The Chancellor of the Exchequer, George Osborne, yesterday delivered his Autumn Statement to the House of Commons. The Statement came in response to the first growth forecasts for the UK economy to emanate from the Office of Budget Responsibility, the body created by the Government in May 2010 to make an independent assessment of the public finances and the economy.
The Statement was accompanied by the publication of a document entitled 'Corporation Tax Reform: delivering a more competitive system'. This bulletin highlights the key tax measures proposed by the Government in the Statement and the accompanying document.
The measures represent largely welcome developments for the majority of taxpayers. As always, the devil is in the detail and we await draft legislation in order to further ascertain the real impact of the changes.
A link to the Office of Budget Responsibility's Economic and Fiscal Outlook and supplementary documents can be found here
A link to the joint HM Treasury and HMRC document 'Corporate Tax Reform: delivering a more competitive system' can be found here
The Corporate Tax Roadmap
The Government has again reiterated that it supports a 'competitive, simpler and more stable' tax system to promote growth in the UK. Accordingly, the Government has confirmed that it plans to undertake reform of the UK's corporate tax system, using an open and transparent consultation process. The first section of the Government's publication, the 'Corporate Tax Roadmap', sets out the principles which will underpin the reform programme, including:
- a simpler tax system - a phased reduction in the main rate of corporation tax from 28% to 24% over four years from April 2011, with fewer available reliefs and allowances, and the avoidance of complex legislation wherever possible;
- a more stable tax system – the avoidance of unnecessary changes to tax legislation; and
- ensuring the tax system is aligned with modern business practice by keeping pace with developments in business.
In order to increase the competitiveness of the UK corporate tax system, the Government will move towards a more territorial system, increasing the focus on taxing profits from UK activity rather than attributing the worldwide income of a group to the UK to determine the tax base.
Key areas for reform which will implement the above principles and the aim of increased territoriality are the controlled foreign companies regime, the taxation of foreign branches and the taxation of intellectual property (IP).
The Government has also confirmed that it does not intend to pursue significant changes to the existing (and largely favourable) rules allowing a deduction for interest expense as a normal business cost regardless of 'where the proceeds of the loan are put to use'.
Controlled Foreign Companies (CFC)
The UK's CFC regime exists to prevent UK resident companies rolling up income in low-tax territories. It operates to bring such income, in certain circumstances, within the UK tax net. Reform of the UK's CFC rules is identified by Government and businesses as a key priority for improving the UK's tax competitiveness. The current rules have been in place for more than 25 years and the Government admits that they have failed to keep pace with the way that businesses now operate in a globalised economy and go further than what is needed to protect the UK tax base.
Reform of the CFC regime is to take place in two stages. Full reform, incorporating the majority of the changes, will not be implemented until Finance Act 2012, with further details and draft legislation being published during the course of next year. In the shorter-term, smaller scale interim improvements will be introduced in Finance Act 2011.
The full reform programme will make changes to the entire CFC regime. Specific attention is paid in the Government's document to amendments to the rules relating to monetary assets (ie instruments that give rise to interest-like returns including cash, cash equivalents, debt and debt equivalents), aimed at making it easier for groups to manage the finances of their overseas operations. The reform additionally focuses on the taxation of IP assets held overseas.
In summary, the main proposed changes are as follows:
- the introduction of a mainly entity based system that aims to operate in a targeted way by bringing within a CFC charge only the proportion of overseas profits that have been artificially diverted from the UK. A number of exemptions will be designed to minimise compliance burdens and focus attention on 'higher risk entities'. Specific rules will exist for specific sectors, including banking, insurance and property;
- the introduction of a partial finance company exemption. The exemption will work by considering the finance company's debt:equity ratio and applying a CFC charge to the extent that the company has excess equity (a minimum debt:equity ratio of 1:2 is currently proposed). Targeted anti-avoidance rules will also be introduced to prevent groups artificially recycling money back to the UK to gain a tax advantage;
- an extension of the finance company proposal to apply to 'excess cash', arising where trading companies are 'swamped' with finance income. Incidental or ancillary interest income arising in such trading entities will be exempted; and
- the introduction of a new approach to manage the risks arising from CFCs with IP related profits. It is proposed that this will operate by identifying those CFCs which present the highest potential risk (including, for example, where IP that has been developed in the UK is transferred to a low tax jurisdiction) and then determining whether 'excessive profits' have arisen in those entities and, if so, what proportion represents artificially diverted UK profits.
The Government requests comments on the proposed changes by 22 February 2011.
