After last year’s self-proclaimed ‘big Budget’, business might have hoped for a ‘boring Budget’ this year, from a government focused on avoiding drama before June’s Brexit referendum. No such luck: the chancellor unveiled an even wider package of business tax reforms than in the previous Budget. These included yet another corporation tax rate cut, to 17%, although this will not take effect until 2020 – and a number of more imminent changes.
Group loss relief
For most groups, the biggest operational changes will come from the ‘modernisation’ of the rules on using losses around the group. There will be, effectively, no restriction on using carried-forward losses arising after 1 April 2017: they can be set off against any profits of the company concerned; or surrendered freely around the group. (This will presumably need to be accompanied by new loss-buying rules – but the existing loss-buying rules will still need to be retained to cover pre-2017 losses.)
This flexibility will be (more than) paid for by restricting the extent to which profits can be sheltered by carried-forward losses. From 2017, only half of a company’s profits exceeding £5m can be offset against carried-forward losses. (Inevitably, the rules are even tougher for banks – and kick in a year earlier.) Again, this will presumably be accompanied by anti-fragmentation and profit shifting rules, to prevent companies pushing their profits below the £5m threshold.
BEPS-type changes
The government had already hinted that it would be enacting restrictions on interest deductions, in line with BEPS Action 4. Although these restrictions are expected to raise almost £1bn a year, the rules announced in the Budget largely represent the most taxpayer-friendly option in Action 4: net interest deductions will be capped at 30% of the UK group’s taxable EBITDA (or, if higher, the worldwide group’s net interest: EBITDA ratio), with exclusions for net interest costs below £2m, and for some public infrastructure projects. The one departure from this general approach is that, in place of the existing worldwide debt cap rules, a further cap on net UK interest deductions will be imposed equal to the worldwide group’s net interest expense. As this cap focuses on net deductions, it appears that the current debt cap system of allocating gross interest disallowances and exemptions around the group is coming to an end.
The Budget also announced a major extension to the withholding tax regime for royalties. From royal assent of Finance Act 2016, all payments for intangibles from UK companies, UK permanent establishments (PEs) and ‘avoided PEs’ will be subject to withholding tax. That is, of course, subject to any relevant double tax treaty (and the EU Interest and Royalties Directive). However, the government has announced a treaty override, with immediate effect, under which treaty protection will be removed if it is reasonable to conclude that there are arrangements which have a main purpose of obtaining a benefit under the treaty – and if that benefit is contrary to the ‘object and purpose’ of the treaty. As this exclusion is based on the tax treaty ‘principal purpose test’ proposed by BEPS Action 6, HMRC suggests that this override is BEPS compliant. Our treaty partners, on the other hand, might reasonably point out that the principal purpose test was supposed to be enacted by bilateral treaty amendment – not imposed unilaterally by the UK.
The royalty changes were presented, partly, as an attempt to improve the ‘reciprocal balance’ in the UK’s tax treaties, by enabling the UK to withhold tax from royalties wherever it is allowed to do so under a treaty. (Quite how a unilateral treaty override improves the ‘reciprocal balance’ in our treaties was, however, left unexplained.) In similar vein, the government announced that it intends to make fuller use of its treaty rights to tax profits from UK land, by taxing all trading profits from UK land, regardless of whether or not the trade is carried on by a UK resident or through a UK PE. Surprisingly, this change, which is forecast to raise over £600m annually, was accompanied by immediate agreed changes to the UK treaties with Guernsey, Jersey and the Isle of Man, to clarify that the new approach was consistent with those treaties.
Finally in the BEPS area, the government will tighten up the new anti-hybrids rules, to cover mismatch transactions involving PEs. That might be seen as a distinctly minority sport; it is surprising, therefore, that the original anti-hybrid rules were expected to raise only £90m a year, whereas this one amendment is forecast to raise over £250m annually.
More to come?
Alongside these changes, the government announced several consultations which will interest multinationals. These include reviews of SSE (which the government says ‘is in need of modernisation’) and the double tax treaty passport scheme, to ensure it is achieving its policy goals. The government also announced a consultation on extending the UK transfer pricing regime ‘to address the underlying cash benefit from incorrect transfer pricing’, by allowing secondary adjustments (for example, deeming the existence of an interest-bearing loan comprising an amount which should, at arm’s length, have been paid to the UK company); and a consultation on partnership taxation to clarify areas of uncertainty (in other words, all areas of partnership taxation). If the government can keep up this pace of corporate tax change, then there should be no more ‘boring Budgets’ for years to come.
