With public sector debt at a record high and tax revenues down, the big question for 2021 is whether we will see any tax increases, one-off taxes or radical changes to the system. A lot turns on the extent to which the vaccine rolls out and the new Trade and Cooperation Agreement (TCA) delivers an economic boost – and whether that comes quickly enough for the Budget on 3 March to be used for tax-raising.
The UK is now free of the shackles of the ‘fundamental freedoms’ and VAT directive so can set its tax policy as it sees fit, subject to observing its commitments to the OECD and wider community and its obligations under the TCA: the UK has in particular committed not to ‘weaken or reduce’ the level of protection in current legislation of OECD procedures and standards and entered into a Joint Political Declaration on Countering Harmful Tax Regimes in particular in line with BEPS 5 – no doubt reflecting the EU’s concerns that the UK could become ‘Singapore-on-Thames’.
On the flip side to states operating beneficial tax regimes, and unlike the free trade agreements negotiated recently by the EU with Canada, Singapore and Vietnam, the TCA does not contain any investment treaty-type provisions – provisions which in some cases have been used to challenge a state’s exercise of taxing rights. The UK does, however, have pre-existing bilateral investment treaties in place with 12 member states, predominantly in Eastern Europe.
One of the most pressing business and social issues is countering climate change. The EU and UK have used the TCA to reaffirm their respective commitments to achieve net zero greenhouse gas emissions by 2050 and to meet their latest ‘carbon budget’ commitments for 2030.
The TCA also affirms the UK’s commitment to maintaining a system of ‘carbon pricing’ but is silent on methodology. The UK does not currently have a carbon tax but has been a member of the EU’s emissions trading scheme (ETS), which through control of the supply of ‘carbon credits’ creates a market price for the right to emit. The UK has left the EU scheme and a UK ETS applies to UK emitters with effect for emissions arising from 1 January 2020. Negotiations are ongoing as to whether credits from one system can be used in the other.
Press reports continue to circulate that the UK may be proceeding with the ‘carbon emissions tax’ on which it consulted in the summer. Although a country generates revenues from auctioning credits in an ETS, it does not see any direct upside from a rise in the price of those credits due to market forces. The EU and UK ETSs also cover only 30-40% of those who actually emit and the amount the UK generates from auctions (£1bn) is relatively modest. Maybe the temptation to tax carbon more heavily will be too great to miss. Taxes designed to discourage activity should, if perfectly successful, lead to no increased tax take – but given how long it will take to turn the carbon super-tanker around, a carbon tax might only be around for the amount of time it will take to pay off coronavirus debts.
More fundamentally, though, the government needs to think strategically about using the tax system to reduce carbon consumption. HMRC and Treasury recently issued a call for evidence on the use of tax incentives to promote ‘cleantech’ innovation. However, we also need to review whether capital allowances need to be properly reformed to ensure businesses buy such emerging technologies, which can often be more expensive when first developed. The Climate Change Working Group in the CIOT (of which Jason Collins is the chair) is calling for the government to publish a climate change road map setting out a comprehensive climate change tax policy strategy for the next 30 years.
On 1 January 2021, the UK left the EU regulations and directives dealing with administrative cooperation, information exchange and recovery of taxes and duties. It of course remains party to OECD information and cooperation schemes (e.g. the CRS, the MLI and CBCR) but to plug gaps in coverage of these schemes the TCA contains express provisions for administrative cooperation regarding VAT, and mutual assistance in the recovery of debts for VAT, customs duties and excise duties.
The most recent EU directive which the UK is no longer bound by is DAC 6. DAC 6 at its simplest creates a common reporting system under which, in the context of all taxes levied in the EU other than VAT, customs duties and excise duties, EU based intermediaries must report to their home state where they assist others to engage in cross-border arrangements which bear certain ‘hallmarks’. The home state is in turn obligated to share the report automatically with all member states affected by the arrangements.
UK legislation has been updated to continue to require UK intermediaries and taxpayers to follow hallmark D of DAC 6, but not the remaining hallmarks A, B, C and E. This is because DAC 6 was born out of the OECD’s BEPS Action 12 (mandatory disclosure rules – MDR). It was the first example of a full-blown reporting system envisaged by BEPS 12, and it was welcomed by the OECD but not designed by it. The only policy area for which the OECD has developed detailed ‘model’ rules is CRS avoidance/opaque structures – which marries up to hallmark D of DAC 6. So, to respect its obligation not to lessen any legislation which implements OECD rules, as a quick fix the UK has decided to continue to require hallmark D reporting for now and presumably to share the reports with concerned member states (it is not clear yet whether the EU plans to reciprocate).
However, during 2021 the UK will consult on new legislation to remove all links to DAC 6 and to implement a suite of its own MDRs consistent with BEPS 12 recommendations – as HMRC puts it, in order to move from ‘EU to international rules’. The UK was a key player in the design of DAC 6 and perhaps relishes the opportunity to design a new set of rules, unconstrained by the need to find EU consensus. Indeed, perhaps it has in mind a project to help the OECD to design a model set. Whatever happens, hopefully the UK will improve some of the worst features of DAC 6, and this may, in our dreams, eventually lead to reforms of those features within DAC 6 itself.
