The key budget changes

Transcription

1 The key budget changes Taking into account Finance Bill 2009 May 2009 Contents 4. Mainstream Corporation Tax 5. briefing on the key expected corporation tax changes 19. briefing on other expected corporation tax changes 30. briefing on the unexpected corporation tax changes 40. The targeted anti-avoidance provisions a checklist that will help you decide whether any of the targeted antiavoidance rules in this year s budget apply to your business 41. Funds briefing on the key budget changes relating to funds 1

2 Our Tax Group philosophy providing you with briefings you will want to keep and refer back to This tax briefing has been prepared in accordance with the Field Fisher Waterhouse tax group philosophy. We look to give practical, useful and easy to digest advice without being superficial. Ours might not always be the first briefing to arrive in your inbox, but we aim for it to be the best. For example, we do not send out a short form budget briefing to clients immediately after the budget, but prefer to wait until the detailed legislation is published in the Finance Bill and to provide clients with a fuller guide which is based on legislation rather than HMRC s short form budget notes. We know that tax is a complex area and not every change in tax law is of equal (or indeed any) interest to all our clients. We aim to give you something which tells you not just what has happened but also why, and what it means for your business, so that you can pick out the information which is relevant to you and skip through the material which is someone else s problem. Our aim is that Field Fisher Waterhouse tax briefings will be the ones that you will wish to keep and refer back to, rather than read and forget. We are always grateful for any feedback our clients wish to give us on our briefings, positive or negative. All of our tax briefings are posted to our website. If you like this briefing, then please do check our website 1 for others that may be of interest. Please feel free to forward our briefings to your colleagues who might be interested or affected by the issues covered. If you receive this briefing from a colleague and like it, let us know and we will add you to our distribution list. If any of the issues raised in this Field Fisher Waterhouse tax briefing affect you then please get in contact with any of us at any time, we would be delighted to hear from you. 1 If you have any difficulty accessing external links within this document please ensure that you do not have any other web pages open when clicking. 2

3 Contents This briefing does not attempt to cover every element of the Finance Bill or every change announced in the Budget. It is aimed at corporation tax payers and businesses and funds. We have for the most part not covered personal taxation, employee taxation, real estate tax, VAT or pensions taxation. For our other briefings which might be of interest, please click the links below: pensions budget briefing employment budget briefing This briefing is broken down into the following subsections, please click the links below to go directly to the relevant sections: Mainstream Corporation Tax briefing on the key expected corporation tax changes briefing on other expected corporation tax changes briefing on the unexpected corporation tax changes The targeted anti-avoidance provisions a checklist that will help you decide whether any of the targeted anti-avoidance rules in this year s budget apply to your business Funds briefing on the key budget changes relating to funds 3

4 The key expected mainstream corporation tax changes Contents Click here for a link to our full briefing on the key changes which were announced as expected in the budget and finance bill. Alternatively click the links below to go straight to a specific item. We circulated a summary of the material included in this briefing in the week before budget day. Access summary. This guide provides considerably more depth than our summary, and is intended to give you a practical guide to what the relevant budget and finance bill provisions mean for your business. This section of the briefing covers the following key budget and finance bill changes: UK international taxation is changing radically (a) (b) (c) (d) Dividends from foreign companies will generally be exempt from corporation tax. Interest deductibility in the UK will be restricted by reference to a worldwide debt cap. The CFC regime is changing. Treasury consents are being abolished. The taxation of foreign dividends in the hands of individuals is changing Individuals will get tax credits going forward in most circumstances. Venture capital schemes are being improved This is broadly positive for investors in smaller entrepreneurial companies. The late paid interest rules are being relaxed This broadly positive change means that interest may be deductible as it accrues even where it is not paid. New principles based anti-avoidance rules are being introduced In particular, rules are aimed at "disguised interest" and transfers of income streams. These rules affect both prospective and historic asset finance and structured finance transactions. 4

