UK releases Finance Bill clauses and consultation documents
On 9 December 2015, the UK released draft clauses for Finance Bill 2016 as well as consultation documents. The key items released include:
- A new requirement for large businesses to publish their tax strategies as they relate to or affect UK taxation. This sits alongside new ‘special measures’ powers for HM Revenue & Customs (HMRC) to tackle businesses that ”persistently engage in aggressive tax planning.” Both measures will have effect after Royal Assent to Finance Bill 2016.
- This will be accompanied by a framework for cooperative compliance, which is proposed to be introduced in April 2016, and which the Government proposes to consult further on in the next few months.
- New patent box legislation (the response to consultation will follow in 2016).
- Clauses to implement the Organisation for Economic Co-operation and Development (OECD) proposals for addressing hybrid mismatch arrangements from 1 January 2017.
- A new consultation on company distributions and legislation strengthening the transactions in securities legislation.
- Legislation to determine when performance awards received by asset managers will be taxed as income or capital gain.
- The introduction of new criminal offenses for tax evasion and for corporates failing to prevent tax evasion. These will be accompanied by new civil penalties for offshore tax evaders and those who enable offshore tax evasion.
- Details of the new 60% general anti-abuse rule (GAAR) penalty and measures to tackle serial tax avoiders
While the draft clauses continue the Government’s commitment to stop tax evasion, tackle tax avoidance and ensure companies pay their fair share of tax, the Government recognizes that it is essential that the tax system successfully supports investment in business. It is no easy task to achieve this and at the same time make the tax system simpler.
Large business transparency strategy
The draft Finance Bill clauses include legislation which would require certain large groups, companies and partnerships to publish an annual tax strategy, in relation to UK taxation. The draft legislation states this must be published on the internet. Non-publication or incomplete content may lead to an appealable penalty of £7,500. The requirement applies to all financial years beginning on or after Royal Assent (likely to be July 2016).
The definition of businesses potentially covered is not clearly set out but appears to be as follows:
- UK groups and sub-groups where the UK group/sub-group’s aggregated turnover is more than £200m or its balance sheet total more than £2b in the previous financial year
- Other UK groups and sub-groups in respect of which there is a mandatory reporting requirement under the UK country-by-country reporting regulations (or would be if headed by a UK resident company)
- Other UK companies not part of a UK group or UK sub-group which meet these turnover or balance sheet thresholds or are members of a country-by-country reporting group as above
- Partnerships that meet the above turnover or balance sheet thresholds
The tax strategy to be published must set out:
- The approach of the UK group/company/partnership to risk management and governance arrangements in relation to UK taxation
- Their attitude towards tax planning (so far as affecting UK taxation)
- The level of risk in relation to UK taxation they are prepared to accept
- Their approach towards their dealings with HMRC
This is not restrictive and the draft legislation states that the tax strategy may also include other information relating to taxation.”
The strategy must be published before the end of each financial year, on the internet, and be accessible to the public free of charge for at least a year after it is first published, with a penalty of £7,500 on the company (not on an individual like the Senior Accounting Officer regime) for failure to comply with these requirements, in line with the Companies House maximum penalty for late/non-filing.
In the case of a non-UK headed group with a UK sub-group, the requirement falls on the UK parent of the UK sub-group, which is responsible for ensuring that a tax strategy for the UK sub-group is published. Where a UK company which is a member of a non-UK headed group which, if headed by a UK resident company, would meet the mandatory country-by-country reporting requirements (but is not part of a UK sub-group), the publication requirement falls on that company. However, as may be the case for many non-UK headed groups, HMRC’s response to the Improving Large Business Tax Compliance consultation clarifies that if the group as a whole has a single global tax strategy, the obligation to publish will be satisfied by publication of that global tax strategy, subject to any UK specific adjustments that it is appropriate to make.
In addition to the transparency strategy, draft legislation has also been published which introduces a special measures regime. This is discussed in the Tax Administration section below.
The draft Finance Bill clauses include legislation on how the patent box computation rules will be amended to make them compliant with the new international framework for preferential tax regimes for intellectual property (IP) as set out by the OECD. The consultation released in October, suggested that the existing legislation would be largely retained and provisions added to introduce the so called ”nexus fraction” and to mandate streaming. While that is largely the effect of the draft legislation, it is much more complex than anticipated with the addition of two self-contained chapters detailing all the computational aspects of the new rules and those applicable to companies in both regimes. This additional complexity is not welcome and this will only add to the compliance burden already posed by the need to track and trace research and development (R&D) expenditure.