In the meantime, DAC 6 continues in the EU without the UK’s participation. Much turns on how individual member states have implemented DAC 6 domestically, but in theory cross-border arrangements concerning only UK taxpayers will no longer be reportable by EU intermediaries (save perhaps in respect of hallmark D). Instead, under UK law, UK users of arrangements (if assisted solely by EU intermediaries) will have to self-report. Likewise, EU users assisted solely by UK intermediaries will have to self-report.
HMRC’s ‘tax under consideration’ for large businesses has risen by 16% to £34.8bn in the year to 31 March 2020, from £29.9bn the year before. Within this, transfer pricing (TP) and thin capitalisation under consideration has jumped 74% to £10.4bn from £6bn. Tax under consideration is HMRC’s estimate of the maximum potential additional tax liability when it begins a check. Historically, around 50% of this figure on average turns out to be due (although HMRC says this percentage is increasing).
HMRC launched the profit diversion compliance facility (PDCF) in January 2019 and, after a short break as a result of the pandemic, has now resumed sending ‘nudge’ letters to businesses, prompting them to reconsider their transfer pricing (TP), residence and profit attribution arrangements and offering them the opportunity to disclose all irregularities under the PDCF and pay any tax owing, in order to avoid an HMRC investigation and a possible exposure to diverted profits tax. Use of the PDCF is not a panacea, and we are already seeing HMRC rejecting the conclusions drawn by some users of the PDCF and launching its own checks.
Businesses may also need to revisit their TP arrangements if the way they conduct business has changed as a result of the pandemic. One of HMRC’s concerns is that businesses are pricing internal transactions based on internal contracts or other documented positions which do not reflect the reality on the ground. Clearly, it is more likely that two connected parties will depart from documented terms than would be the case for two independent enterprises, so keeping up with reality can be hard for a head of TP.
HMRC has disclosed that it has started a number of fraud investigations, centred on whether knowing misrepresentations have been made during HMRC’s enquiries into TP, residence and profit attribution arrangements. This serves as a warning for heads of tax to be sure of their facts before making any submissions to HMRC – because if the facts are later found to differ from those presented, HMRC will want to know whether that was purely accidental, careless or knowing. It can make for an uncomfortable relationship but HMRC will understandably have to ask some difficult questions to establish state of mind. Even if the corporate can show that the misrepresentation wasn’t deliberate, carelessness will provide grounds for HMRC to impose penalties.
Many large businesses expressed relief that HMRC has deferred proposals for requiring large businesses to notify HMRC of uncertain tax positions until April 2022. From public domain comments made by a senior HMRC official, it sounds as if HMRC is (rightly) rethinking one of the most controversial aspects of the proposal, which is the fact that businesses would have to decide whether the position they have taken is one with which HMRC may not agree. We may find out in the Budget what is proposed instead.
In April 2019, the European Commission concluded that the full and partial exemption for non-trading finance profits in the UK’s CFC rules was incompatible with EU state aid rules to the extent that the profits are generated from UK activities (tested by reference to relevant significant people functions) and required the UK to recover the unlawful state aid, with interest, from groups which benefited. The period affected is 1 January 2013 to 31 December 2018.
The UK has challenged the decision before the EU courts but is still obliged to recover the state aid notwithstanding this litigation. As the alleged aid is an amount absolved under UK tax legislation, recovery falls outside the usual tax assessment system. To avoid having to rely on costly and protracted civil proceedings to recover the aid, the Taxation (Post-Transition Period) Act 2020 gives HMRC new powers to recover the alleged aid using a process of issuing charging notices, using a ‘pay now argue later’ system similar to that used for diverted profits tax and advance payment notices. The notices can also be used to recover amounts from a related company. We can expect to see many of these notices issued during 2021.
The pandemic has accelerated the exploitation of the digital economy and made changes to country taxing rights to deal with digitisation and consumer-facing brands even more pressing. The OECD had aimed to have agreement to a new rule book by the end of 2020. However, this was not possible, partly as a result of intransigence of the US, which sees the measures as unfairly targeting US owned technology companies, and partly as a result of the pandemic. Meanwhile countries which are major markets for the technology giants continue to take more aggressive stances under current rules on ‘digital PEs’ and withholding taxes – or like France and the UK press ahead with temporary unilateral digital services taxes. If international agreement cannot be reached on new taxing rights in early 2021, we are likely to see even more unilateral digital services taxes, including the mothballed EU wide proposal. The need to collect taxes to pay off coronavirus-related borrowing is only likely to add to the pressure.
The arena of disputes over country taxing rights has also seen the successful use of a bilateral investment treaty by Cairn Energy to defeat, in arbitration, India’s use of retrospective legislation to tax the gain made from the sale by a non-Indian company of shares it held in an Indian company. India has not yet said what its next move will be, but in an age where the UK intimated that it would not follow international law to a ‘specific and limited’ extent in connection with the Northern Ireland protocol, who knows what India might do.