5 UK International Taxation of Companies Dividends from foreign companies will generally be exempt from corporation tax What is the change? In simple terms, the change means that foreign dividends received by a UK company will nearly always be exempt from corporation tax. In nearly all cases, this will significantly simplify the tax position of a UK company receiving dividends. The new rules apply in principle to both UK and non-uk dividends. UK dividends were historically always exempt from corporation tax. This long standing exemption is repealed, and UK and non-uk dividends are now generally taxable or not on the same basis. For large groups, the simplification is off-set by the corresponding complexity arising under the new worldwide debt cap, considered in the next section. As originally announced, the new exemption applied only to large or medium sized corporates or groups. This has changed in the budget announcement, and it now appears that the new exemption will apply to ALL UK companies and groups, regardless of size. When will it apply? The new rules will apply to all relevant dividends or other distributions received on or after 1 July Which dividends are exempt? Nearly all dividends are exempt. The new rules do not apply to capital distributions, which remain subject to taxation of chargeable gains rules. There are two versions of the rules a simple version for small companies and a more complex version for other companies. For small companies, dividends are exempt if all of the following conditions are met: (i) the payer is either resident in the UK or in a qualifying territory (being in broad terms a non-tax haven jurisdiction); (ii) the distribution does not arise from interest treated as a distribution (for example as a result of interest exceeding a reasonable commercial return); (iii) the distribution does not give a non-uk resident a non-uk tax deduction; and (iv) the distribution is not part of a tax avoidance scheme. For companies which are not small, the rules are more fiddly, and to be exempt, a distribution must fall within an exempt class and not be subject to anti-avoidance rules. However, provided that the dividend is not paid as part of a structured tax avoidance scheme, it is quite hard to fall outside the exempt classes (see further below). 5

6 In addition to the fiddly rules: (i) distributions arising from the rules which treat payments of interest as a distribution (for example interest exceeding a reasonable commercial rate of return) are NOT exempt; and (ii) distributions which give a non-uk resident a non-uk tax deduction are NOT exempt. For other foreign distributions you receive, you will need to decide whether that distribution is exempt. In summary, a dividend received will be exempt if: (i) It is a distribution from a controlled company; OR (ii) it is a distribution paid on non-redeemable ordinary shares; OR (iii) It is a distribution paid to a shareholder who (alone or with connected persons) holds less than 10% of the issued share capital, profits available for distribution or assets available to shareholders on a winding up; OR (iv) it is not a distribution paid out of profits arising from a transaction achieving a reduction in UK tax, unless that reduction either is minimal or was not the main purpose or one of the main purposes of the transaction in question. These general rules are subject to anti-avoidance provisions. Broadly, if you are a party to a scheme which seeks to give a UK tax advantage and the new dividend exemption is an important part of the tax analysis of the scheme, these anti-avoidance rules will always need to be carefully reviewed. If the anti-avoidance rules do not apply, a dividend will generally have to squeeze through a very narrow window to not to be exempt. To NOT be exempt: (i) The dividend must be paid on redeemable or preference shares; AND (ii) the shareholder (and connected persons) must hold a greater than 10% interest in the relevant company WITHOUT having control; AND (iii) the underlying profits must arise from a transaction which achieved a reduction in UK tax where both (a) the reduction was more than minimal and (b) it was one of the main purposes of the said transaction to achieve the said reduction. It is possible to elect for a particular distribution to be taxable. HMRC put forward two reasons why a taxpayer might choose to make this election: (i) dividends can only be taken into account for CFC acceptable distribution policies (which remain available under transitional provisions notwithstanding the wider repeal of the ADP exemption) if they are taxable; (ii) exemption might increase withholding tax payable. 6

7 The Worldwide Debt Cap What is the change? The Worldwide Debt Cap applies ONLY to large groups. See below for a summary of what constitutes a large group. The Worldwide Debt Cap applies to restrict deductions for interest paid by UK companies where in broad terms, UK debt costs exceed worldwide debt costs. The finance bill legislation as initially published is not complete, and amendments will be made as the Finance Bill progresses. The expected changes are outlined in a letter from the Financial Secretary, available at the following link: In particular, legislation expected to provide exclusion for Financial Services companies and setting out a targeted anti-avoidance provision will be published later. The finance bill legislation includes gateways, so that the rules apply only where: (i) UK net debt (broadly financial liabilities less financial assets of companies in the UK group relief group) exceeds 3 million; and (ii) UK net debt exceeds 75% of worldwide gross debt (broadly financial liabilities of the worldwide group). If your group passes through the gateways, the rules will apply so that, broadly, finance deductions are restricted where: (i) the adjusted aggregate finance costs of companies in your group relief group which have net adjusted finance costs, exceeds (ii) the adjusted external finance costs payable by your largest consolidated worldwide group. Where deductions are restricted, any companies in your group relief group which have net adjusted finance income can reduce that income by an amount up to the restriction. When will it apply? The rules do not apply straight away, and will apply to accounting periods commencing on or after 1 January When will interest deductions be restricted? NOTE: The finance bill rules are quite different, and use some different terminology, from the most recent HMRC discussion paper issued on 7 April It remains to be seen how far the rules will continue to develop during the finance bill process. This simple exposition, that the Cap restricts deductions for interest paid by UK companies where the UK debt costs exceed worldwide debt costs, hides an underlying complexity which has been widely commented on (and criticised). HMRC have responded to some of this criticism, in particular through the inclusion of gateways and through an increasing reliance on accounting principles, but the rules remain complex. It is still necessary to make a series of adjustments to the figures shown in consolidated and company accounts, and a complex return of tax adjustments will generally need to be completed and submitted. It is not possible in a briefing of this sort to go into the real detail of the Worldwide Debt Cap rules (which run to nearly 80 clauses of densely drafted legislation with more to follow), but what we can do is give you an indication of the sort of process you need to go through to determine whether (and by how much) your interest deductions might be restricted. If you are prepared to take a deep breath and dive into the detail, that process might be summarised as follows. 7

