Mr Darling’s first Pre-Budget Report was rather limited as far as tax changes are concerned – probably because it was conceived as a pre-election announcement. The principal changes relate to reformof the capital gains tax regime and changes to inheritance tax which obviously affect individuals (would-be voters) rather than companies.
More detailed briefings in relation to some of the PBR announcements will follow. PBR press releases and supportingmaterial can be accessed at www.hm-treasury.gov.uk and http://www.hmrc.gov.uk/pbr2007
Capital gains tax reform
The headline news fromthe Pre Budget Report in relation to CGT for individuals, trustees and personal representatives is the abolition of taper relief and the imposition of a single rate of CGT at 18%.
Under current law, the availability of taper relief reduces the amount of the gain chargeable to CGT. The amount of relief is dependent upon the length of time an asset has been held and whether it is classified as a business asset or a non-business asset. Capital gains on the disposal of business assets held for two years, such as shares in unlisted trading companies, are subject to the low effective tax rate of 10%.
The abolition of taper relief applies to disposals from 6 April 2008 (and held over gains coming into charge after this date) even where assets were held prior to this date; accordingly, individual owners of private companies, who are currently considering disposing of their shares,may wish to think about bringing forward the disposal to before this date, if they have accumulated enough business asset taper relief to benefit fromthe effective 10%tax rate.
In a private equity context, the current uncertainty surrounding when the “clock” for taper relief starts in relation to a carried interest will need to be taken into account. It is understood that HMRCmay argue that the “clock” only starts when the carried interest hurdle is reached and not when the carried interest is granted. The alternative view is that due to the nature of partnership law, partners hold the interest fromday one, although theymay not be entitled to share in the disposal proceeds until the carried interest hurdle is met. If HMRC’s argument were to prevail, in practice this couldmean that the two year requisite holding period for the 10%effective tax rate is not met on certain disposals.
The Pre Budget Report announced additionalmeasures in relation toCGTwith effect for disposals on or after 6 April 2008:
- withdrawal of indexation allowance: this was frozen for individuals, trustees and personal representatives at 6 April 1998 for assets held at that time and provided relief fromtax on gains due to the effect of inflation prior to the date;
- abolition of the “kink” test: this only affects assets that were held on 31March 1982 and provides that the disposal of an asset held at this date is the lower of two amounts: the gain (or loss) calculated by reference to the original acquisition cost of the asset and the gain (or loss) based on treating the value of the asset on 31 March 1982 as the total allowable expenditure up to that date. The abolition of the kink test willmean that all assets held on 31March 1982 will be deemed to have a cost equivalent to theirmarket value on that date;
- abolition of “halving” relief: these rules currently reduce the amount of a chargeable gain which, because of the previous operation of certain reliefs, effectively includes a deferred gain that relates to a period prior to 31March 1982;
- share identification rules: these rules, which currently provide a complex order of identification dependent upon the dates when the assets were acquired, will be simplified.
The annual exemption for individuals and trustees will remain – the current level for 2007/8 is £9,200 for individuals and £4,600 for some trustees. In addition, principal private residence relief, business assets roll-over relief and business asset gift hold-over relief will continue to apply, as will CGT reliefs aimed at Enterprise Investment Schemes and Venture Capital Trusts.
Residence and domicile
Currently UK residents who are not domiciled or not ordinarily resident in the UK can use the remittance basis of taxation. This means that any income and capital gains arising overseas are only taxed in the UK when that income or gain is remitted to the UK. The remittance basis of taxation (and reformof such basis) has always been politically controversial; the Government has longmooted reformin this area without putting forward concrete proposals. With effect from6 April 2008, non-domiciled individuals who have been resident in the UK for seven years will only be able to use the remittance basis of taxation if they pay an additional annual charge of £30,000 – the seven year period starts fromthe commencement of their period of residence and not fromwhen the new rules come into effect. If the individual decides not to pay the additional tax charge they will be taxed on all their worldwide income and gains.
