payable is capped at the greater of £250,000 or the company’s PAYE and NIC liabilities for the period to which the loss relates. A clawback applies if the plant and machinery concerned is sold within four years after the end of the loss-making period.
Small Plant & Machinery Pools
Where a business has unrelieved expenditure of £1,000 or less in its main or special rate capital allowances pool, it will be able to claim a writing down allowance equal to that unrelieved expenditure. The aim is to enable small businesses to avoid having to make annual claims for writing down allowances where only a relatively small balance remains in the pool.
Energy Efficient Technologies
The range of energy efficient and water saving technologies qualifying for 100% first year allowances is to be enhanced with effect from a date this Summer. A revised list of qualifying technologies will be published.
R&D Tax Relief
The rate of tax relief for small and medium companies increases from 150% of the expenditure to 175% and for large companies from 125% to 130%.
Industrial Buildings Allowances, Enterprise Zone Allowances
The phased withdrawal of these allowances was announced last year. For industrial and agricultural buildings, 75% of the annual writing down allowance can be claimed for 2008/9, 50% for 2009/10 and 25% for 2010/11. No relief will be available from April 2011.
Enterprise zone allowances will continue to be available for expenditure up to March 2011.
Enterprise Management Incentive Scheme
The maximum value of shares in respect of which options can be granted to an individual under an Enterprise Management Incentive scheme is increased from £100,000 to £120,000.
The main advantage of an EMI scheme was that it was favourably treated for taper relief purposes. As taper relief is being abolished the only reason for having an EMI scheme would seem to be the comparatively high value of shares for which options can be granted compared with a conventional company share option scheme.
An additional condition for an EMI scheme is to apply from 6 April 2008. Only companies with fewer than 250 full-time employees will be eligible. Where a company has part-time employees they will be treated as representing a “just and reasonable” number of full-time employees.
Anti-Avoidance: Interest and Lease Rentals
Measures are introduced targeting a number of specific arrangements notified to HMRC under the tax scheme disclosure regime introduced in 2004. Principally, these arrangements give rise to amounts which HMRC contend are in substance “disguised interest”, create artificial losses, or involve the sale of the right to lease rentals for a tax-free sum.
Leased Plant or Machinery
Anti-avoidance measures will be introduced targeted at businesses which lease then on-lease plant and machinery to exploit mismatches in the taxation of lease rentals paid and received. The measures will also target schemes under which leases of plant and machinery are granted in exchange for premiums or other capital payments which currently escape taxation. The measures will apply to transactions entered into on or after 13 December 2007.
Balancing Allowances on Sale of a Trade
If a company sells a trade to a third party and the sale proceeds of the plant and machinery are substantially less than the tax written down value, the company is entitled to a balancing allowance representing the difference. HMRC suggest that this is being exploited. It is proposed that where a trade sale is “part of arrangements the main purpose, or one of the main purposes of which, is to create that balancing allowance”, the plant and machinery will be treated for tax purposes as if it had been transferred at its tax written down value (as would be the case in an intra-group transfer of trade). HMRC maintain that there have been a number of cases where a profit making company has acquired a company with latent balancing charges in order that the acquired company shortly afterwards sells its trade and crystallises the balancing charge, which can then be group relieved against the profit making company’s profits.
It may be remembered that the Chancellor had some proposals which were designed to prevent a tax advantage being gained by one person shifting income to another person who pays a lower rate of tax e.g. his spouse. This was a direct result of the shameful episode culminating in the House of Lords decision in favour of the taxpayer in Arctic Systems.
The proposed new rules for income splitting were extremely wide and went much further than merely reallocating dividends; they extended to partnerships and would have affected many commercial arrangements, the idea being that if income is shifted, the income remains that of the shifter and not of the shiftee. However, we need not worry too much about this for the moment. There have been some fairly robust views expressed on the wisdom of this proposed legislation and the Chancellor has decided it needs further consideration so it has been deferred for 12 months. Let us hope we have heard the end of it.
Sideways Loss Relief for Non-Active Traders
Provisions were introduced in the 2007 Finance Act to block schemes whereby partners involved in a trade to a limited extent only (less than 10 hours a week active involvement) were generating losses to be claimed against their other income and gains. One particular target was Film Partnerships.
HMRC have since discovered that the 2007 provisions are being circumvented by individuals acting as traders on their own account rather than as partners.
With effect from 12 March 2008 the amount of sideways loss relief available to an individual carrying on a trade in a “non-active capacity” will be limited to £25,000 a year – but no relief at all if the loss results from a tax avoidance arrangement.
An individual will be “non-active” if less than 10 hours a week on average in a relevant period is spent personally engaged in activities of a trade carried on commercially and with a view to realisation of profits. Transitional rules apply to losses of an accounting period straddling 12 March 2008. The same restriction previously applied to “non-active” partners, so individuals trading as their own account are merely being brought into line.
The change does not apply to those in the film trade who are involved in sale and leaseback transactions, (the promoters of which successfully lobbied for an exemption from the 2007 restrictions on partnership losses) or to Lloyds Underwriters.