It is clear that the only companies that are truly grandfathered are those which are not new entrants (i.e., a patent box election has been made which has effect before 1 July 2016) and which have no income attributable to new qualifying IP rights. In this respect, a ”new qualifying IP right” means a right effectively filed on or after 1 July 2016 (and so would generally exclude patents that are pending before that date). It also includes a right acquired from a connected person on or after 2 January 2016 which is not entitled to a regime under another territory which are designated by Regulations made by the Treasury as corresponding to the UK patent box. There would seem to be no requirement that the vendor actually elected into the corresponding regime.
Under the new rules it will be necessary to divide qualifying income into separate sub-streams on a patent by patent basis and allocate costs to each stream on a just and reasonable basis. This can be done on a product sub-stream basis where it would not be reasonably practicable to apportion income between individual patents or where associated costs could not be split on such a granular level. The nexus fraction will then be applied to each sub-stream.
The nexus fraction equals the proportion of a company’s total R&D expenditure represented by the sum of its in-house and externally subcontracted R&D (potentially uplifted by 30%). This must be calculated on a cumulative basis up to the end of the accounting period in question. A company may go back no more than 15 years to calculate the cumulative fraction and in the transitional period a company will generally be required to include data from 1 July 2016, but in some circumstances it can be as early as 1 July 2013. Ensuring systems are in place to capture this data will therefore be key even where existing patents are currently grandfathered.
Notably the draft legislation does not cover some of the most complex areas in particular the potential use of an alternative approach in exceptional circumstances (rebuttable presumption), situations where companies engage in collaborative development or where businesses with separate R&D histories combine. We understand that the intention is that these will be included in the final legislation but that HMRC wishes to reflect on the input from the consultation before suggesting a preferred approach. Comments on the draft legislation are also being welcomed so further change to it should be expected.
Hybrid mismatch arrangements
New rules to address hybrid and other mismatches are to be introduced to implement the best practice recommendations in the OECD’s final report on base erosion and profit shifting (BEPS) Action 2. The rules replace the UK’s current anti-arbitrage rules and have considerably wider scope. Hybrid mismatches are defined as cases where an amount is deductible in one jurisdiction but not taxed in any other (a deduction/non-inclusion mismatch), or where an amount is deductible more than once (double deduction mismatches). They are not restricted to financial transactions and are also seen, for example, in respect of payments relating to intellectual property.
The draft legislation released covers structures that involve mismatches from financial instruments and from hybrid entities, as well as dual-resident companies. Likewise, hybrid transfers such as repos and stock loans can be included. In some circumstances, a deduction/non-inclusion mismatch is deemed to occur where an accrual is deducted in one jurisdiction, but no taxable payment is actually made. Where the payment is taxed in a later period than the deduction is enjoyed, the rules allow for a 12 month gap between the accounting periods before there is a mismatch. Alternatively, a claim to HMRC for just and reasonable treatment can be made.
Hybrid mismatches are countered by a primary response of disallowing a deduction where the UK is the jurisdiction of the payer in respect of a deduction/non-inclusion mismatch. Where the UK is the payee jurisdiction, and the primary response has not been applied in another jurisdiction, the UK will bring the receipt into charge. In the case of a double deduction, the UK will deny the deduction where it is the parent jurisdiction. If the UK is the payer jurisdiction and the deduction is not denied in the parent jurisdiction, the UK will deny the deduction to the payer.
Unlike the current anti-arbitrage provisions, there is no purpose test in the new rules. The new rules apply whenever it is reasonable to suppose that there is a relevant hybrid mismatch. However, there is provision for adjustments to be made later if the supposition ceases to be reasonable. The rules require that the UK resident entity is subject to corporation tax, although there is a special provision to treat LLPs as opaque for UK tax purposes if they are used to prevent deductible amounts from being taxed.
In general, transactions are included where the parties to them are related (meaning a 25% relationship) or they are structured transactions where it is reasonable to suppose they were designed to produce the tax mismatch. When the UK end of a transaction is part of an overarching scheme which produces a mismatch in another jurisdiction, the rules allow the UK to take countermeasures against an imported mismatch.
There are several exemptions within the rules. Payments which are not taxed by virtue of being paid to a tax haven or a jurisdiction that only taxes local source income are excluded. Likewise payments to an exempt entity such as a pension fund are also generally excluded, as are those to widely-held funds and sovereigns. Regulatory capital securities are also excluded together with repos and stock loans entered into as part of a financial trade, as long as they are not structured transactions.