Provisions will also be included in Finance Bill 2008 with effect from6 April 2008 in order that:
- days of arrival and departure will be counted as days of presence in the UK for residence test purposes;
- subject to a deminimis of £1,000 per annumof unremitted overseas income, individuals taxed on a remittance basis will not be entitled to personal allowances;
- certain anomalies in the remittance basis, whichmean that individuals can arrange their tax affairs to avoid paying UK tax on foreign income and gains effectively brought into the UK, will be removed;
- the restrictions on the availability of the remittance basis to investment income arising in the Republic of Ireland or to earnings fromemployment with an employer resident in the Republic of Ireland will cease.
Finance Bill 2008 will introduce legislation to enable a claimto bemade to transfer any unused IHT nil-rate band on a person’s death to the estate of their surviving spouse or civil partner who dies on or after 9 October 2007, regardless of the date on which the first spouse or civil partner died. Currently, the estate bequeathed by someone who dies is entitled to a nil-rate of IHT up to an amount of £300,000 for 2007/8. As transfers of property between spouses or civil partners are exempt fromIHT, if a person who dies leaves some or all of their property to their spouse or civil partner, theymay not utilise fully their entitlement to the nil-rate band. The new rules will enable any unused nil-rate band on the first death to be used when the surviving spouse or civil partner dies. It should be noted that this only achieves what can currently be achieved before with careful tax planning, for example, by ensuring that on the death of the first spouse part of the estate up to the value of the nil-rate band is bequeathed to children or grandchildren.
In addition, corresponding amendments will bemade for alternatively secured pensions (ASP). Under current law, a charge arises on residual ASP funds once a relevant dependent’s pensions benefits cease and the rates of tax are those applying at the date of that event rather than as at the date of death of the schememember. In future, any unused IHT nil-rate band when the original owner of the ASP died can be applied at the date of the later event and can be available against the ASP.
Loss relief: anti-avoidance
With effect from9 October 2007, an avoidance scheme designed to accelerate tax relief for interest payments made by individuals on certain qualifying loans, such as loans to invest in partnerships, will be blocked. The measure denies tax relief for interest that relates to a later tax year than the year in which the interest is paid. Income shifting
The Government will be consulting on draft legislation to take effect from2008-09 to address “income shifting”. This follows the House of Lords’ decision in the Arctic Systems case in which the Lords held that dividends froma family company received by one spouse could not be taxed under the settlement provisions as income of the other spouse who paid tax at a higher rate.
Holiday pay anti-avoidance
The longstanding NICs exemption which allows employers to provide holiday pay to employees without paying NICs is to be removed with effect from30 October 2007. The construction industry, however, will still be able to benefit fromthe exemption before the exemption is withdrawn completely for that sector by 30 October 2012.
Avoidance of Corporation Tax – disguised interest
Legislation will be introduced in the Finance Bill 2008 to have effect in relation to distributions paid on or after 9 October 2007 to counteract a scheme which has been notified to HMRC which aims to circumvent the “share as debt” anti-avoidance rules introduced by the Finance (No. 2) Act 2005. The “share as debt” rules provide that certain shares thatmimic debt should be treated as loans so that distributions paid in respect of such shares are charged to corporation tax as income, rather than being exempt in the way that distributions of profits paid by UK companies to other UK companies are generally exempt fromcorporation tax.
The scheme attempts to avoid the corporation tax charge which is charged under the existing “share as debt” rules only on straightforward distributions, such as dividends, by structuring shares so that they pay other types of distribution that are not charged to corporation tax under the current rules. Pursuant to the new proposed legislation, all distributions paid in respect of the shares will fall within the rules provided relevant conditions aremet, regardless of the type of distribution.