Rises in personal taxes, if not in 2021 but in 2022, seem likely. The chancellor has asked the OTS to review capital gains tax, and its initial report published in November on policy design and principles has already set a number of hares running. Talk of more closely aligning CGT rates with income tax rates, replacing business asset disposal relief with a relief more focused on retirement and slashing the annual exempt amount may lead to more business sales to ‘beat the change’, with the 3 March budget now being a seminal date. The report also suggests abolishing the CGT uplift on death and recommends that the government should revisit the appropriateness of taxing some share-based rewards of employment as capital rather than income. It also proposes taxing the accumulation of retained earnings in smaller owner-managed companies at income tax rates.
For anyone who has been working in tax for a long time, there is a sense of déjà vu to many of these suggestions. Retirement relief, indexation allowance and the close company apportionment regime (which stopped profits being stored up in small companies) have all been past features of our tax system, swept away in different times.
A further OTS report is promised for early 2021 and will ‘explore key technical and administrative issues’. Some of the possible changes would require a more substantial rethink of the system, including its interaction with inheritance tax and so could not be made without considerable legislative changes. Of course, increasing rates or slashing the annual exempt amount would be simple to bring into force and so could apply more immediately. Cuts in the annual exemption would have to be weighed against the increase in administrative costs for HMRC if significantly more people have to complete a tax return to declare relatively small sums of CGT.
If CGT rates are increased to be in line with a taxpayer’s marginal rate of income tax, UK resident beneficiaries of offshore trusts could suffer an effective tax rate of 72% on distributions they receive. This is because distributions are taxed based on ‘stockpiled capital gains’ within the trust (i.e. capital gains that have not yet been distributed). When a capital gain is stockpiled for more than two years, a surcharge of 10% of the capital gains tax is added to the liability. This continues each year up to a maximum of six years. So, 45% x (10% x 6 years) = 72%.
There are concerns from the private equity industry about an increase in tax on carried interest. Although such a measure may have popular support, the industry fears an outflow of funds to countries which retain a more favourable regime for private equity executives.
Another option for clawing back some cash is to make changes to pensions tax relief. This relief is costly for the Treasury and disproportionately benefits middle to higher earners so we could see 40% and 45% taxpayers’ relief cut to 20 per cent or the introduction of a 30% flat rate of tax relief, or more radical measures such as abolishing the 25% tax free lump sum or giving the tax relief when money comes out rather than when it goes in.
A one-off wealth tax has also been suggested by some. The Wealth Commission, a group of tax policy experts, suggested in December that a one-off wealth tax payable on all individual wealth above £500,000 and charged at 1% a year for five years would raise £260bn; at a threshold of £2m it would raise £80bn. This would be paid by individuals whose total wealth after mortgages and other debts, and after splitting the value of shared assets such as a jointly-owned family home, exceeded the tax threshold, and only on the value of wealth above that threshold.
The pandemic-delayed changes to the so-called IR35 off-payroll working rules will come into force on 6 April 2021. The rules essentially shift the responsibility for ‘observing’ the rules to the engager (if a medium or large business), as happened first for public sector engagers. Although many businesses have already changed practices and taken some roles directly on to payroll, we still expect to see some businesses struggle with compliance where roles continue to be sourced through intermediary working.
We could also see more moves to reduce the difference between the way the employed and the self-employed are taxed. When he announced support for the self-employed at the beginning of the pandemic, Rishi Sunak warned that it was much harder to justify the ‘inconsistent contributions’ between people of different employment statuses when the self-employed are (mostly) also benefiting from state support as a result of the pandemic.
The temporary SDLT reduction comes to an end on 31 March 2021. This makes the first £500,000 of the consideration for a residential property (including a second home or investment property) SDLT free.
The next day will see the introduction of the SDLT surcharge for non-residents buying residential property or taking the grant of a lease of residential property in England or Northern Ireland. The surcharge increases the SDLT rates by 2% and is in addition to the 3% surcharge on the acquisition of second homes. It will apply where the effective date of a transaction (usually completion) is on or after 1 April 2021.
The surcharge is the latest in a series of changes designed to make it more expensive for non-residents to hold UK property. The first change back in 2012 was the introduction of a 15% SDLT charge for residential property with a purchase price of more than £2m bought by a non-natural person such as a company – a structure typically used by non-UK residents to hold UK property. This £2m threshold has since been reduced to £500k and the non-resident surcharge will effectively make the highest rate of SDLT 17%.
It seems likely that the ‘double whammy’ of withdrawing the temporary SDLT reduction and the non-resident surcharge will dampen the UK property market for the last three quarters of 2021.
The domestic reverse charge for the construction sector (to counter organised VAT fraud) is another of those measures which seem to have been talked about for a while and keep getting deferred. Its introduction was initially delayed from 1 October 2019 to 1 October 2020, because there were concerns that many businesses were unprepared for the changes. Then coronavirus delayed it until 1 March 2021. It is still doubtful whether businesses are prepared for the change and it remains to be seen whether it will have to be delayed even further.