The rules are intended to come into effect from 1 January 2017. Where a company has an accounting period that straddles 1 January 2017, it is deemed to have a new accounting period start on that date.
The lack of grandfathering rules and an effective date in just over a year makes reviewing the implications of these rules a priority. The wide scope of the draft legislation means that even structures that have previously been cleared by HMRC may now need to be looked at again.
Loan relationships and derivative contracts
As promised at the Autumn Statement, draft clauses have been provided which address three situations, in the context of interest-free loans and other loans on non-market terms:
- Deductions for notional finance costs on the reversal of an accounting discount will be restricted where a loan liability is initially recognized in the borrowing company’s accounts at an amount less than the amount borrowed without the accounting discount arising on inception being taxed. It will apply in cases where the lender is an individual (or other non-corporate) or where there is a corporate lender which is resident in a non-qualifying territory.
- Amendments will be made to ensure that companies are not taxed under the corporate debt or derivative contract rules on credits arising where debits, previously denied for tax under the transfer pricing rules, later reverse.
- Additional amendments will ensure that exchange gains and losses provisions do not apply where one loan or derivative is matched with another, or is subject to matching under the Disregard Regulations.
From 2021, it is the intention that all banking groups will be subject to bank levy on the balance sheet liabilities of UK based entities and on the balance sheets of any branches which operate in the UK. The Government has indicated that it believes adjustments to the calculation method for foreign banking groups will make it an appropriate framework for all banking groups from 2021. In its consultation, which closes on 4 March 2016, the Government asks for input on its proposals with changes to legislation to be included in Finance Bill 2017.
The consultation document proposes that there will not be a blanket carve-out for liabilities of a UK parent used to fund overseas subsidiaries, which may result in a lower overall reduction in the bank levy than UK parented global banking groups may have hoped for, or may distort decisions between direct funding of an overseas subsidiary or funding via the parent. A number of other design issues are raised around the treatment of Tier 1 capital and netting.
The consultation also covers proposed amendments to the definition of High Quality Liquid Assets following the introduction of new EU liquidity coverage ratio requirements. These changes will be brought in by secondary legislation in 2016.
The draft legislation includes provisions to address certain anomalies identified by the life industry with the legislation introduced by Finance Act 2012. Those anomalies have previously been discussed and agreed as such with HMRC, and their rectification is welcome. These welcomed changes will:
- Ensure the correct operation of the minimum profits charge where a company has non-trading loan relationship regime deficits
- Provide in-year rather than merely later year relief for any excess of debits over credits under the intangible fixed assets regime
- Remove a restriction on the utilization of life business trade losses by reference to a net position on derivative contracts – restoring the restriction to the pre-Finance Act 2012 position
Further, regulations were laid on 9 December which will give effect to various proposals to improve the rules relating to intra-group transfers of life insurance business under Finance Act 2012. The proposals were previously discussed and agreed between representatives of HMRC, the insurance industry and advisors, and accordingly we welcome them.
The regulations will:
- Ensure that the rules intended to tax valuation differences on an intra-group transfer apply only to taxable assets and liabilities
- Provide for a fair apportionment of uncrystallized transitional amounts on an intra-group transfer of part of the long-term business
- Ensure that ”grandfathered” treatment of certain assets under the transitional rules continues to apply following an intra-group transfer
Other business tax measures
A number of measures announced with the Autumn Statement and having effect from 25 November 2015 are unchanged. These include the anti-avoidance measures aimed at two schemes involving capital allowances and leasing as well as the measures to counter arrangements involving partnerships and intangible fixed assets. The clauses to provide relief from the loans to participators rules for certain loans or advances made to charitable trusts are also unchanged. Draft legislation has been published for the introduction of ”orchestra tax relief.”
The Government has published draft legislation designed to align the provisions for inheritance tax deemed domicile with the proposals for income and capital gains tax. Non-domiciled individuals will be deemed domiciled in the UK once they have been resident for 15 out of the last 20 tax years. Deemed domiciled individuals will be subject to inheritance tax on their worldwide assets. However, there will be an exception for overseas assets settled into trust before the individual became deemed domiciled in the UK.
Individuals born in the UK, with a domicile of origin here will be deemed domiciled while they are UK resident, provided they have been resident in one of the preceding two tax years. This means that such individuals could become deemed domiciled in the UK within their first year of presence here. The exception for assets in trust will not apply to these individuals.
UK domiciled individuals leaving the UK will be remain deemed domiciled for six complete tax years following their departure or until three years after acquiring a domicile of choice overseas, if this is later.