Leased plant andmachinery – antiavoidance
Legislation will be introduced by the Finance Bill 2008 in relation to transactions involving leasing of plant ormachinery entered into on or after 9 October 2007 which aims to:
- Counter avoidance involving the sale and finance leaseback of existing plant ormachinery by removing the rules which were introduced in 1997 to counter tax avoidance involving the sale and finance leaseback of plant or machinery by entities not liable to tax which involved the purchaser being able to claimcapital allowances on the plant ormachinery it leased back to the original owner. The 1997 rules, which allow most of the sale proceeds to be received free of tax but enable the purchaser to claimonly restricted capital allowances, have been exploited. Abuse of the 1997 rules was partially countered in 2004 but new arrangements continue to exploit the 1997 rules. The proposed legislationwill remove both the 1997 rules andmost of the 2004 rules and bring leases in sale and finance leaseback arrangementswithin the scope of the long funding lease rules. This measure will not have effect if plant or machinery is less than fourmonths old when sold.
- Counter attempts to exploit the rules for taxing long funding leases to create a tax loss where there is little or no commercial loss. A lessor under a long funding lease is not entitled to claimcapital allowances on the cost of the leased asset, but is instead only taxed on a small proportion of the lease rental income. Avoidance schemes have been developed which purport to establish an alternative deduction for the cost of the leased asset with the aimof generating a tax loss approximately equivalent to the cost of the leased asset even though there is no commercial loss. The proposed legislation aims to put beyond doubt that where a deduction is available for the cost of the leased asset the rules restricting the amount of taxable income do not apply, thereby preventing the generation of artificial losses by the lessor.
Sale of lessors – companies in partnership
Legislation will be introduced in the Finance Bill 2008 to amend Schedule 10 to Finance Act 2006 to avoid an unintended and unfair tax liability where a single company acquires all of the business of leasing plant andmachinery carried out by a partnership. The effect of themeasurewill be backdated so that it has effect on and after 5December 2005, the date fromwhich Schedule 10 had effect.
Schedule 10 counters avoidance involving the sale of companies leasing plant ormachinery by bringing into charge an amount of income that is taxed on the seller’s group and giving an equal amount of relief to the purchaser’s group.Where the business is carried on by companies in partnership and there is a change in a partner’s interest in the business the legislation brings into charge an amount of income for the selling partner and a relief for the acquiring partner. The current legislation similarly brings an amount of income into charge for the corporate partners when a leasing business carried on by companies in partnership is sold to a single company, but does not however currently givematching relief to the purchaser. The amendments to the legislation aim to ensure relief is available to the purchasing company in this case.
The investmentmanager exemption (IME) enables non-resident funds and individuals to appoint UK-based investmentmanagerswithout the risk of exposing themselves to UK taxation provided certain conditions aremet.
Following a period of public consultation, in July 2007 HMRC revised its guidance on the IME in an updated version of Statement of Practice 1/01. The Government has announced that legislation will be introduced, with effect fromthe date that the Finance Bill 2008 receives Royal Assent, to effect certain changes that could not be introduced through guidance.
The legislation will amend the IME legislation to
(1) clarify and simplify the scope of transactions to which the IME applies, by aligningmore closely the list of transactions to which the IME applies to activities regulated by the Financial Services Authority with certain exceptions;
(2) provide amore proportionate tax effect for arrangements or transactionswhere one of the IME conditions is not met, by removing the rule that causes the whole of a non-resident’s UK profits to be brought into UK tax if the investmentmanager carries out any transactions in the capacity of a permanent establishment.We welcome this as a positive change if it will provide, as is suggested, that the failure to satisfy one of the conditions will not result in the whole of the exemption being unavailable.
These changes arise fromongoing consultation with representative bodies fromthe assetmanagement sector.
The Treasury has published a discussion paper setting out how the government intends tomodernise the off-shore funds rules and invites comments by 9 January 2008. The paper proposes a new definition of off-shore fund which we consider will require considerable help fromindustry to be workable.
The current definition of off-shore fund is based on the FSMA definition of “collective investment scheme” (with somemodifications introduced by the Finance Act 2007). The Government believes that any new off-shore fund definition should be based on characteristics which should be applied to a company, trust or any other vehicle including the entitlement of an investor to realise substantially the net asset value of his interest on a realisation. The stated aimis to counter unintended tax advantages being obtained where an off-shore arrangement is technically outside the current definition of off-shore fund but the arrangements are economically the same.