8 Note this is a summary and may leave out key elements of the rules which are crucial to your particular factual position. (i) Are you a large group? (See further below for guidance on what constitutes large for this purpose.) If not, you can ignore the rules. (ii) Are you a financial services company? The rules are not expected to apply, although legislation has not yet been published. (iii) Are you a company with an oil and gas ring fenced trade, subject to the tonnage tax regime or with a real estate trade? If so, the rules apply to you in a special way (which we have not considered here). (iv) What is your available amount? Take the sum of the following amounts as disclosed in your worldwide consolidated profit and loss account or income statement: (a) (b) (c) (d) (e) (f) (g) interest payable on amounts borrowed; amortisation of discounts on amounts borrowed; amortisation of premiums on amounts borrowed; amortisation of ancillary costs relating to amounts borrowed; the financing cost implicit in payments made under finance leases; the financing cost relating to debt factoring; anything else specified in regulations (we will have to wait and see whether anything emerges under this paragraph). Disregard any amount which represents a dividend paid on redeemable preference shares, where those shares are accounted for as a liability. (v) What is your tested expense amount? (a) For each member of your UK group relief group, take the sum of your financing expense amounts, being: (1) Loan relationship debits, excluding impairment losses, exchange losses and debits from related transactions; (2) Financing costs implicit in payments under finance leases; (3) Financing costs under debt factoring transactions. (b) On an entity by entity basis, deduct the sum of your franchising income amounts, being (1) Loan relationship credits, excluding impairment gains, exchange gains and credits from related transactions; (2) Financing income implicit in payments under finance leases; (3) Financing income under debt factoring transactions. (c) Where expenses exceed income, ignore the answer if it is less than 500,000 for any company. Where the answer is higher than 500,000, make apportionments of the resulting net financing deduction where net finance expense subsidiaries have: (1) joined or left the group in the consolidated worldwide accounting period; or (2) have accounting periods which are different from the consolidated worldwide accounting period. (d) Aggregate the resulting apportioned amounts to give you your tested expense amount. 8

9 (vi) What fiddly bits do you need to consider before you make the comparison? (a) We are expecting a targeted anti-avoidance provision, although legislation has not yet been published. (b) Is there short term debt? Some short term debt is ignored. (c) Do you have a treasury company (or companies)? Special rules apply. (d) Do any of your UK group relief companies receive finance income from a group EEA company which does not get a deduction in its home jurisdiction for the corresponding expense? Special rules apply. (vii) If the tested expense amount is higher than the available amount, you must allocate the difference across each of your UK group relief group companies which have net financing deductions, reducing the recognised amount of that expense for tax purposes. (viii) You can then allocate a similar amount across each of your UK group companies (if any) which have net financing income, reducing the recognised amount of that income for tax purposes. UK group companies include all UK corporation tax paying companies in the worldwide group, regardless of whether they are group relief group companies. If this reduction gives you stranded non-trading deficits in a particular creditor company, you may be able to recalculate your tested amount in a way which may (or may not) help, depending on the position of the relevant creditor and debtor. There is an anti-avoidance provision hidden away in the definition of relevant group company (which is essentially the UK group relief group) a company will be treated as a relevant group company if it is a party to arrangements one of the main purposes of which is to secure that it is not a relevant group company. Are you a large group? A large group is one where no member is a micro, small or medium sized enterprise as defined in relevant EU legislation, subject to some important adjustments. Note that members of groups are generally attributed the personnel and assets of other group members, so it is not possible to set up a group containing lots of medium sized companies each company will be deemed large through its association with the others. The EU legislation and a useful guide on its application can be found at the following link: This means that, broadly, if in the current accounting period your consolidated group (including all >50% subsidiaries consolidated at 100% and a proportion equal to the consolidated group interest in joint ventures where the interest is greater than 25% and less than 50%) has: (i) (ii) A headcount of 250 or more; and both: (a) Turnover of 50 million or more; and (b) A balance sheet of 43 million or more Then you are a large group. 9