In the midst of the pandemic, HMRC published a surprise change in practice in relation to VAT and contract terminations in its Revenue & Customs Brief 12/2020, which it claimed would have retrospective effect. A surprising aspect of the brief was the suggestion that principles established in two CJEU cases relating to termination payments for mobile phone and digital media contracts meant that all compensation payments in relation to contracts were now subject to VAT and not out-of-scope compensation payments. This resulted, in particular, in confusion as to how the brief applied to real estate, including dilapidation payments under leases. We understand that HMRC is backing down on making the change retrospective and intends to issue a further brief this month, which should clarify its new position.
The Brexit transition period has come to an end and the UK is fully out of the EU. Leaving aside the immediate challenges for those importing goods from and exporting goods to the EU, who are having to grapple with new procedures, 2021 may be the year when we begin to see the UK moving away from EU VAT law in some areas – or at least signaling where it intends to do so in the future.
The call for evidence into the VAT group rules launched in the autumn suggests that this could be an area where the government is looking to make changes. Points being considered include making it so that only UK businesses and the UK establishments of non-UK businesses would be able to be VAT grouped; making grouping compulsory rather than elective; allowing limited partnerships and Scottish limited partnerships to join VAT groups – an area which definitely needs to be clarified. Although it may be ambitious to expect changes to the regime to happen in 2021, we should at least hear more about the likely direction of travel.
Another call for evidence published in December suggests that the government is looking at possible changes in relation to digital platforms in the ‘sharing economy’. The platforms typically maintain that legally and for VAT purposes they provide information technology and agency services only, and that the underlying service (such as a rental) is a supply by the service provider, who is often under the VAT registration threshold, to the customer. The call for evidence suggests the government may accept defeat on the legal analysis but change the rules to make the platform the supplier for VAT purposes. The call for evidence closes on 3 March 2021, which means we will have to wait to see if this is likely to turn into a full-blown change in tax policy.
As a reaction to large number of cases (particularly in relation to immigration), the government has appointed a panel of experts to look at the case for reform of the judicial review process. Separately, the government is also looking at making it harder to obtain permission to appeal from the Upper Tribunal to the Court of Appeal. Changes in either area could have deep-seated implications for disputes with HMRC and we should hear more about what the government proposes to do during 2021.
The Tooth case concerning ‘discovery’ assessments is due to be heard in the Supreme Court in March 2021. There are a number of important issues for the Supreme Court to consider, including whether HMRC made a ‘discovery’ of an insufficiency in a tax return; if so, did the return contain an ‘inaccuracy’; and, if so, was the inaccuracy ‘deliberate’. Further, although it was not pleaded or argued at any stage below that the discovery had become stale, HMRC seems to be hoping that the Supreme Court will use the case to rule on whether the concept of ‘staleness’ exists.
In relation to VAT and other parts of the tax system which constitute ‘retained EU law’, the tax tribunals and the courts will have to begin to use new rules to interpret that legislation. UK courts and tribunals will not be bound by decisions of the CJEU made after 31 December 2020 and the Supreme Court will be able to depart from CJEU decisions made before that time in the same way as they are able to depart from their own decisions. The government has extended this power to depart from CJEU decisions to the Court of Appeal and its equivalents. It seems unlikely, though, that these new rules will have a major impact in 2021. They are more likely to lead to disputes as UK VAT moves away from the EU system.
HMRC is likely to continue to deploy significant resources to audit and investigate non-compliance with furlough and the other government coronavirus support schemes. Those who have claimed the support need to continue to remain vigilant to ensure that they are complying with the rules and to make sure that they are aware of what has been happening on the ground. There are sure to be many cases where, unbeknown to senior management, employees have been working whilst on furlough, whether as a result of an instruction from their line manager or because they think they are helping their employer. As these cases come to light, it will be important that employers make a full disclosure to HMRC and repay any amounts overclaimed as soon as possible.
HMRC raids in relation to the strict liability facilitation of tax evasion offences, also known as the corporate criminal offence (CCO), began at the end of 2018. It is possible that charges will be brought in relation to some of these cases in 2021. HMRC raid activity has, naturally, been hampered by the lockdown restrictions so we expect to see an uptick in raid activity as and when such restrictions are lifted.
In 2021, we are also likely to see more coordinated interventions to tackle transnational tax fraud, such as facilitation offences, from the Joint Chiefs of Global Tax Enforcement (J5). This involves the heads of tax enforcement from the UK, US, Australia, the Netherlands and Canada. In January 2020, the group carried out a globally coordinated day of action against an international financial institution suspected of facilitating money laundering and tax evasion.
2021 may turn out to be a seminal year in tax – at least in terms of some big changes in international and domestic tax policy, even if some of those policies might not come into effect until 2022 (meaning that FA 2022 may be more likely to be quoted regularly into the future than FA 2021). We will also see HMRC tasked with carrying out more and more interventions to drive investigation yield. The pace at which the global economy recovers will drive timing in both respects. One does have to question HMRC’s bandwidth to make these interventions and changes, particularly as it grapples with finding its new way as tax-collector to a sovereign state and an enormous change in its relationship with the EU. We’re sure though that it is confident it can rise to meet the challenge.
The authors thank Clara Boyd, Josie Hills, Steven Porter and Andrew Sackey of the Pinsent Masons tax team for their contributions to this article.