The current off-shore funds regime only applieswhere an investor holds a “material interest” in an off-shore fund, that is where the investor reasonably expects to be able to realise their investment within seven years at a value reasonably approximate tomarket value. The Government are proposing to abolish the “material interest” requirement. If enacted, this appears tomean that any limited life off-shore companies (regardless of the length of the life of the company) will be within the off-shore funds regime and close considerationwill have to be given to any intention by the company to redeemshares to assesswhether this amounts to an entitlement of an investor to realise his investment at substantially net asset value. The Government has indicated that it recognises that the reference to entitlement to “realise substantially the net asset value”may raise questions for certain stakeholders and welcomes comments in this regard.
Other changes such as the proposed election for “Reporting Fund” status (essentially replacing “distributing fund” status) appear to bemore bureaucratic. Othermore significant proposals are that;
- a Reporting Fund will “report” income (determined by a new calculation of “reportable income”) to the UK investor (rather than having to distribute 85%of income under the current rules) ie, UK investors will pay tax on reported income regardless of howmuch is physically distributed and
- a Reporting Fund will not be subject to the current investment restrictions which limit the permitted investment by a distributing fund in non-distributing funds (the 5%rule).
A specific briefing will follow on this subject.
Hedging foreign exchange risks
Two measures were announced tomake changes to the tax treatment of exchange gains and losses on loans and derivatives that are used to hedge foreign exchange risk arising froma company’s investment in non-sterling trading or business operations.
The first will allow companies to elect to value “matched” shares at the value of the net foreign currency assets underlying the shareholding, rather than at book value as at present. Amendments to the Disregard Regulations (in Statutory Instrument 2004/3256) to allow such net asset valuematching will bemade later this year, and are expected to have effect for company accounting periods beginning on or after 1 January 2008.
The secondmeasure will replace the present rules for identifying which loans and derivatives arematched with shares, which rely on the company’s intentions, with amore straightforward and objective approach. Draft regulations will be published for consultation early in 2008, and it is intended that the changes will apply to periods beginning on or after 1 January 2009.
The changes are likely to affect large andmedium-sized companies who are exposed to foreign exchange risk because they have investments in overseas subsidiaries. The relevant rules are currently split across primary and secondary legislation. The Government has also announced its intention for the appointed day for the repeal of the primary legislation to be 1 January 2009, and to introduce fromthat date regulations which provide a comprehensive code for all foreign exchangematching.
Tax appeals against decisionsmade by HMRC
HMRC has published a consultation document relating to tax appeals with responses requested by 31 December 2007. The consultation document relates to (i) the proposal for the introduction of impartial internal reviews by HMRC of its decisions to reduce the number of disputes going to a tribunal hearing; (ii) administrativematters relating to appeals such as the alignment of time limits and (iii) transitionalmatters relating to the transfer (intended in April 2009) of the functions of the current tax tribunals to the new First-tier Tribunal and Upper Tribunal under the Tribunals, Courts and Enforcement Act 2007.
FromBudget Day 2008, transfers that currently attract stamp duty of notmore than £5 (whether fixed or ad valorem) will be exempt and will not need to be presented for stamping.
Stamp duty land tax
FromBudget Day 2008, where the chargeable consideration for a land transaction is less than £40,000 there will no longer be any need to notify HMRC. Leases will only need to be notified where the termis seven years or more and where any chargeable consideration ismore than £40,000 and the annual rent ismore than £1,000.
This change will reduce the number of transactions which fall beneath the SDLT thresholds (£125,000 for residential property, £150,000 for non-residential property) but which nevertheless require notification. At present, notification is required formost transactions involving the acquisition of amajor interest in land for consideration unless specifically exempted. Broadly speaking, leasesmust currently be notified if they are for at least seven years and are granted for chargeable consideration, or if they are for less than seven years and are chargeable to SDLT at a rate of at least 1%.
Anti-avoidance legislation affecting partnerships
It is intended that the changesmade by Finance Act 2007 will 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.