10 The CFC regime is changing What is happening? (i) The CFC rules remain under review, and at some point we should expect a wholesale revision to be announced and implemented. (ii) For the time being, only two amendments, each consequential on the move to a general exemption for foreign dividends, are to be made. These two amendments were announced some time ago and have been widely considered and commented on. (iii) Briefly, two exemptions from the application of the CFC rules are repealed, subject to transitional periods and rules, being: (a) The exemption for companies which implement an acceptable distribution policy (ADP); and (b) The exemption for holding companies carrying on exempt activities. (iv) These exemptions are no longer seen as relevant once foreign dividends in many cases become exempt from tax under UK law: (a) An ADP which is exempt will not bring underlying profits into the charge to UK corporation tax the dividends remain exempt; (b) The profits received by the relevant holding company (which would be made up primarily of dividend income) would be exempt under UK rules in any event, giving rise to no taxable profit to apportion to UK shareholders. It is also possible for a holding company to receive other non-exempt income and still qualify for the CFC exemption. HMRC were concerned that this element might be subject to abuse once the dividend exemption is introduced. (v) If an ADP dividend is paid while transitional rules apply, it will not be treated as an exempt dividend under the new dividend taxation rules. When will the change apply? The new rules apply (subject to transitional rules) to accounting periods commencing on or after 1 July

11 The Treasury Consent rules are changing What is changing? The treasury consent rules, which apply where a UK company causes or permits shares in a non-uk company which it controls to be created, issued or transferred, are to be repealed. Instead, a new post transaction reporting obligation will apply, but only in particular circumstances, in particular where the transaction value exceeds 100 million. There are exclusions from the new reporting requirement, for example where the relevant assets are transferred by way of security. This change will get a heart-felt cheer from many advisers who have lived for decades with the prospect of accidentally criminalising their clients for no good reason. The treasury consent rules are a hangover from the increasingly distant days of exchange control, and made it unlawful (which carries connotations of criminality) for a UK company to cause or permit a non-uk company over which it has control to create, issue or transfer any shares. The strict rules did not apply to companies within the EU (although a post transaction reporting obligation did apply), and in practice there were general consents which took many transactions out of the scope of the rules. However, it was easy for an innocuous looking transaction to slip through the net, and approaches to the Treasury for confirmation that no action would be taken after the event were surprisingly common place. The parties (and their advisers) would then need to deal with the technical unlawfulness of their transaction, causing unnecessary headaches for clients and advisers alike. But as of 1 July 2009, we can all relax because these annoying rules will be consigned to history, where they belong. When will it apply? The new rules apply to transactions on or after 1 July

12 The taxation of foreign dividends in the hands of individuals What is changing? (a) Individual recipients of: (i) UK dividends, and (ii) foreign dividends where the individual shareholder holds less than a 10% interest in the underlying non-uk company; already receive a non-payable tax credit equal to one-ninth of the dividend receivable. (b) (c) (d) Where a dividend paid by a non-uk company is received after deduction of foreign withholding tax, the amount of the non-payable tax credit is equal to one-ninth of the grossed up dividend (i.e. after adding back the foreign withholding tax). Going forward, a non-payable tax credit will also extend to many individual recipients of foreign dividends where the individual shareholder holds more than a 10% interest in the underlying company. See further below for the effect of receiving a non-payable tax credit and a description of those foreign dividends which qualify under the new rules. A draft of the underlying legislation for inclusion in Finance Bill 2009 was published on 19 January 2009, and we have known the change was coming since the last budget in When will the new rules apply? The rules already apply, having effect for dividends received on or after 6 April What is the effect of getting a non-payable tax credit? (a) Absent the non-payable tax credit, individuals pay tax on dividends at special dividend rates, chargeable on the aggregate of the grossed up dividend and the non-payable tax credit, being: (i) 10% for basic rate taxpayers; (ii) 32.5% for higher rate taxpayers where the dividend falls within the 40% income tax rate bracket; (iii) With effect from 6 April 2010, 42.5% for higher rate taxpayers where the dividend falls within the new 50% income tax rate. (b) (c) The non-payable tax credit reduces the effective tax rate on a dividend received to 0%, 25% and 36.1% for these shareholders respectively. Where a foreign dividend is received subject to deduction of foreign withholding tax, credit for the foreign withholding tax is also available. In practice, the non-payable tax credit and credit for foreign withholding tax taken together can reduce the UK tax payable in respect of a foreign dividend to a minimum of zero, but will not give rise to a right to repayment of tax. 12