A response to the wider consultation on the reform of the taxation of non-doms and further draft legislation is now expected in the New Year. The Government notes that legislation does not currently take account of any representations made in the course of the consultation. The changes will not apply until 6 April 2017.
Company distributions and transactions in securities
Following an announcement in the Summer Budget, HMRC has published its consultation document in relation to the taxation of company distributions. This consultation was accompanied by draft amendments to the transactions in securities rules and a targeted anti-avoidance rule in relation to certain arrangements for converting income to capital, both applying from 6 April 2016. The consultation is aimed at addressing a Government concern that, in certain situations, arrangements are being made to convert distributions that should properly be subject to income tax into capital gains tax disposals, a situation that may be exacerbated once dividend tax rates increase next April. The consultation, and the legislative changes, apply for income tax only and so are not applicable to corporate shareholders.
The targeted anti-avoidance rule is addressed at what is known as ”phoenixism” where a company is wound up and a new one established which carries on broadly the same activities. It would apply to treat a distribution made on or after 6 April 2016 as liable to income tax if it arises on the winding up of a close company (whether UK or non-UK resident) where, within two years of the distribution, the individual (or a connected person or company in which he/she is a participator) carries on a trade or activity that is the same as, or similar to, that carried on by the company that has been wound up, and that the avoidance of income tax was one of the main purposes of the winding up.
A distribution would be excluded from this rule to the extent it represents a repayment of capital originally subscribed. There is a further exclusion for a distribution of irredeemable shares in a subsidiary. This is intended to allow liquidation demerger transactions to fall outside this anti-avoidance rule, though is limited in scope as it does not include demergers where the trade (or other business) of the company being liquidated is directly transferred to a new company as part of the demerger.
The proposed changes to the transactions in securities rules apply to transactions occurring on or after 6 April 2016 and are more wide ranging. Their scope is being expanded to include repayments of share capital or premium and distributions on a winding up, in line with the general theme of the consultation. This is potentially a far-reaching change as both mechanisms have commonly been used by UK and non-UK companies as a means of returning value to shareholders in a capital form.
Further changes are being made to widen the scope of the purpose test and the circumstances in which an income tax advantage can arise. The definition of assets available for distribution is expanded to include distributable reserves of other controlled companies, which may lead to problems where subsidiaries have reserves but are prevented from distributing them (e.g., due to banking restrictions). Also, the exclusion for assets representing a return of sums paid on the issue of securities is being tightened. Certain transactions involving a fundamental change of ownership are excluded from the scope of the rules, but the definition is being amended to exclude situations where shareholders retain economic rights of more than 25% of the company in question.
As the changes take effect from 6 April 2016, HMRC has included legislation which means that clearances granted prior to this date cannot be taken to apply to transactions taking place after 5 April which would otherwise be caught by the new rules. Lastly, a change to the notification requirements brings the rules more in line with the self-assessment regime.
Further issues being explored in the consultation include the purchase of own share rules for unquoted companies (which allow capital gains tax treatment of distributions received in certain circumstances), and whether a broader review of the distributions regime would be desirable, including for instance whether more comprehensive relief should be available for demergers (which would be welcomed). Responses are sought by 3 February 2016.
Asset managers’ performance-based rewards
The Government has published a response to the consultation document on performance linked rewards for investment managers, together with draft legislation to be included in Finance Bill 2016. The consultation was concerned with ensuring that capital gains tax treatment only applied to carry payments received by asset managers in circumstances where the investment fund engaged in long-term investment activity.
Following consultation, the Government proposes to introduce new rules which will look at the average holding period that investments are held by funds. Where the average period exceeds four years, the carry received by the investment manager will be subject to capital gains tax. Where the average investment period is less than three years, the whole amount will be subject to income tax. Where the average falls between three and four years, there will be a graduated system for determining the amounts subject to income and capital gains tax.
The average holding period for investments will be calculated on a weighted average, based on holding period and value invested as a proportion of the fund. Special rules deal with circumstances where a significant investment is made in tranches and where exit from such an investment takes place in stages, subject to certain conditions. The calculation will also depend on whether the carry for the fund is calculated on a whole fund or asset by asset basis.
Where carry arises to an individual in the first four years of a fund making investments, it is possible to qualify for ”conditional exemption” from the income tax charge. In such circumstances, a further calculation is made to determine the treatment of the payment at the time the exemption is lifted.
There are number of further detailed provisions dealing with direct lending funds, derivatives and hedging. The Government has also indicated that it is prepared to consider a different test for venture capital funds and provision is made in the draft Finance Bill clauses for this to be achieved by secondary legislation.