With public sector debt at a record high and tax revenues down, the big question for 2021 is whether we will see any tax increases, one-off taxes or radical changes to the system. A lot turns on the extent to which the vaccine rolls out and the new Trade and Cooperation Agreement (TCA) delivers an economic boost – and whether that comes quickly enough for the Budget on 3 March to be used for tax-raising.
The UK is now free of the shackles of the ‘fundamental freedoms’ and VAT directive so can set its tax policy as it sees fit, subject to observing its commitments to the OECD and wider community and its obligations under the TCA: the UK has in particular committed not to ‘weaken or reduce’ the level of protection in current legislation of OECD procedures and standards and entered into a Joint Political Declaration on Countering Harmful Tax Regimes in particular in line with BEPS 5 – no doubt reflecting the EU’s concerns that the UK could become ‘Singapore-on-Thames’.
On the flip side to states operating beneficial tax regimes, and unlike the free trade agreements negotiated recently by the EU with Canada, Singapore and Vietnam, the TCA does not contain any investment treaty-type provisions – provisions which in some cases have been used to challenge a state’s exercise of taxing rights. The UK does, however, have pre-existing bilateral investment treaties in place with 12 member states, predominantly in Eastern Europe.
One of the most pressing business and social issues is countering climate change. The EU and UK have used the TCA to reaffirm their respective commitments to achieve net zero greenhouse gas emissions by 2050 and to meet their latest ‘carbon budget’ commitments for 2030.
The TCA also affirms the UK’s commitment to maintaining a system of ‘carbon pricing’ but is silent on methodology. The UK does not currently have a carbon tax but has been a member of the EU’s emissions trading scheme (ETS), which through control of the supply of ‘carbon credits’ creates a market price for the right to emit. The UK has left the EU scheme and a UK ETS applies to UK emitters with effect for emissions arising from 1 January 2020. Negotiations are ongoing as to whether credits from one system can be used in the other.
Press reports continue to circulate that the UK may be proceeding with the ‘carbon emissions tax’ on which it consulted in the summer. Although a country generates revenues from auctioning credits in an ETS, it does not see any direct upside from a rise in the price of those credits due to market forces. The EU and UK ETSs also cover only 30-40% of those who actually emit and the amount the UK generates from auctions (£1bn) is relatively modest. Maybe the temptation to tax carbon more heavily will be too great to miss. Taxes designed to discourage activity should, if perfectly successful, lead to no increased tax take – but given how long it will take to turn the carbon super-tanker around, a carbon tax might only be around for the amount of time it will take to pay off coronavirus debts.
More fundamentally, though, the government needs to think strategically about using the tax system to reduce carbon consumption. HMRC and Treasury recently issued a call for evidence on the use of tax incentives to promote ‘cleantech’ innovation. However, we also need to review whether capital allowances need to be properly reformed to ensure businesses buy such emerging technologies, which can often be more expensive when first developed. The Climate Change Working Group in the CIOT (of which Jason Collins is the chair) is calling for the government to publish a climate change road map setting out a comprehensive climate change tax policy strategy for the next 30 years.
On 1 January 2021, the UK left the EU regulations and directives dealing with administrative cooperation, information exchange and recovery of taxes and duties. It of course remains party to OECD information and cooperation schemes (e.g. the CRS, the MLI and CBCR) but to plug gaps in coverage of these schemes the TCA contains express provisions for administrative cooperation regarding VAT, and mutual assistance in the recovery of debts for VAT, customs duties and excise duties.
The most recent EU directive which the UK is no longer bound by is DAC 6. DAC 6 at its simplest creates a common reporting system under which, in the context of all taxes levied in the EU other than VAT, customs duties and excise duties, EU based intermediaries must report to their home state where they assist others to engage in cross-border arrangements which bear certain ‘hallmarks’. The home state is in turn obligated to share the report automatically with all member states affected by the arrangements.
UK legislation has been updated to continue to require UK intermediaries and taxpayers to follow hallmark D of DAC 6, but not the remaining hallmarks A, B, C and E. This is because DAC 6 was born out of the OECD’s BEPS Action 12 (mandatory disclosure rules – MDR). It was the first example of a full-blown reporting system envisaged by BEPS 12, and it was welcomed by the OECD but not designed by it. The only policy area for which the OECD has developed detailed ‘model’ rules is CRS avoidance/opaque structures – which marries up to hallmark D of DAC 6. So, to respect its obligation not to lessen any legislation which implements OECD rules, as a quick fix the UK has decided to continue to require hallmark D reporting for now and presumably to share the reports with concerned member states (it is not clear yet whether the EU plans to reciprocate).
However, during 2021 the UK will consult on new legislation to remove all links to DAC 6 and to implement a suite of its own MDRs consistent with BEPS 12 recommendations – as HMRC puts it, in order to move from ‘EU to international rules’. The UK was a key player in the design of DAC 6 and perhaps relishes the opportunity to design a new set of rules, unconstrained by the need to find EU consensus. Indeed, perhaps it has in mind a project to help the OECD to design a model set. Whatever happens, hopefully the UK will improve some of the worst features of DAC 6, and this may, in our dreams, eventually lead to reforms of those features within DAC 6 itself.