13 Which foreign dividends benefit from a non-payable tax credit? (a) (b) (c) Not every foreign dividend will benefit from the new non-payable tax credit. For individual shareholders with less than a 10% interest in the underlying non-uk company, a nonpayable tax credit is in most cases available. For individual shareholders with more than a 10% interest in the underlying non-uk company, a nonpayable tax credit is in most cases available: (i) if the company paying the relevant dividend is resident of (and only of) a qualifying territory, being one with which the UK has a double tax treaty including a non-discrimination article, and (ii) where a dividend flows through a number of countries on its path into the UK as part of a scheme: (a) each company in the chain is a resident of (and only of) a qualifying territory ; and (b) the scheme is not a tax advantaged scheme. (d) For a list of countries which HMRC currently accepts as having an appropriate non-discrimination article in another similar legislative context, click this link: (e) (f) Most major countries are included. Tax haven jurisdictions are notably absent from the list. The definition of tax advantaged scheme is an interesting departure from normal main purposes tests, and is in the following terms: tax advantaged scheme means a scheme that, ignoring any incidental purposes, has as its only purpose or purposes either or both of (i) enabling a person to obtain a UK non-payable tax credit or (ii) enabling a person to obtain (in any territory) any other relief from tax on a distribution. The provision is aimed at treaty shopping, and broadly denies a tax credit where companies have been inserted into a structure for tax purposes. Tax reliefs outside the UK are relevant to the test, which is quite unusual. (g) There are some other detailed rules to take into account (for example in relation to dividends from offshore funds), which are outside the scope of this update. The guide above will generally be relevant for most individuals receiving dividends from investments in listed companies. 13

14 Venture capital schemes are being improved What is changing? (a) (b) (c) (d) The Enterprise Investment Scheme (EIS), Corporate Venturing Scheme (CVS) and Venture Capital Trust (VCT) schemes all provide for tax relief on investment into qualifying companies, which are targeted to encourage investment into unquoted (or AIM listed) companies carrying on entrepreneurial activity at the smaller end of the corporate market. The schemes are subject to stringent rules as to the nature of the investment and the company invested in. The EIS and CVS rules are similar and apply in principle to direct investments in companies, with EIS applying to investments by individuals and CVS applying to investments by companies. The VCT rules expressly contemplate a pooled investment by individuals in a listed company which in turn invests in unquoted (or AIM listed) companies. The stringent rules are relaxed to an extent, which will be welcomed by both investors and investees. For EIS: (i) Prior to the budget, it was necessary to use 80% of the funds raised within (generally) 12 months of the investment, with the remainder being used within a further 12 months. This rule is repealed and now 100% of funds must be used within 24 months without further constraint. (ii) Prior to the budget, the investee company was required to use money raised from cotemporaneous issues of non-eis shares of the same class within the same time limits. This rule is repealed, and it is now only necessary to worry about how quickly the money raised from EIS shares is utilised. (iii) Prior to the budget, investors could carry back EIS relief to the previous tax year, but only in relation to shares issued prior to 6 October in a given year and then only in respect of half of the subscriptions in that period to a maximum of 50,000. This restriction is repealed, and the whole 500,000 can in principle be carried back. There is an overall restriction of relief on 500,000 for any given tax year. (iv) Prior to the budget, in addition to a claw back of EIS relief, a charge to capital gains tax could arise where the investor exited early from his investment through an exchange of his EIS shares for shares issued by a purchaser. This anomalous result is corrected, and going forward the EIS claw back will still apply but otherwise the EIS shareholder will be entitled to the same capital gains tax relief as other shareholders on a share for share exchange. (e) For VCS and VCT: (i) Prior to the budget, it was necessary to use 80% of the funds raised within (generally) 12 months of the investment, with the remainder being used within a further 12 months. This rule is repealed and now 100% of funds must be used within 24 months without further constraint. When will the change apply? The changes already apply, taking effect for investments in EIS, CVS or VCT shares made on or after 22 April

15 Further update good news for investors On 29 April 2009 the Treasury announced that EIS, CVS and VCT schemes have each received state aid approval from the European Commission, giving certainty to investors over future investment in these schemes. Approval is subject to four changes to the current sets of rules: (a) Territorial rules this the most significant rule change which will allow companies to pursue international investment opportunities. The current rule requiring at least 50% of a company s qualifying activities to be in the UK will be relaxed so that going forward, companies will only be required to have a permanent establishment in the UK. This is a positive change, and will benefit multinational businesses or those considering international expansion but who have previously had to weight up the benefits of being a qualifying company against the restrictions imposed on their international businesses. (b) Enterprises in difficulty these entities will not be eligible for investment under any of the venture capital schemes to bring the rules in line with the Risk Capital Guidelines (RCGs). Care will be needed to ensure this restriction doesn t bite, particularly in the current market. (c) Minimum equity requirements for VCTs the current requirement for at least 21% of total funds to be held in ordinary shares will be increased so that in future, VCTs will be required to hold at least 49% of total funds in equity, bringing the rule in line with the RCGs. A new definition of equity will be introduced incorporating the concept of quasi equity which will allow a wider range of equity investments than at present despite the increase in required percentage. (d) VCT listing requirements the requirement that VCTs be listed in the UK will be relaxed to allow listing on any European Union Regulated Market. The changes will be introduced in Finance Bill 2010 following consultations with the industry. 15

