Draft clauses of the UK Finance Bill 2015 were published on 10 December 2014. They will now be the subject of consultation until 4 February 2015. This Alert provides more details on the most significant measures contained in the draft Finance Bill. It is not intended to be exhaustive but to provide a summary of the key areas and the issues surrounding them.
Diverted profits tax
A new "diverted profits tax" has been introduced in response to the publicity surrounding multinationals conducting extensive business within the UK but falling outside the charge to UK corporation tax. This would generally arise either by an overseas entity structuring itself so that its business activities in the UK did not amount to a permanent establishment or by an entity being party to arrangements in which fees are payable to a parent in a low tax jurisdiction, thus reducing UK profits. The government has introduced a 25-percent tax payable on amounts deemed to be diverted profits. The rate of tax is apparently designed to alter corporate behaviour since it is higher than the 21-percent corporation tax payable in the UK.
The diverted profits tax can apply in two sets of circumstances. The first test is when an overseas entity with substantial UK activities deliberately avoids establishing a UK taxable presence. The avoidance of UK corporation tax has to be the "main purpose or one of the main purposes" of the structure.
The second test applies to UK companies or UK permanent establishments that reduce their corporation tax by making payments to related parties with an effective lower tax rate—for example, by paying royalties. This applies only if the payment would not have been made at all were it not for the tax benefit of doing so.
In terms of administration, companies are obliged to inform HM Revenue & Customs (HMRC) if they might be within the regime. Beyond that, HMRC is generally able to make an estimated assessment and serve a "charging notice" upon the company, which must then pay the tax within 30 days. Following this, there is a one-year review period to determine if the assessment was correct. The company can then appeal to the courts under normal procedures.
Certain exemptions apply, such as an exemption for small and medium-sized enterprises and an exemption for entities with limited UK sales.
Duane Morris comment
Although the principle behind this legislation is understood, it appears to contain some controversial elements. First, some parts of the tests are very subjective. This, combined with the process of payment on demand from HMRC with the opportunity to appeal only arising later, places considerable power in the hands of HMRC. Finally, the issue of diversion of profits is part of the Organisation for Economic Co-operation and Development's (OECD) ongoing Base Erosion and Profit Shifting (BEPS) initiative, and thus, the measure seems premature.
Disguised investment management fees
Draft clauses in the Finance Bill provide for the income taxation of "disguised fee income"—sums that investment managers receive for their investment management services via partnerships or other transparent vehicles. The measure is intended to stop investment managers' converting into capital receipts what the government considers to be trading income.
A new chapter of the Income Tax Act 2007 provides that if an individual provides investment management services for a collective investment scheme through an arrangement involving any number of partnerships, any sums received for those services will be treated as profits of a trade, unless already charged to income tax as employment or trading income. Sums will not be caught if they represent carried interest or constitute a return of capital that the individual invested or a commercial return on that capital.
The measure contains an anti-avoidance rule providing that no regard is to be had for any arrangements intended to circumvent the rules. It also contains rules preventing double taxation. The measure is to have effect for sums arising on or after 6 April 2015, regardless of when the arrangements giving rise to the sums were made.
Duane Morris comment
These draft clauses appear to be insufficient in a number of areas.
First, the definition of "carried interest" in the clause is not in line with the commercial reality since it requires a preferred return of 6 percent. This is not necessarily the case with many funds, notably venture capital funds and those investing in certain industries or jurisdictions. There is thus a risk that what is genuinely carried interest will not fit within the definition provided.
Second, sums representing a commercial return on capital invested are not subject to income tax, but "commercial" is defined by reference to a commercial rate of interest. This may be appropriate for income generating funds but not for those designed to produce primarily capital returns for their investors.
Third, it is not apparent how certain leveraged co-investment might be impacted by the new rules, especially in the case of prior arrangements.
Fourth, the legislation has a very broad remit in that if the investment management activity is carried on even partly in the UK, it is deemed to be carried on entirely in the UK. This appears somewhat wide, especially in these days of electronic communications.
This is an area in which representations will be made, and it should be monitored closely.
Overseas owners of UK residential property – capital gains tax
Draft legislation to extend capital gains tax to disposals of UK residential property by non-UK resident persons has been published. Companies that are widely held will be exempt from the charge, as will unit trust schemes and open-ended investment companies that meet a widely marketed fund condition.
The legislation will have effect for disposals on or after 6 April 2015, subject to transitional provisions.
Duane Morris comment
This measure was announced in the 2013 Autumn Statement and was the subject of a consultation that closed on 20 June 2014. The government published a response to the consultation outlining the main features of the extended charge on 27 November 2014. Accordingly, this development is not unexpected.
Stamp Duty Land Tax (SDLT) reform
The UK's system of SDLT on residential property has been reformed with immediate effect. SDLT for residential property will now be charged at different rates depending upon the portion of the purchase price that falls within each rate band. The new rates are set out below.
Click here to view the table.