In the meantime, DAC 6 continues in the EU without the UK’s participation. Much turns on how individual member states have implemented DAC 6 domestically, but in theory cross-border arrangements concerning only UK taxpayers will no longer be reportable by EU intermediaries (save perhaps in respect of hallmark D). Instead, under UK law, UK users of arrangements (if assisted solely by EU intermediaries) will have to self-report. Likewise, EU users assisted solely by UK intermediaries will have to self-report.
HMRC’s ‘tax under consideration’ for large businesses has risen by 16% to £34.8bn in the year to 31 March 2020, from £29.9bn the year before. Within this, transfer pricing (TP) and thin capitalisation under consideration has jumped 74% to £10.4bn from £6bn. Tax under consideration is HMRC’s estimate of the maximum potential additional tax liability when it begins a check. Historically, around 50% of this figure on average turns out to be due (although HMRC says this percentage is increasing).
HMRC launched the profit diversion compliance facility (PDCF) in January 2019 and, after a short break as a result of the pandemic, has now resumed sending ‘nudge’ letters to businesses, prompting them to reconsider their transfer pricing (TP), residence and profit attribution arrangements and offering them the opportunity to disclose all irregularities under the PDCF and pay any tax owing, in order to avoid an HMRC investigation and a possible exposure to diverted profits tax. Use of the PDCF is not a panacea, and we are already seeing HMRC rejecting the conclusions drawn by some users of the PDCF and launching its own checks.
Businesses may also need to revisit their TP arrangements if the way they conduct business has changed as a result of the pandemic. One of HMRC’s concerns is that businesses are pricing internal transactions based on internal contracts or other documented positions which do not reflect the reality on the ground. Clearly, it is more likely that two connected parties will depart from documented terms than would be the case for two independent enterprises, so keeping up with reality can be hard for a head of TP.
HMRC has disclosed that it has started a number of fraud investigations, centred on whether knowing misrepresentations have been made during HMRC’s enquiries into TP, residence and profit attribution arrangements. This serves as a warning for heads of tax to be sure of their facts before making any submissions to HMRC – because if the facts are later found to differ from those presented, HMRC will want to know whether that was purely accidental, careless or knowing. It can make for an uncomfortable relationship but HMRC will understandably have to ask some difficult questions to establish state of mind. Even if the corporate can show that the misrepresentation wasn’t deliberate, carelessness will provide grounds for HMRC to impose penalties.
Many large businesses expressed relief that HMRC has deferred proposals for requiring large businesses to notify HMRC of uncertain tax positions until April 2022. From public domain comments made by a senior HMRC official, it sounds as if HMRC is (rightly) rethinking one of the most controversial aspects of the proposal, which is the fact that businesses would have to decide whether the position they have taken is one with which HMRC may not agree. We may find out in the Budget what is proposed instead.
In April 2019, the European Commission concluded that the full and partial exemption for non-trading finance profits in the UK’s CFC rules was incompatible with EU state aid rules to the extent that the profits are generated from UK activities (tested by reference to relevant significant people functions) and required the UK to recover the unlawful state aid, with interest, from groups which benefited. The period affected is 1 January 2013 to 31 December 2018.
The UK has challenged the decision before the EU courts but is still obliged to recover the state aid notwithstanding this litigation. As the alleged aid is an amount absolved under UK tax legislation, recovery falls outside the usual tax assessment system. To avoid having to rely on costly and protracted civil proceedings to recover the aid, the Taxation (Post-Transition Period) Act 2020 gives HMRC new powers to recover the alleged aid using a process of issuing charging notices, using a ‘pay now argue later’ system similar to that used for diverted profits tax and advance payment notices. The notices can also be used to recover amounts from a related company. We can expect to see many of these notices issued during 2021.
The pandemic has accelerated the exploitation of the digital economy and made changes to country taxing rights to deal with digitisation and consumer-facing brands even more pressing. The OECD had aimed to have agreement to a new rule book by the end of 2020. However, this was not possible, partly as a result of intransigence of the US, which sees the measures as unfairly targeting US owned technology companies, and partly as a result of the pandemic. Meanwhile countries which are major markets for the technology giants continue to take more aggressive stances under current rules on ‘digital PEs’ and withholding taxes – or like France and the UK press ahead with temporary unilateral digital services taxes. If international agreement cannot be reached on new taxing rights in early 2021, we are likely to see even more unilateral digital services taxes, including the mothballed EU wide proposal. The need to collect taxes to pay off coronavirus-related borrowing is only likely to add to the pressure.
The arena of disputes over country taxing rights has also seen the successful use of a bilateral investment treaty by Cairn Energy to defeat, in arbitration, India’s use of retrospective legislation to tax the gain made from the sale by a non-Indian company of shares it held in an Indian company. India has not yet said what its next move will be, but in an age where the UK intimated that it would not follow international law to a ‘specific and limited’ extent in connection with the Northern Ireland protocol, who knows what India might do.