After last year’s self-proclaimed ‘big Budget’, business might have hoped for a ‘boring Budget’ this year, from a government focused on avoiding drama before June’s Brexit referendum. No such luck: the chancellor unveiled an even wider package of business tax reforms than in the previous Budget. These included yet another corporation tax rate cut, to 17%, although this will not take effect until 2020 – and a number of more imminent changes.
Group loss relief
For most groups, the biggest operational changes will come from the ‘modernisation’ of the rules on using losses around the group. There will be, effectively, no restriction on using carried-forward losses arising after 1 April 2017: they can be set off against any profits of the company concerned; or surrendered freely around the group. (This will presumably need to be accompanied by new loss-buying rules – but the existing loss-buying rules will still need to be retained to cover pre-2017 losses.)
This flexibility will be (more than) paid for by restricting the extent to which profits can be sheltered by carried-forward losses. From 2017, only half of a company’s profits exceeding £5m can be offset against carried-forward losses. (Inevitably, the rules are even tougher for banks – and kick in a year earlier.) Again, this will presumably be accompanied by anti-fragmentation and profit shifting rules, to prevent companies pushing their profits below the £5m threshold.
BEPS-type changes
The government had already hinted that it would be enacting restrictions on interest deductions, in line with BEPS Action 4. Although these restrictions are expected to raise almost £1bn a year, the rules announced in the Budget largely represent the most taxpayer-friendly option in Action 4: net interest deductions will be capped at 30% of the UK group’s taxable EBITDA (or, if higher, the worldwide group’s net interest: EBITDA ratio), with exclusions for net interest costs below £2m, and for some public infrastructure projects. The one departure from this general approach is that, in place of the existing worldwide debt cap rules, a further cap on net UK interest deductions will be imposed equal to the worldwide group’s net interest expense. As this cap focuses on net deductions, it appears that the current debt cap system of allocating gross interest disallowances and exemptions around the group is coming to an end.
The Budget also announced a major extension to the withholding tax regime for royalties. From royal assent of Finance Act 2016, all payments for intangibles from UK companies, UK permanent establishments (PEs) and ‘avoided PEs’ will be subject to withholding tax. That is, of course, subject to any relevant double tax treaty (and the EU Interest and Royalties Directive). However, the government has announced a treaty override, with immediate effect, under which treaty protection will be removed if it is reasonable to conclude that there are arrangements which have a main purpose of obtaining a benefit under the treaty – and if that benefit is contrary to the ‘object and purpose’ of the treaty. As this exclusion is based on the tax treaty ‘principal purpose test’ proposed by BEPS Action 6, HMRC suggests that this override is BEPS compliant. Our treaty partners, on the other hand, might reasonably point out that the principal purpose test was supposed to be enacted by bilateral treaty amendment – not imposed unilaterally by the UK.
The royalty changes were presented, partly, as an attempt to improve the ‘reciprocal balance’ in the UK’s tax treaties, by enabling the UK to withhold tax from royalties wherever it is allowed to do so under a treaty. (Quite how a unilateral treaty override improves the ‘reciprocal balance’ in our treaties was, however, left unexplained.) In similar vein, the government announced that it intends to make fuller use of its treaty rights to tax profits from UK land, by taxing all trading profits from UK land, regardless of whether or not the trade is carried on by a UK resident or through a UK PE. Surprisingly, this change, which is forecast to raise over £600m annually, was accompanied by immediate agreed changes to the UK treaties with Guernsey, Jersey and the Isle of Man, to clarify that the new approach was consistent with those treaties.
Finally in the BEPS area, the government will tighten up the new anti-hybrids rules, to cover mismatch transactions involving PEs. That might be seen as a distinctly minority sport; it is surprising, therefore, that the original anti-hybrid rules were expected to raise only £90m a year, whereas this one amendment is forecast to raise over £250m annually.
More to come?
Alongside these changes, the government announced several consultations which will interest multinationals. These include reviews of SSE (which the government says ‘is in need of modernisation’) and the double tax treaty passport scheme, to ensure it is achieving its policy goals. The government also announced a consultation on extending the UK transfer pricing regime ‘to address the underlying cash benefit from incorrect transfer pricing’, by allowing secondary adjustments (for example, deeming the existence of an interest-bearing loan comprising an amount which should, at arm’s length, have been paid to the UK company); and a consultation on partnership taxation to clarify areas of uncertainty (in other words, all areas of partnership taxation). If the government can keep up this pace of corporate tax change, then there should be no more ‘boring Budgets’ for years to come.
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