Anti-avoidancemeasures were introduced by Finance Act 2007 which amended the definitions of chargeable consideration for the purposes of transfers into and out of partnerships and transfers of interests in property investment partnerships. Some property investment partnerships raised concerns that an effect of these changes was that SDLT could be payable on every change in size of a share held within such a partnership, regardless of whether any consideration is given for the change.
This amendment will have effect on and after Budget Day 2008 though will apply to transactions that occurred on or after 19 July 2007.
Planning gain supplement
The Government has announced that PGS will not be introduced in the next Parliamentary session but legislation will be introduced in the Planning ReformBill to empower local planning authorities to apply new planning charges to new developments.
Air passenger duty
Business class only flights
With respect to any carriage of a passenger beginning on or after 1 November 2008, the current definitions of classes will be amended so that business class only services will attract the standard rate of air passenger duty (APD).
At present, where flights havemultiple classes, the lowest class will attract the “reduced” rate, while all other classes will attract the “standard” rate. Carriers offering business class only flights currently account for APD at the reduced rate. It is proposed that seat pitch (leg room) will be introduced as one of the criteria for class definition, and where on single class flights the seat pitch exceeds 40”, the standard rate of APD will apply.
It is also proposed that, from1 November 2009, APD will be replaced by a tax payable per plane rather than per passenger.
Companies owning investment life insurance policies
Legislation is to be introduced in FB 2008 which will add life policies which are capable of having a surrender value, and contracts for a purchased life annuity in the categories of contracts to be governed by the loan relationships legislation. Termassurance, including group life policies, will not be affected nor will policies or contracts held for the purposes of a registered pension scheme.
A credit will be given (in computing a non-trading loan relationship credit) where the policy has been subject to an I minus E charge.
Gains on life insurance policies and life annuity contracts held by companies are currently taxed under the chargeable event rules in Chapter 2, Part 13 ICTA.Most of this will be repealed
This will apply for accounting periods beginning on or after 1 April 2008. There will be a transitional provision for existing policies.
BLAGAB expenses and reinsurance arrangements
A measure has been proposed that will affect life insurance companies that reinsure some or all of their life insurance business. Often, such companies will receive a payment fromthe reinsurer (a “ceding” or “reinsurance” commission) – designed to cover the life company’s costs incurred in selling the reinsured business (“sale expenses”). Under current law, this commission is offset against the sale expenses incurred by the life company so that the life company only obtains a deduction for its net expenses.
HMRC are concerned however with instances of life companies seeking to claimrelief for the full amount of sale expenses, without recognising the effective reimbursement of those costs by the reinsurer. Accordingly, it is proposed to introduce legislation in FB 2008 which will amend section 76 of ICTA.
So as to make it clear that a deduction for sale expenses is restricted to those expenses relating to the reinsured business of which the life company has borne the economic cost.
This will apply in respect of policies or contracts entered into by the cedant for periods ending on or after 9 October 2007. It will also apply to adjust the amount of deductible acquisition expenses carried forward fromearlier periods which can be deducted in accounting periods beginning on or after 9 October (1 January 2008 inmost cases).
Life insurance company taxation: consultation
The consultation process to simplify certain aspects of tax law relating to life insurance companies commenced in May 2006. Divided into five strands, this process has already led tomeasures which have been enacted in FB 2007. Two changes announced yesterday in PBR 2007 are further products of this process. The first change repeals the rules which apply to apportioning the investment return where a life insurance company has reattributed its inherited estate.
Repeal of inherited estates apportionment estates rules
Where a life insurance company has reattributed its inherited estate to shareholders, complex rules provide for the apportionment of the entire investment return arising fromthe inherited estate to BLAGAB. The aimis to ensure that the benefit of exemptions available for the investment return on pension business are not granted to the return on inherited estates assets which are not backing pension business liabilities.
The government has concluded that these complex rules have not provided sufficient revenue since their introduction to justify their complexity.
Draft legislation was published by HMRC yesterday repealing these rules, although the issue of the taxation of inherited estates following reattributionwill remain under consideration.
This amendment will have effect on and after Budget Day 2008.