Rises in personal taxes, if not in 2021 but in 2022, seem likely. The chancellor has asked the OTS to review capital gains tax, and its initial report published in November on policy design and principles has already set a number of hares running. Talk of more closely aligning CGT rates with income tax rates, replacing business asset disposal relief with a relief more focused on retirement and slashing the annual exempt amount may lead to more business sales to ‘beat the change’, with the 3 March budget now being a seminal date. The report also suggests abolishing the CGT uplift on death and recommends that the government should revisit the appropriateness of taxing some share-based rewards of employment as capital rather than income. It also proposes taxing the accumulation of retained earnings in smaller owner-managed companies at income tax rates.
For anyone who has been working in tax for a long time, there is a sense of déjà vu to many of these suggestions. Retirement relief, indexation allowance and the close company apportionment regime (which stopped profits being stored up in small companies) have all been past features of our tax system, swept away in different times.
A further OTS report is promised for early 2021 and will ‘explore key technical and administrative issues’. Some of the possible changes would require a more substantial rethink of the system, including its interaction with inheritance tax and so could not be made without considerable legislative changes. Of course, increasing rates or slashing the annual exempt amount would be simple to bring into force and so could apply more immediately. Cuts in the annual exemption would have to be weighed against the increase in administrative costs for HMRC if significantly more people have to complete a tax return to declare relatively small sums of CGT.
If CGT rates are increased to be in line with a taxpayer’s marginal rate of income tax, UK resident beneficiaries of offshore trusts could suffer an effective tax rate of 72% on distributions they receive. This is because distributions are taxed based on ‘stockpiled capital gains’ within the trust (i.e. capital gains that have not yet been distributed). When a capital gain is stockpiled for more than two years, a surcharge of 10% of the capital gains tax is added to the liability. This continues each year up to a maximum of six years. So, 45% x (10% x 6 years) = 72%.
There are concerns from the private equity industry about an increase in tax on carried interest. Although such a measure may have popular support, the industry fears an outflow of funds to countries which retain a more favourable regime for private equity executives.
Another option for clawing back some cash is to make changes to pensions tax relief. This relief is costly for the Treasury and disproportionately benefits middle to higher earners so we could see 40% and 45% taxpayers’ relief cut to 20 per cent or the introduction of a 30% flat rate of tax relief, or more radical measures such as abolishing the 25% tax free lump sum or giving the tax relief when money comes out rather than when it goes in.
A one-off wealth tax has also been suggested by some. The Wealth Commission, a group of tax policy experts, suggested in December that a one-off wealth tax payable on all individual wealth above £500,000 and charged at 1% a year for five years would raise £260bn; at a threshold of £2m it would raise £80bn. This would be paid by individuals whose total wealth after mortgages and other debts, and after splitting the value of shared assets such as a jointly-owned family home, exceeded the tax threshold, and only on the value of wealth above that threshold.
The pandemic-delayed changes to the so-called IR35 off-payroll working rules will come into force on 6 April 2021. The rules essentially shift the responsibility for ‘observing’ the rules to the engager (if a medium or large business), as happened first for public sector engagers. Although many businesses have already changed practices and taken some roles directly on to payroll, we still expect to see some businesses struggle with compliance where roles continue to be sourced through intermediary working.
We could also see more moves to reduce the difference between the way the employed and the self-employed are taxed. When he announced support for the self-employed at the beginning of the pandemic, Rishi Sunak warned that it was much harder to justify the ‘inconsistent contributions’ between people of different employment statuses when the self-employed are (mostly) also benefiting from state support as a result of the pandemic.
The temporary SDLT reduction comes to an end on 31 March 2021. This makes the first £500,000 of the consideration for a residential property (including a second home or investment property) SDLT free.
The next day will see the introduction of the SDLT surcharge for non-residents buying residential property or taking the grant of a lease of residential property in England or Northern Ireland. The surcharge increases the SDLT rates by 2% and is in addition to the 3% surcharge on the acquisition of second homes. It will apply where the effective date of a transaction (usually completion) is on or after 1 April 2021.
The surcharge is the latest in a series of changes designed to make it more expensive for non-residents to hold UK property. The first change back in 2012 was the introduction of a 15% SDLT charge for residential property with a purchase price of more than £2m bought by a non-natural person such as a company – a structure typically used by non-UK residents to hold UK property. This £2m threshold has since been reduced to £500k and the non-resident surcharge will effectively make the highest rate of SDLT 17%.
It seems likely that the ‘double whammy’ of withdrawing the temporary SDLT reduction and the non-resident surcharge will dampen the UK property market for the last three quarters of 2021.
The domestic reverse charge for the construction sector (to counter organised VAT fraud) is another of those measures which seem to have been talked about for a while and keep getting deferred. Its introduction was initially delayed from 1 October 2019 to 1 October 2020, because there were concerns that many businesses were unprepared for the changes. Then coronavirus delayed it until 1 March 2021. It is still doubtful whether businesses are prepared for the change and it remains to be seen whether it will have to be delayed even further.