Tax Treaty Abuse: Foreign Partnerships
Legislation will be introduced reaffirming that UK residents who are entitled to benefit from the profits of a foreign partnership cannot obtain exemption from UK tax on those profits by the exploitation of a tax treaty Business Profits Article. The change is intended to block avoidance schemes whereby the UK resident is settlor and beneficiary of an offshore trust, the trustees of which then become partners in a foreign partnership, mandated to remit the partnership income share to the UK beneficiary as it arises. The users of the scheme argue that the trustees share of partnership income is taxable only in the treaty jurisdiction by virtue of the Business Profits Article used in most treaties; since the income mandated to the beneficiary is the same income as receives treaty protection, the scheme promoters argue that it is not taxable in the UK. The proposed clauses will put the matter beyond doubt for income arising after Budget Day.
The Government is keen to continue the success of Gift Aid relief and have announced wide-ranging measures to make it easier for both donors and charities to take advantage of the relief. The measures include the launch of a user-friendly web information service, provision of small charity training programs and the development of a Gift Aid toolkit containing standard forms, guidance and marketing materials.
It was also announced that Gift Aid will be received by charities for the next 3 years at a transitional rate of 22%, made up of the new 20% basic income tax rate and an additional 2% from the Treasury. Currently where a net donation of £100 (gross £128) is made by a higher rate taxpayer, the charity is able to reclaim a £28 tax refund (22%) under Gift Aid. The taxpayer receives higher rate tax relief worth £23. The reduction in the basic rate means that the gross amount of the donation will be only £125 and the charity will be able to recover only £25 (20%). Under the new proposals HMRC will pay to the charity an additional £3 (2%) which they otherwise would have lost. This will mean that charities will continue to receive the same amount of money as before but that charitable donations will be even more attractive to the taxpayer because his higher rate tax relief will be worth £25 (20%) to him.
Employment Related Securities
The treatment of employment related securities in respect of internationally mobile employees is both unsatisfactory and capricious. Amendments are to be made so that employment related securities received by employees who are resident but not ordinarily resident in the UK will be liable to UK tax on the amount attributable to their UK duties, with the foreign element being subject to the remittance basis.
The income tax charges allow the employers a deduction of an amount of the securities concerned which constituted earnings of the employee. The legislation does not elaborate further, and accordingly it has been argued that any such earnings need not necessarily be earnings liable to UK income tax but could be earnings which were exempt from tax. This also applied to corporation tax relief in respect of awards of employment related securities
It was obviously not intended that a deductible amount could be a sum which was exempt from income tax and the legislation is to be amended to put this beyond doubt. Although changes in past years in this area have often had retrospective effect, this will be changed only for relevant events and transactions occurring on or after 12 March 2008. The argument in relation to deductible amounts will still be open in relation to relevant events prior to that date.
Investment Manager Exemption
There are specific provisions to allow investment managers to handle business on behalf of nonresident persons without causing the client to become liable to UK tax. The relevant legislation is of huge antiquity, but it was recast by the Finance Act 1995 to allow UK resident investment managers to conduct transactions on behalf of non-residents who trade in the UK through the manager without giving rise to liability to tax in this country. The legislation is rather cumbersome and HMRC will put together a single list of the transactions which satisfy the rules for exemption. This list will be capable of amendment by HMRC at any time.
The 1995 legislation will also be amended so that where one transaction falls outside the conditions for the exemption, this will not be allowed to taint all other transactions through the investment manager for the same client which do satisfy the conditions.
Taxation of Personal Dividends
UK dividends received by UK resident individuals are free of basic rate tax and are charged at an effective rate of 25% in the hands of the higher rate taxpayer. This arises by reason of the combination of the 10% tax credit and the 32.5% rate on dividends received.
The same rates of tax have applied to foreign dividends, but with credit only for foreign tax deducted at source if any. So the tax liability for UK residents on foreign dividends has been at the rate of either 10% or 32.5 % less the foreign tax.
From 6 April 2008, a UK resident individual having a shareholding in non UK resident company will benefit from a 10% tax credit in respect of foreign dividends from the company, provided that he or she has less than 10% of the share capital in the company. This will mean that they receive the same effective treatment as UK dividends.
From 6 April 2009, there will be a further extension of this treatment to individuals who own more than 10% of the share capital. If the foreign company is liable to tax on its profits of similar nature to UK corporation tax it is proposed that these larger shareholders will also be able to benefit from 10% tax credits on the dividends.
Profits on the disposal of shares or units in certain offshore funds are charged to income tax rather than capital gains tax. At present, the distinction is between funds which do not distribute at least 85% of their income each year (for which the income tax charge applies) and those which do satisfy this test (in which case the shares or units are within the capital gains tax regime). The rules to satisfy the 85% test are notoriously complex and they contain many traps which can easily catch out the fund managers and thus adversely affect the tax position of all UK investors in the fund. The offshore funds regime is to be reformed over the next two years. The old “distributor status” test is to be abolished and instead the fund will be able to “report” its income each year to investors who will then be subject to tax on the reported income, thus opening the way for capital gains tax treatment to apply to the units or shares when they are disposed of by the investor.