The draft clauses include measures to fundamentally change the way dividends are taxed in the hands of individuals. From 6 April 2016, the dividend tax credit will be removed and replaced by a tax-free dividend allowance for the first £5,000 of dividend income per year.
UK residents will pay tax on any dividends received over the £5,000 allowance will also change to:
- 7.5% on dividend income within the basic rate band
- 32.5% on dividend income within the higher rate band
- 38.1% on dividend income within the additional rate band
At present these rates do not seem to be included in the draft clauses. It is also unclear what rate will apply to trustees although it does appear unlikely that the nil rate band will apply to them.
Dividend income which falls within the nil rate band will still count as income for the purpose of calculating entitlement to the personal savings allowance.
As announced at Autumn Statement, draft clauses have been published which will affect the stamp duty and stamp duty reserve tax (SDRT) treatment of ”deep in the money options” (DITMOs) which are used to transfer shares to a depositary receipt issuer or clearance service. HMRC has also published a technical consultation in respect of the draft legislation. Shares transferred to a depositary receipt issuer or clearance service as a result of the exercise of an option will now be charged at the 1.5% higher rate of stamp duty or SDRT based on either their market value or the option strike price, whichever is higher.
The changes will apply to options granted on or after 25 November 2015 and exercised on or after Budget Day 2016. This is a major change and it is expected that it will have a significant impact on DITMO activity. The closing date for comments on the technical consultation is 3 February 2016.
The draft Finance Bill legislation did not include clauses relating to the 3% point stamp duty land tax (SDLT) charge on additional properties that was announced at Autumn Statement and is intended to apply from 1 April 2016. This will now be published in January 2016 for consultation.
As previously announced, the Finance Bill clauses also included provisions on the following:
- SDLT seeding relief in relation to property authorized investment funds and co-ownership authorized contractual schemes
- Extension of reliefs from the annual tax on enveloped dwellings and from the 15% SDLT rate for equity release schemes, properties occupied by employees and properties acquired for demolition or conversion into non-residential use.
Tax administration and other anti-avoidance measures
Large business special measures regime
The draft legislation introduces a special measures regime said to be aimed at tackling the small number of large businesses (defined as for the large business transparency strategy measure above) that engage in aggressive tax planning, or refuse to engage with HMRC in an open and collaborative manner. Notices under the regime can be given only after the start of a company’s or partnership’s financial year beginning after Royal Assent, but notices may take into account consideration of a business’s behavior before that time.
The legislation allows a designated HMRC officer to issue a warning notice to a group, company or partnership which it considers meets the special measures regime conditions. These conditions are that the business has persistently engaged in unco-operative behavior contributing to two or more significant unresolved tax issues, and there is a reasonable likelihood of further uncooperative behavior contributing to significant tax issues in future.
Uncooperative behavior is defined as either being party to an avoidance scheme, or behaving in a manner which has delayed or hindered HMRC in the exercise of their functions in determining the business’ UK tax liability. A number of factors are listed as indicating such behavior, including the use by HMRC of formal information powers, the number and seriousness of inaccuracies within returns, and reliance on ”speculative” interpretations of legislation.
Where a business has been given a warning notice, it has 12 months to make representations. If the business continues to meet the special measures regime conditions at the end of this 12 month period, HMRC may issue a special measures notice, which renders the business liable to potential sanctions. In issuing the special measures notice, the HMRC officer must set out why the business is considered to meet the conditions. The potential sanctions set out in the legislation include removing the defense of ‘reasonable care’ for the purpose of penalties in respect of inaccurate returns and – if the special measures notice is confirmed by HMRC following an extended 24 month period of being in special measures – power for HMRC to publish the name and address and any other identifying information in relation to the business and the fact that it is subject to the special measures regime. HMRC has also indicated that administrative sanctions could include the removal of access to non-statutory clearances.
Penalties for the general anti-abuse rule
As expected, draft legislation has been published that seeks to increase the deterrence effect of the general anti-abuse rule (GAAR).
The main additional deterrent is the introduction of a new penalty of 60% of the tax involved where a tax advantage is counteracted under the GAAR. This is in addition to any penalty that might be charged under the existing penalty rules for errors (under Schedule 24 Finance Act 2007), subject to an overriding limit of 100% of the tax involved (other than for offshore matters where higher penalties can apply).
A number of other procedural changes to the GAAR rules are being introduced at the same time. These include the ability to counteract equivalent arrangements to those counteracted by the GAAR advisory panel and the ability to issue a provisional counteraction notice in order to protect HMRC’s position.