In the midst of the pandemic, HMRC published a surprise change in practice in relation to VAT and contract terminations in its Revenue & Customs Brief 12/2020, which it claimed would have retrospective effect. A surprising aspect of the brief was the suggestion that principles established in two CJEU cases relating to termination payments for mobile phone and digital media contracts meant that all compensation payments in relation to contracts were now subject to VAT and not out-of-scope compensation payments. This resulted, in particular, in confusion as to how the brief applied to real estate, including dilapidation payments under leases. We understand that HMRC is backing down on making the change retrospective and intends to issue a further brief this month, which should clarify its new position.
The Brexit transition period has come to an end and the UK is fully out of the EU. Leaving aside the immediate challenges for those importing goods from and exporting goods to the EU, who are having to grapple with new procedures, 2021 may be the year when we begin to see the UK moving away from EU VAT law in some areas – or at least signaling where it intends to do so in the future.
The call for evidence into the VAT group rules launched in the autumn suggests that this could be an area where the government is looking to make changes. Points being considered include making it so that only UK businesses and the UK establishments of non-UK businesses would be able to be VAT grouped; making grouping compulsory rather than elective; allowing limited partnerships and Scottish limited partnerships to join VAT groups – an area which definitely needs to be clarified. Although it may be ambitious to expect changes to the regime to happen in 2021, we should at least hear more about the likely direction of travel.
Another call for evidence published in December suggests that the government is looking at possible changes in relation to digital platforms in the ‘sharing economy’. The platforms typically maintain that legally and for VAT purposes they provide information technology and agency services only, and that the underlying service (such as a rental) is a supply by the service provider, who is often under the VAT registration threshold, to the customer. The call for evidence suggests the government may accept defeat on the legal analysis but change the rules to make the platform the supplier for VAT purposes. The call for evidence closes on 3 March 2021, which means we will have to wait to see if this is likely to turn into a full-blown change in tax policy.
As a reaction to large number of cases (particularly in relation to immigration), the government has appointed a panel of experts to look at the case for reform of the judicial review process. Separately, the government is also looking at making it harder to obtain permission to appeal from the Upper Tribunal to the Court of Appeal. Changes in either area could have deep-seated implications for disputes with HMRC and we should hear more about what the government proposes to do during 2021.
The Tooth case concerning ‘discovery’ assessments is due to be heard in the Supreme Court in March 2021. There are a number of important issues for the Supreme Court to consider, including whether HMRC made a ‘discovery’ of an insufficiency in a tax return; if so, did the return contain an ‘inaccuracy’; and, if so, was the inaccuracy ‘deliberate’. Further, although it was not pleaded or argued at any stage below that the discovery had become stale, HMRC seems to be hoping that the Supreme Court will use the case to rule on whether the concept of ‘staleness’ exists.
In relation to VAT and other parts of the tax system which constitute ‘retained EU law’, the tax tribunals and the courts will have to begin to use new rules to interpret that legislation. UK courts and tribunals will not be bound by decisions of the CJEU made after 31 December 2020 and the Supreme Court will be able to depart from CJEU decisions made before that time in the same way as they are able to depart from their own decisions. The government has extended this power to depart from CJEU decisions to the Court of Appeal and its equivalents. It seems unlikely, though, that these new rules will have a major impact in 2021. They are more likely to lead to disputes as UK VAT moves away from the EU system.
HMRC is likely to continue to deploy significant resources to audit and investigate non-compliance with furlough and the other government coronavirus support schemes. Those who have claimed the support need to continue to remain vigilant to ensure that they are complying with the rules and to make sure that they are aware of what has been happening on the ground. There are sure to be many cases where, unbeknown to senior management, employees have been working whilst on furlough, whether as a result of an instruction from their line manager or because they think they are helping their employer. As these cases come to light, it will be important that employers make a full disclosure to HMRC and repay any amounts overclaimed as soon as possible.
HMRC raids in relation to the strict liability facilitation of tax evasion offences, also known as the corporate criminal offence (CCO), began at the end of 2018. It is possible that charges will be brought in relation to some of these cases in 2021. HMRC raid activity has, naturally, been hampered by the lockdown restrictions so we expect to see an uptick in raid activity as and when such restrictions are lifted.
In 2021, we are also likely to see more coordinated interventions to tackle transnational tax fraud, such as facilitation offences, from the Joint Chiefs of Global Tax Enforcement (J5). This involves the heads of tax enforcement from the UK, US, Australia, the Netherlands and Canada. In January 2020, the group carried out a globally coordinated day of action against an international financial institution suspected of facilitating money laundering and tax evasion.
2021 may turn out to be a seminal year in tax – at least in terms of some big changes in international and domestic tax policy, even if some of those policies might not come into effect until 2022 (meaning that FA 2022 may be more likely to be quoted regularly into the future than FA 2021). We will also see HMRC tasked with carrying out more and more interventions to drive investigation yield. The pace at which the global economy recovers will drive timing in both respects. One does have to question HMRC’s bandwidth to make these interventions and changes, particularly as it grapples with finding its new way as tax-collector to a sovereign state and an enormous change in its relationship with the EU. We’re sure though that it is confident it can rise to meet the challenge.
The authors thank Clara Boyd, Josie Hills, Steven Porter and Andrew Sackey of the Pinsent Masons tax team for their contributions to this article.
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