The main change to be introduced ahead of the full reform programme is the exemption of a CFC which carries on a range of 'foreign to foreign' activities involving transactions wholly or partly with other group companies, provided there is little or no risk of erosion of the UK tax base. In summary, the specific amendments involved in this change are as follows:
- an exemption for a CFC carrying on intra-group trading activities where there is minimal connection with the UK and little risk that UK profits have been artificially diverted;
- an exemption for a CFC with a main business of IP exploitation where the IP and the CFC have minimal connection with the UK;
- a three year exemption for foreign subsidiaries that, as a consequence of a reorganisation or change to UK ownership, come within the scope of the CFC regime for the first time; and
- improvement of the de minimis exemption and deferral of the withdrawal of the exemption for certain holding companies.
Draft legislation setting out the interim changes will be published on 9 December 2010. Comments may be made on the draft legislation up to 9 February 2011, ahead of its inclusion in Finance Bill 2011.
Foreign Branch Taxation
Broadly, a foreign branch is established by a UK company if it carries on part of its trade in another jurisdiction without establishing a separate trading subsidiary company there. The current rules on the taxation of foreign branches of UK companies are viewed as uncompetitive when compared to other jurisdictions and have been particularly controversial since 1 July 2009 when UK companies have generally not been subject to UK corporation tax on the receipt of a dividend from a foreign subsidiary but have still been taxed (subject to double tax relief) on the profits of foreign branches.
In Finance Bill 2011 the Government will provide for an exemption from UK corporation tax on the profits earned and gains incurred by foreign branches of UK companies. The key aspects of the new regime are:
- it will be available to large and medium companies only;
- it will be effective for accounting periods beginning on or after a specified date in 2011;
- it will be an 'opt in' system. Companies within the exemption will not receive relief for foreign branch losses arising after the election has been made;
- the election into the regime will be irrevocable. Any company choosing to opt in to the regime will in effect be opting for all its current and future branches to be permanently exempt from UK corporation tax. It will only apply to the company that made the election;
- the regime will apply to foreign branch trading profits and to investment income that is 'effectively connected' to the branch (ie genuinely connected to the business of the branch). Profits within the exemption will be calculated by reference to the terms of individual double tax treaties. For branches in territories where there is no treaty, the measure of exempt profits will be determined by the OECD model treaty;
- the exemption will be extended to chargeable gains. Broadly, any part of the gain which is (or was) taxable in accordance with the treaty will be exempt from UK corporation tax. For example, if the host state taxes a gain arising on immovable property in the branch territory, that gain would be fully exempt from UK corporation tax. A company within the branch exemption should prepare a computation of all its chargeable gains and losses in the same way as it currently does. It will then deduct from the total any gain, or part of a gain, attributable to an exempt branch and add back any loss, or part of a loss, so attributable;
- the regime will apply to all countries and territories – even those that do not have a double tax treaty with the UK except in the case of foreign branches of small companies where the exemption is not available for non-treaty countries;
- the regime will include rules against the artificial diversion of profits. If a branch does not comply with the anti-diversion rule in any year, the profits arising from that branch in the year will be subject to corporation tax, with credit for foreign tax given in the usual way; and
- companies will be expected to minimise the profits that are subject to tax in the branch jurisdiction, for example by taking full advantage of tax reliefs and allowances available in the jurisdiction in which the branch is located.
The legislation will feature transitional rules to address the situation where a company opts in to foreign branch exemption but which has branch losses. Here, the company's branch profits will become exempt as soon as the tax losses of those branches in the six years immediately preceding the making of the election have been matched by profits (subject to certain modifications in the case of 'very large' losses (yet to be defined)).
The foreign branch exemption will not be available to a company whose business is wholly or mainly investment business, as defined in section 1218 Corporation Tax Act 2009. Similarly, the exemption will not extend to international air transport and shipping as these activities are generally not taxed by the foreign jurisdiction.
The Taxation of Innovation and Intellectual Property (IP)
The UK will introduce a 'preferential regime' for the taxation of profits arising from patents (and not at this stage any other IP rights or assets such as copyright) – a so called Patent Box tax. The key features of the Patent Box tax are as follows:
- it will be optional;
- it will apply to all patents first commercialised on or after 29 November 2010;
- it will apply to 'relevant profits' arising from 1 April 2013;
- it will apply at a rate of 10% to net profits (after associated expenses) arising from patents. This is materially higher than regimes offered by other jurisdictions but the UK Government considers that it does not need to match those rates as the UK has other advantages;
- it will apply to royalty income and 'embedded' income included in the price of patented products. 'Embedded' income will be determined using a formula;
- there will be detailed transitional rules; and
- it appears that the regime will apply to UK and EU registered patents only.
The existing research and development (R&D) tax rules (which provide enhanced tax relief for certain expenditure) are aimed at the creation and the development of IP. Full R&D tax relief will be retained. Specifically, the Government has sought views on the effectiveness, breadth and depth of the existing R&D regime.
The Patent Box changes take effect from yesterday so careful record keeping is needed to ensure that you are in the best position to benefit from the preferential regime. Notably, the Patent Box only applies to patent income – it may be worth considering whether certain IP rights you have should be patented.
Comments on the proposed changes are due by 22 February 2011.