16 The late paid interest rules are being relaxed What is changing? (a) Generally, interest relief for companies is given on an accruals basis. Prior to the budget, that was not the case where (broadly): (i) the underlying loan relationship was between connected parties; (ii) interest was unpaid for 12 months or more from the end of the accounting period in which it accrued; and (iii) no taxable credit was brought into account by the lender. (b) (c) This provision was aimed at loan relationships from a foreign company to a connected UK company. The rule was designed to remove the temptation to take advantage of an ongoing accrual of tax relief in the UK coupled with potential deferral of tax liability in a lending jurisdiction which taxed on a paid basis. However, the rule was considered contrary to European law where the lender was resident in an EU jurisdiction. Going forward, the rule will apply only where the lending company is resident in a non-qualifying territory, which has the same meaning as for transfer pricing and the individual tax credit for shareholdings over 10%, and includes most major jurisdictions but notably excludes tax haven jurisdictions. The link below is to an HMRC list of those territories currently considered qualifying : (d) Equivalent changes are made to similar rules, for example the rules which apply to late payment of discount on deeply discounted bonds issued to a connected company. When will the change apply? The rules take effect for accounting periods commencing on or after 1 April

17 Financial products tax avoidance disguised interest and transfers of income streams Some background on principles based legislation (a) (b) (c) (d) We have included these rules in the mainstream corporation tax section of our briefing partly because they are the first examples of so called principles based drafting to make it onto the statute book. The courts have, over the last few years, moved to a purposive interpretation of tax law in the context of anti-avoidance. When presented with an avoidance structure, the Courts seek to apply the statute read purposively to the facts viewed realistically. Speaking extra-judicially, Lord Hoffman (one of the key law lords responsible for the restatement of tax anti-avoidance jurisprudence) has criticised highly prescriptive legislation on the basis that it is not possible to read a statute purposively where it is intended to operate prescriptively. Speaking in 2005 at an event attended by the author (the text of his speech reproduced in the British Tax Review, 2005 Volume 2, titled Tax Avoidance and should be required reading for anyone involved in tax planning), Lord Hoffman invited HMRC to draft tax law from a principled perspective so that the purpose of the legislation is clear, and then to trust the courts to know what parliament intended to the extent that taxpayers seek to take advantage of perceived loopholes. This principles based legislation could be seen as HMRC s response to Lord Hoffman s invitation. HMRC have legislated on a number of occasions to counter specific schemes intended to create an interest-like return which is receivable tax free. The new legislation is aimed at replacing this piecemeal (and prescriptive) legislation with an overarching anti-avoidance principle which catches all the interestlike returns which HMRC consider should be taxed. (e) The journey to the current form of the legislation has been a long one, with consultation and open days enabling taxpayers to respond to early drafts. Disguised interest What is changing? (i) New legislation is being introduced to ensure that investments which give rise to an interest like return are taxed as interest. (ii) This legislation replaces existing piecemeal legislation intended to achieve the same result in specific circumstances. There are a couple of tweaks in the finance bill, but it generally follows the previously announced format. (iii) The fundamental principle underlying the legislation is that a return economically equivalent to interest is taxed as if it were interest. A return economically equivalent to interest arises if (and only if): (a) it is reasonable to assume that it is a return by reference to the time value of an identified amount of money; (b) it is at a rate reasonably comparable to what is (in all the circumstances) a commercial rate of interest; and (c) at the time the arrangement is entered into by the company there is no practical likelihood that it will cease to be produced in accordance with the arrangement, unless the person by whom it falls to be produced is prevented (by reason of insolvency or otherwise) from producing it. (iv) There are three key exclusions from the general rule: (a) the return is taxed under other rules (as trading income, under the derivatives rules or under the intangibles rules) or is already taxed as interest; 17