Transfers of long-termbusiness
The focus of work relating to the legislation governing transfers of insurance business schemes has been on simplification of the law and the development of a targeted anti-avoidance rule (the “TAAR”).Measures were partially enacted in Finance Act 2007, but the Act also contained a time-limited power tomake secondary legislation. Draft regulations were published with the PBR.
Themain developments to note are:
- Simplification of the rules relating to accounting periods and periods of account where there is a transfer.
- Simplification of the “transferor” Case I rules in sections 444AB to 444ABC ICTA so that the same rule will apply for both whole and part transfers. The “transferee” rules in sections 444AC and 444ACZA ICTA will also be simplified.
- The TAAR will be divided into two, with one part dealing with the case where an advantage arises fromthe whole of transfer scheme arrangements and one part dealing with the case where an advantage is only obtained frompart of the arrangements.
- Section 444ABD ICTA,which dealswith profit on transfer where liabilities exceed assets, has been amended so that it works effectively in relation to part transfers.
- Section 213 TCGA, which deals with spreading of gains and losses, is amended to allow a carry back of a loss on transferred assets where the transferee is an existing company.
The work groups created in the consultation process are expecting to produce further provisions for inclusion in Budget 2008. These are expected to include provisions to deal with the simplification of the policyholder tax legislation as it applies to friendly societies, and the tax principles to be applied to allmethods of providing finance to the long-termfund including contingent loans, financial reinsurance and other contributions. Discussions on issues surrounding apportionment are now to restart after being put on hold since last autumn. It is expected that some legislation on this area will be included in Finance Bill 2008, however discussions on themain apportionment issues are expected to continue into 2008 and 2009.
Employers contributions – spreading of tax relief
The Government will introduce legislation in Finance Bill 2008 to ensure that rules that spread tax relief for large employer pension contributions cannot be circumvented. Currently employers are allowed deductions against their taxable profits in respect of contributions paid to a registered pension scheme.When a contribution ismore than 210%of the contribution paid in the previous chargeable period and exceeds 110%of the contribution paid in that previous period by at least £500,000, the contribution is spread over a period of up to four years for tax relief purposes. The newmeasures, which will take effect for paymentsmade on or after 10 October 2007 under binding obligations entered into on or after 9 October 2007, will ensure that the spreading of contributions cannot be avoided by routing them through a new company
Pensions: tax simplification
The Pre Budget Report has heralded a number of technical improvements to the pensions tax regime. Themeasures announced include:
- changes to the rules relating to how the lifetime allowance operates for pension increases: (1) the exemptions fromthe benefit crystallisation event test three will be widened, (2) increases in pensions will be exempt provided that they do not exceed a normal rate of increase in a one year period, (3) schemes will be obliged to use the Retail Price Index figures published two months before the pension increase occurs. These changes will be backdated to 6 April 2006 (A Day), except the RPI calculation which will be effective from 10 October 2007;
- protection of lump sums: the rules relating to the calculation of protected lump sums (that is, existing rights on 5 April 2006 to lump sums exceeding 25%of pension rights) will bemade administratively simpler with effect fromA Day as schemes will no longer have to calculate whether the relevant benefit accrual has taken place;
- taxable property provisions: with effect fromA Day, the definition of investment regulated pensions schemes is to be amended so that it does not include schemes (such as large occupational schemes) where individual members could not in reality be expected to influence scheme decisions to invest in taxable property;
- IHT on overseas pensions schemes: with effect from A Day, the Finance Bill 2008 will include legislation to restore IHT protection to UK tax-relieved pension savings held in overseas pension schemes.
Pensions tax: anti-avoidance
Anti-avoidance legislation will be included in Finance Bill 2008 to ensure that tax-relieved pensions savings diverted into inheritance using scheme pensions and lifetime annuities are subject to unauthorised payment tax charges (which are subject to income tax charges of up to 70%), and possibly, IHT. This will be an extension of existing anti-avoidance rules to prevent the use of pension tax reliefs throughmembers surrendering rights under registered pension schemes during their lifetime or through the reallocation of assets after amember’s death. The amendments will only apply to pension schemes with 20 or fewermembers.