There are no changes to certain other SDLT rules. For example, the changes do not apply to SDLT on purchases of non-residential property or on the rent payable when a new lease is granted. Certain anti-avoidance provisions will also continue to apply, such as the rates for commercial property being used where six or more residential properties are acquired as part of a single transaction. Furthermore, the 15-percent SDLT rate payable by certain non-natural persons that purchase residential property for more than ?500,000 will also remain in force.
Duane Morris comment
The application of SDLT rates to the amount of the purchase price within each band is likely to be a welcome reform. The government has been keen to emphasise that 98 percent of purchases will be subject to a reduced rate of SDLT. However, for purchases where the consideration is more than £937,000 (not uncommon in London), the rate will be higher and the rises quickly become steep. For example, a property costing £2.5 million would attract £175,000 in SDLT under the old regime. Under the new regime, £213,750 is due, a difference of nearly £50,000. Hence, those who pay more under the new regime pay significantly more.
Those individuals who are resident but not domiciled in the UK are entitled to use the "remittance basis" of taxation, which means they are taxed on overseas source income and gains only to the extent the same are "remitted" to the UK. After a certain number of years, an annual charge applies for the use of this basis of tax. Changes have been made in this area.
The charge for those resident for seven of the past nine years, but fewer than 12 of the past 14 years, will remain at £30,000. The charge for those who have been resident for 12 of the past 14 years will increase from £50,000 to £60,000 from April 2015. Finally, also from April 2015, a new charge of £90,000 will be introduced for those who have been resident for 17 of the past 20 years.
Currently, individuals may make an annual choice as to whether they use the remittance basis and pay the charge or whether they are taxed on an arising basis in the same manner as those domiciled in the UK. Consultation is being introduced to consider whether an election should apply for three years.
Duane Morris comment
The "17 of the past 20 years" test for the application of the new £90,000 charge matches the residence test used for the purposes of the deemed domicile rules for inheritance tax. However, it is slightly incongruous in the light of the residence tests for the £30,000 and £60,000. A remittance basis user who has been resident for only six of the past nine years, or 11 of the past 14 years, may have been resident for 17 of the past 20 years. This means that potentially an individual who is not subject to either the £30,000 or £50,000 charges under the current rules could still be subject to the new £90,000 charge from April 2015.
The consultation on the application of the election for three years appears aimed at those who elect to use the remittance basis on a "one off" occasion in a year in which they anticipate substantial offshore gains or income. However, it seems that many will oppose the inflexibility that will likely ensue.
Enforcement by deduction from accounts
The draft legislation includes provisions allowing HMRC to recover tax and tax credit debts of £1,000 or more directly from taxpayer bank and building society accounts. The draft legislation includes the power for HMRC to issue "information notices" [requiring a bank or building society to provide specified information about a taxpayer's bank account(s)], "hold notices" (requiring a bank to prevent the funds in a taxpayer's account(s) from being removed) and "deduction notices" (requiring the bank to pay a taxpayer's debt directly to HMRC). Certain sanctions apply to banks—a time limit is given for banks to respond to these notices and there is a fixed penalty of £300 on a bank that does not comply with its obligations, and daily penalties of £60 per day for ongoing failures. Specific provisions are included to deal with taxpayers with multiple accounts and accounts where a taxpayer is one of two or more joint account holders.
Certain safeguards, such as the requirement for HMRC to leave a minimum of £5,000 in a taxpayer's account, the extension of the period for requesting an internal review from 14 to 30 days and the right to appeal the decision of an internal review to the county court, are included in the draft legislation.
Duane Morris comment
This measure, although anticipated, seems to be part of a move toward giving HMRC wide discretion before taxpayers have had a proper opportunity to present their case. Although there is an obligation on HMRC to be satisfied that a taxpayer is aware of a debt owed to HMRC before implementing the procedure, no requirement exists to hold a face-to-face meeting with a taxpayer. However, secondary legislation, introducing greater safeguards, will be published in the spring of 2015, so it is anticipated that further details will be made available at that time.
Entrepreneurs' relief – with immediate effect, individuals and trustees who are eligible for entrepreneurs? relief will no longer have to forego this entitlement if they defer their gain into investments that qualify for Enterprise Investment Scheme (EIS) or Social Investment Tax Relief (SITR). Gains that accrued and were reinvested before this date suffer tax at the full capital gains tax rate (18 percent or 28 percent) when they come back into charge on disposal of the EIS or SITR investment. Gains accruing and deferred on or after 3 December 2014 will be eligible for entrepreneurs' relief when they come back into charge, reducing the tax rate to 10 percent.
Annual Tax on Enveloped Dwellings ("ATED") – as anticipated, new, higher rates of ATED, applicable to UK residential property owned by certain non-resident, non-natural persons have been announced. Measures are also under way for the reduction of the value of properties within the scope of ATED to £500,000.
Employee benefits and exemptions – the government has published draft legislation to introduce a new tax exemption for non-taxable expenses paid or reimbursed to an employee and to abolish the current dispensation regime. The exemption will not apply if the expenses are paid or reimbursed as part of a salary sacrifice arrangement. These measures will take effect from 6 April 2016.