18 (b) it is not a main purpose or one of the main purposes of the arrangement to secure that the return is not brought into account as income for corporation tax purposes; or (c) the return arises only from the increase in value of shares in (in simple terms) a group company (although see further below in respect of shares which are accounted for as a liability). (v) There are separate rules relating to shares which are accounted for as a liability (i.e. as debt rather than equity). For example, this accounting treatment might generally be expected to apply to shares where the holder of the share (rather than the company) can choose whether to redeem or where payment of dividends is mandatory rather than discretionary. These rules ONLY APPLY if the relevant share is held for an unallowable purpose, which is a standard main purpose type antiavoidance provision. (vi) If the shares as liabilities rules apply, they require the shareholding to be treated as a creditor relationship in the hands of the shareholder and for distributions to be treated as interest, in each case under the loan relationships rules. The rules are harsh, in that they tax the shareholder without allowing corresponding interest deductions for the issuing company. There are a series of exceptions where a company issues shares to unconnected parties. When will it apply? The new rules apply to arrangements to which a company becomes party on or after 22 April 2009, but will also apply to arrangements which fall within the scope of pre-existing disguised interest legislation. Is it principles based? (i) The answer to this question is broadly yes. (ii) Early drafts of the legislation went further and sought to state expressly the purpose of the legislation. The current draft has dropped this concept, but does state early on and in clear terms the principle that a return economically equivalent to interest should be taxed as interest. Transfers of income streams What is changing? (i) New legislation is being introduced to tax as income any lump sum receivable on the transfer of an income stream without a transfer of the underlying asset, if the said lump sum would not otherwise be taxable as income. (ii) As for the new rules on disguised interest, this new rule replaces a range of piecemeal (and prescriptive) legislation. (iii) The rules apply to a transfer of an annuity (where the asset is the income stream). (iv) The rules do not apply to transfers of income arising from the grant or transfer of a lease or an oil licence, or to sales of income arising under loan relationships or derivatives contracts where the income would have been subject to exclusions under the loan relationship or derivatives rules. (v) The rules also do not apply to transfers of an income stream by way of security. When will the change apply? The new rules apply to transfers of income taking place on or after 22 April Is it principles based? As for the disguised interest rules, the answer is broadly yes.

19 Other (less key) expected mainstream corporation tax changes In addition to the key changes to mainstream corporation tax, a number of other changes made in the budget had been previously announced. This section takes you through these other expected changes, and highlights any elements announced on budget day which were not included in the earlier announcements. Click here for a link to our briefing on the other (less key) expected changes made in the budget This section of the briefing covers: The good (a) (b) (c) (d) (e) Group relief extension to categories of preference shares which do not break a group Foreign denominated losses profits and losses valued using the same exchange rate Double taxation relief on dividends cap on relief set at blended rate (not 28%) for periods straddling the change from 30% to 28% headline rate of corporation tax Hedging future rights issues anomalies in the matching regime corrected Voluntary managed payments plans corporation tax payments can be spread over a period The neutral (a) (b) (c) Manufactured interest case law on deemed manufactured interest payments reversed, treatment of actual manufactured interest payment clarified Interest rates for late paid tax are to be harmonised HMRC are introducing an HMRC Charter The rest (a) (b) HMRC will have a new information power requiring third parties to provide details of tax debtors Penalty regimes for late filed returns are to be reformed 19

20 The good Group relief extension to categories of preference shares which do not break a group Who is interested in this change? This change is primarily of interest to financial institutions which are funded in part by preference shares constituting part of their regulatory capital. However, it applies in principle to all companies with preference share capital. The provisions are primarily a reaction to bank fund raising which has taken and may continue to take place in response to the credit crunch, where large amounts of preference share capital has been issued in order to shore up banks regulatory capital position against past and prospective losses. What has changed? A group relief group can be broken where an equity holder is entitled to an interest in a company s assets or profits. Prior to the budget and finance bill changes, all shareholders (including in principle preference shareholders) were treated as equity holders subject to a narrowly defined exclusion for holders of fixed rate preference shares. The exclusion for preference shares has been widened to include, in particular, preference shares carrying a (market based) floating rate return or an index linked return. Also included in the newly widened exclusion for preference shares are shares where, in accordance with their terms, no dividends can be paid in certain circumstances, including severe financial difficulties or regulatory capital constraints. When will the change apply? The change applies retrospectively to all accounting periods commencing on or after 1 January 2008, unless an election is made to retain the existing treatment of shares issued before 18 December

21 Foreign denominated losses profits and losses valued using the same exchange rate Who is interested in this change? Companies which use a functional currency other than sterling and have losses which are carried back or forward to other accounting periods. What has changed? As things stood before the budget, profits and losses were translated into sterling for each accounting period, meaning that a loss of say 1,000 might have a sterling value of 600 in accounting period A while a corresponding profit of 1,000 has a sterling value of 900 in accounting period B. The 1,000 loss would not therefore fully shelter the 1,000 profit when converted into sterling because of the exchange rate change between the two periods. Going forward, companies will be required to recalculate the sterling value of losses carried forward or back using the exchange rate applied to the profits sheltered. Additional rules apply where the operating currency of the company has changed between the relevant losses and profits being accrued. There are more detailed rules where the functional currency changes between relevant accounting periods. What does it mean for me? This change cuts both ways. If the numbers in the example above were to be reversed, it can be seen that under the old rules a 1,000 loss could have sheltered more than 1,000 of profit. The new rules will remove this exchange rate benefit at the same time as removing the exchange rate cost referred to above. When will it apply? The new rules apply to accounting periods ending on or after 29 December 2007 unless an election is made to defer the commencement date to the first accounting period beginning on or after Royal Assent to the finance bill. Companies which use a functional currency other than sterling will wish to consider exchange rate changes in their accounting periods ending on or after 29 December 2007 to determine whether an election should be made. 21

