Today’s Budget contains the following measures which may impact investment managers.
CAPITAL GAINS TAX
- Capital gains tax rate reduction: For higher rate taxpayers, the capital gains tax rate reduces from 28 per cent to 20 per cent for disposals on or after 6 April 2016 (and from 18 per cent to 10 per cent for basic rate taxpayers). Disposal is generally defined as the time of an unconditional contract for sale not the later time of completion. This change may cause individuals to delay signing transactions for a few weeks. The reduction does not apply to gains on residential property or carried interest.
- Employee shareholder shares (ESS): This regime, which provides an uncapped tax exemption for gains on qualifying shares, has been widely used to deliver equity to managers of private equity backed companies. A lifetime cap of £100,000 of gains will be introduced for ESS shares acquired on or after 17 March 2016. This change will not impact ESS shares acquired on or before 16 March 2016 which will continue to benefit from an uncapped exemption. Given the reduction in CGT rates, the maximum benefit from new ESS schemes will be £20,000 per person. This is likely to result in ESS no longer being used for senior managers in private equity backed companies.
- Entrepreneurs’ relief (ER): ER provides for a 10 per cent capital gains tax for up to £10m of qualifying gains per individual.
- ER retained for management teams: Despite fears, there have been no changes to the basic rules for ER with the result that this planning can still be used in relation to equity held by senior managers in a private equity investment. Given the capping of ESS benefits, there will be a renewed focus on ER on new private equity transactions.
- Extension of ER to external investors: ER has been extended to non-employee investors in unlisted trading companies in respect of shares issued on or after 17 March 2016 and then held for three years from 6 April 2016. The £10m exemption for this extended ER will stand separate from the existing £10m ER relief.
- Carried interest: It has been confirmed that the income based carried interest rules will come into effect for carried interest arising on or after 6 April 2016 although we must wait for the publication of the draft Finance Bill on 24 March before we can see what changes there will be from the December draft legislation.
- Rate reduction: The current rate is 20 per cent. This will reduce to 19 per cent from 1 April 2017. It was due to reduce to 18 per cent from 1 April 2020 but will now reduce to 17 per cent at that time.
- Group relief: An issue for private equity backed businesses is stranded losses from excess interest expense in non-operating companies (i.e. Midco and Bidco). This arises from the limitation that only current year losses can be surrendered between group companies by way of group relief. From 1 April 2017, it will be possible to group relieve carried forward losses and use losses generally against all types of income.
- Interest deduction cap: It has been confirmed that a cap on interest deductions at 30 per cent of EBITDA will be introduced from 1 April 2017 with certain limited reliefs. The cap will not reduce net interest deductions below £2m. This change will inevitably reduce the tax deductions available to private equity backed UK businesses, particularly in the early years of an investment. We await further details on the changes (in particular, the flexibility around the carry forward of denied deductions) before the full impact can be assessed.
- Restriction on use of carried forward losses: From 1 April 2017, only 50 per cent of profits over £5m can be sheltered by carried forward losses. This change interacts with the group relief and interest cap changes and will slow down the use of carried forward losses, including those arising from interest deductions, in private equity backed companies.
- SDLT on commercial property: This regime will follow the residential regime and go from a slab to a slice system with a higher 5 per cent rate for consideration over £250,000. There will be a zero rate for consideration up to £150,000 and a 2 per cent rate between £150,000 and £250,000. This will result in a higher SDLT cost for purchases over £1,050,000 and savings below that level. In relation to leases, there will be a higher 2 per cent rate on lease rentals with an NPV over £5m (1 per cent on an NPV between £150,000 and £5m, and zero below £150,000). These changes have effect from 17 March 2016, but with transitional provisions for contracts signed before then.
- Non-UK companies developing UK land: Changes are being made to ensure that non-UK companies pay corporation tax on profits from developing UK land.
- Higher SDLT on purchase of additional residential properties: It was announced in the 2015 Autumn Statement that a 3 per cent SDLT surcharge would be applied to purchases of additional residential properties (including second homes and buy to let properties) with effect from 1 April 2016. It has been confirmed that this surcharge will come into force much as expected, but the expected exemption for significant investors, such as owners of a portfolio of residential properties, will be omitted. The period to claim a refund, where a person buys a new main residence before their old one is sold, has been extended from 18 months to 36 months.