Authorised Investment Funds
Authorised unit trusts and OEICs are restricted in the types of investments which they can contain, but there are proposals for specialist funds to be able to invest in alternative investment products, these mainly being non qualifying offshore funds.
Under current tax rules, any gain made by the authorised investment fund on its disposal of an interest in a non qualifying offshore fund is subject to corporation tax, and in addition investors are liable to capital gains tax in the normal way on their disposal of units in the fund.
It is now proposed that an authorised fund may elect for treatment under what is to be known as the “tax FAIFs” regime, whereby the fund itself will be exempt from tax on its offshore income gains. But instead the investor of the fund will be chargeable to income tax on any gain made on disposal of units in the fund.
A rather similar regime is to be introduced for authorised investment funds that invest mainly in UK real estate investment trusts or other similar foreign companies. If the fund makes an appropriate election, rental profits and other property related income will be exempt from tax within the fund. This income will normally be distributable to investors under deduction of basic rate tax which will be allowed for credit to the investors, or repayment in the case of non-tax payers. Any UK dividends received by the fund not be exempt within the fund, and on distribution to investors will obtain a tax credit as at present.
HMRC: Penalties and Powers
A new penalty regime is to be introduced on 1 April 2009 whereby the large number of different penalty provisions specific to each of the relevant taxes will be replaced by a single legislative framework for penalties for incorrect returns and other failures. The amount of the penalty would be based on the amount of tax understated, the nature of the behaviour and the extent of the disclosure by the taxpayer. There will be no penalty where a taxpayer makes a mistake but there will be a penalty of up to:
- 30% for failure to take reasonable care;
- 70% for a deliberate understatement; and
- 100% for a deliberate understatement with concealment.
Each of these penalties can be reduced where the taxpayer makes a disclosure – and they suggest that an unprompted disclosure of a failure to take reasonable care could cause the penalty to be reduced to zero. Where a taxpayer discloses fully when prompted by a challenge from HMRC each of the penalties could be reduced by up to 50%.
HMRC has a combination of information powers some of which need authorisation by the Commissioners and others which can only be used on the basis of an enquiry into a self assessment. For some reason, HMRC would like more and a new package is proposed whereby they have greater powers to inspect records and to require the provision of supplementary information, to visit business premises to inspect records and assets and generally to require third parties to provide information relevant to a taxpayers tax position (presumably without a section 20 notice). It is anticipated that these powers will come into force on 1 April 2009.
Value Added Tax
The taxable turnover threshold is increased from £64,000 to £67,000. The turnover threshold below which a registered person can deregister is increased from £62,000 to £65,000. The registration and deregistration threshold for acquisitions from other EU member states is increased from £64,000 to £67,000.
Time Limit for Claims
The House of Lords has recently ruled that the three year time limit for making claims for input VAT cannot apply to claims which arose before 1 May 1997. Consequently, measures are to be enacted providing for a transitional period during which claims for input tax may be made for accounting periods ending between 1 April 1973 and 1 May 1997. Broadly similar provisions will be made as regards claims for recovery of overpaid output tax.
Option to Tax
The option to tax rules are to be rewritten with a view to simplification. They will include some significant changes. It is proposed that when an option to tax is exercised it may be revoked within a certain “cooling-off” period. In addition, it is proposed that, from 1 August 2009 a taxpayer may be able to revoke an option to tax after 20 years.
Stamp Duty: SDLT
Loan Capital Exemption
Transfers of most forms of loan capital are exempt from stamp duty, but where the right to interest on a loan capital instrument is determined to any extent by the results of a business or the value of any property, the exemption does not apply. Such loan capital instruments will in future also be exempt provided they are party to a capital market arrangement and the right to interest is on limited recourse terms.
Stamp Duty: Abolition of £5 Minimum Duty on Stock Transfers
According to HMRC 68% of all stock transfers executed are liable for only the £5 minimum stamp duty. To reduce the administrative burden on business, instruments executed on or after budget day which would previously have been liable to the £5 duty are exempt from stamp duty and need not be presented to HMRC.
The SDLT notification threshold for non-leasehold transactions is raised from £1,000 to £40,000. Transactions involving leases for a term of seven years or more need only be notified where the chargeable consideration other than rent is more than £40,000 or where the annual rent is more than £1,000.
As from a date to be announced, agents will be able to sign a certificate (Form SDLT60) that no SDLT is due on a transaction. Presently the SDLT 60 can only be signed by the person making the transaction.
Transfers of Property within Investment Partnership
Under current SDLT rules, deemed transfers for tax purposes of property within an investment partnership (e.g. where there is a change in profit shares) can give rise to an SDLT charge. The rules are to be amended to ensure that where there is a transfer of an interest in a property within an investment partnership there will be no charge to SDLT.
Where a property is transferred intra-group, exemption from SDLT normally applies. If the acquiring company leaves the group within three years, the exemption is clawed back. HMRC have become aware of cases where the clawback has been avoided by reason of the vendor company leaving the group first. The rules are to be amended so that where the vendor leaves the group and there is a change in control of the purchaser within a period of three years of the asset having been transferred, the clawback charge will arise.