22 Double taxation relief on dividends cap on relief set at blended rate (not 28%) for periods straddling the change from 30% to 28% headline rate of corporation tax Who is interested in the change? Any company entitled to credit for foreign tax on foreign dividends received in an accounting period straddling 1 April What has changed? On 1 April 2008, the corporation tax rate reduced from 30% to 28%. Companies with an accounting period straddling 1 April 2008 pay a blended rate of tax somewhere between 28% and 30%. Credit for foreign tax on dividends received was capped by reference to the rate of corporation tax in force at the time the dividend was received. In relevant accounting periods, for dividends received before and after 1 April 2008 the cap would be 30% and 28% respectively, while the actual rate of corporation tax applied was a blended rate between 28% and 30%. This unintentional mismatch has been corrected, and the cap is changed with retrospective effect to match the actual rate of corporation tax payable. When will the change apply? The change needs to be retrospective to have the desired effect, and so takes effect from the financial year beginning 1 April

23 Hedging future rights issues anomalies in the matching regime corrected What has changed? This change will be made by an amendment of the relevant statutory instrument, rather than in legislation included in the finance bill. There have been a large number of rights issues in the last twelve months, with more to come. Some of these rights issues have or will be in a non-sterling currency. An issuer of non-sterling shares may enter into a derivative contract to hedge against future currency fluctuation. The existing rules give rise to an anomalous tax treatment in these circumstances the derivative contract is closed out when the rights issue is completed (as the funds are received at that date). At this point, an exchange gain or loss would be brought into account for tax purposes. This had the effect that the hedge was not fully effective after tax. Going forward, the tax rules are changed so that an exchange gain and loss is not brought into account for tax purposes when the rights issue is completed, provided that the hedge is actually applied to protect the capital value, and in particular any exchange gain is retained in the business. However, if any exchange gain is not retained in the business, and is instead distributed to shareholders, the exchange gain will be brought into account for tax purposes. When does the change apply? The change will generally apply to hedges entered into on or after 1 January

24 Voluntary managed payments plans corporation tax payments can be spread over a period Who is interested in the change? In principle, all corporation tax payers. In practice, corporation tax payers who wish to spread the cost of meeting their corporation tax liability. What has changed? HMRC have announced that they will introduce managed payment plans, which will in broad terms permit taxpayers to spread their tax payments over a period straddling the normal due dates without giving rise to interest or penalties. The plans will be voluntary. When will it apply? Although the legislation will have effect from Royal Assent to the finance bill, in practice HMRC need to change their computer systems to cope with the new concept, and so plans themselves will not be introduced before April However, HMRC s business payment support service, which is already in operation, enables corporation (and other) tax payments by struggling but viable businesses to be spread. We understand that over 100,000 businesses are already using this service. 24

25 The neutral Manufactured interest treatment of actual manufactured interest payment clarified and will remain as previously widely accepted Who is interested in the change? Parties to repo and stocklending arrangements relating to interest paying securities. These will generally (but not always) be banks and financial services companies. What has changed? The announcement relates to two things - a change to the law and a clarification. Under a repo or stocklending transaction, the parties agree a sale and repurchase of a security, with the sale price usually lower than the repurchase price. The transaction is generally economically equivalent to a secured loan. The parties will generally agree what happens if an interest payment is paid on the underlying security during the life of the transaction. Economically, the interest should belong to the original owner, but it is received by the temporary owner while the repo or stock loan is in place. There are broadly two alternatives firstly, the benefit of the interest payment can be passed to the original owner by reducing the repurchase price (a deemed manufactured payment). Secondly, the recipient can make a manufactured interest payment to the original owner (an actual manufactured payment). The change in the law relates to a previously announced intention to reverse a recent High Court decision relating to the treatment of deemed manufactured interest payments (DCC Holdings (UK) Limited v R&CC [2009] STC 77). In that case, a taxpayer was held to be entitled to a deduction determined by a literal reading of the prescriptive rules on deemed manufactured interest payments notwithstanding that this led to a tax treatment out of kilter with the accounting treatment and the economic gains and losses made by the parties. The clarification relates to actual manufactured interest payments. The budget announcement states that the High Court case is considered to have cast some doubt on the correct tax treatment of actual manufactured interest payments. Legislation will therefore also be introduced to ensure that the tax treatment of actual manufactured interest payments follows the accounting treatment. When will the changes apply? The change to reverse the High Court case in the context of deemed manufactured interest payments will apply to deemed manufactured interest payments on or after date the intention to legislate was announced, being 27 January The legislation to clarify the position for actual manufactured interest payments will apply retrospectively to all actual manufactured interest payments. 25