Examining the draft Finance Bill 2013

On 11 December, so called ‘legislation day’, the government published the draft tax legislation for inclusion in Finance Bill 2013, as well as responses to consultations that have taken place over the summer. This is the third year that, under the process outlined in HM Treasury’s document, Tax Policy Making: A New Approach, the draft Finance Bill clauses have been published before Christmas, seeking to increase the competitiveness of the UK by making the policy making process more transparent.

Technically, this stage of consultation, which is open until 6 February 2013, is focused on the efficacy of the technical drafting of the clauses, rather than the underlying tax policy issues, which have previously been the subject of consultation. However, given that the draft legislation itself provides more detail as to how the policies apply, we can expect that further discussion on many of the items included will continue.

The Finance Bill clauses have the following key themes:

• growth and incentives;
• countering tax avoidance;
• clarification measures; and
• EU law responses.

There are also tax administration changes, including details of the interest and penalty regime for real time information reporting.

Growth and incentives

The draft Finance Bill clauses include a number of measures to support growth. These include a number of measures which were announced by the chancellor in the Autumn Statement in the previous week, such as the reduction in the main rate of corporation tax to 21% in 2014 and the increase in the annual investment allowance for plant and machinery to £250,000 for two years from 1 January 2013. The legislation will also take forward the promised reliefs for the creative sector, subject to compliance with EU State aid rules, and the capital gains tax relief on qualifying shares for ‘employee shareholders’.

There is confirmation of the introduction of an ‘above the line’ tax credit for research and development activities for large companies. This credit will be taxable and will be available at the headline rate of 9.1% (49% for companies in the oil and gas ring-fence) to enable no less than the current effective rate of relief to be obtained. Following concerns from some sectors, the ATL credit will initially be introduced alongside the existing super-deduction in April 2013 but fully replace the super-deduction in April 2016. Companies will be able to elect to claim R&D relief via the ATL credit at the end of their accounting period, for expenditure incurred on or after 1 April 2013. Once a company has elected to claim the ATL credit it will not be able to claim via the super-deduction scheme in subsequent accounting periods.

The payable credit will be limited to the amount of a company’s total PAYE and NIC liabilities in relation to staff engaged in qualifying R&D activities in the accounting period. This cap will apply to the credit after the offset of the claimant’s current year corporation tax liability. The amount up to the cap can be utilised in a variety of ways, including being group relieved or offset against other tax liabilities of the company. However, the order of offset is prescribed by legislation. The excess over the cap will be treated as an ATL credit in the following accounting period, and we have confirmed with HMRC that this excess can be carried forward indefinitely.

The PAYE and NIC cap, which will have come as a surprise to many, may significantly reduce the ability for companies to obtain the refundable payment in situations where, for instance, claims are made with a large proportion of expenditure on consumables and/or externally-provided workers.

Tax avoidance

The draft legislation implements several actions against tax avoidance, including the general anti-abuse rule (GAAR) and amendments to the controlled foreign companies (CFC) rules to close avoidance and planning opportunities. Specific anti-avoidance measures, along with accompanying draft legislation, were announced at the time of the Autumn Statement and these will also be included in Finance Bill 2013.

The GAAR

The draft legislation covering the introduction of the GAAR has been amended from that contained in the 12 June 2012 consultation document to reflect feedback received. The first draft of the guidance has also been released for comment. The guidance is particularly important as it needs to be taken into account by a court or tribunal in considering the application of the GAAR.

In a welcome change of policy, it has been confirmed that the GAAR will not apply to arrangements which began prior to Royal Assent of Finance Bill 2013. Where the arrangements form part of broader arrangements that began before Royal Assent, the taxpayer (but not HMRC) may refer back to the broader arrangements where to do so would show that the post-commencement arrangements are not abusive.

The core ‘double reasonableness test’ now explicitly states that, in determining whether the test is met, consideration should be given to whether the means of achieving the overall result involves one or more ‘contrived or abnormal steps’.

The draft legislation has also been amended so that non-commercial terms of transactions or agreements are no longer highlighted as indicators that the arrangements are abusive, not least to address concerns that this indicator is always present when considering inheritance tax. In addition, the indicators set out in the draft legislation of abusive arrangements are only to be taken as such if it is reasonable to assume that such a result was not the intended result of the provisions.

The provisions dealing with counteraction and consequential adjustments have been expanded, and the legislation will make it clear that the consequential adjustments can only reduce a person’s liability to tax. The updated draft legislation sets out the procedural requirements relevant to the application of the GAAR. This includes details of the role in this process of the GAAR advisory panel including the appointment by the chair of a sub-panel of three with relevant expertise. This panel will consider written representations by both HMRC and the taxpayer and will provide a joint opinion or separate opinions on the application of the GAAR on a particular case. It has previously been announced that HMRC will not be represented on the panel and that an independent chair will appoint the members.

The panel is also responsible for approving the guidance, the first draft of which has now been issued, though further work is required before it becomes final. This draft guidance includes a series of examples of arrangements to which HMRC would, and would not, seek to apply the GAAR.

CFCs

The draft clauses include legislation to prevent a potential loss of tax by amending the new CFC rules and limiting double taxation relief in order to close avoidance and planning opportunities. In line with the new CFC rules, the legislation will affect CFCs with accounting periods beginning on or after 1 January 2013.

The legislation will:

• clarify the definition of ‘relevant finance lease’ to include arrangements of a similar substantive character so the definition applies to any asset. This will prevent arrangements structured, for example, as hire purchase business, from falling outside the CFC rules dealing with finance leases;
• limit the UK double tax relief available in circumstances where loans made by one CFC to another CFC are routed through one or more UK companies. Relief for withholding tax will no longer be claimable for an amount in excess of the corporation tax liability on the relevant loan relationship;
• ensure that, throughout the new CFC rules, questions of accounting treatment where accounts have not been prepared under either UK generally accepted accounting practice or international accounting standards are considered by reference to international accounting standards; and
• introduce a minor consequential provision to ensure the arbitrage rules do not apply merely as a result of the application of another territory’s CFC rules that are similar to the UK CFC rules.

These changes are corrections to the new CFC rules targeted at specific situations and do not represent fundamental changes to the regime.

Other measures

There are proposed changes to the worldwide debt cap exemption for group treasury companies. These amend the conditions that companies have to satisfy in order to make an election under TIOPA 2010 s 316 to be treated as outside the worldwide debt cap and how the election applies to financing expenses and financing income. The draft clauses are intended to ensure that only the financing expenses and financing income related to treasury activities are included in the election.

The draft legislation will also enact the proposals announced in Budget 2012 to counter avoidance of stamp duty land tax, including the introduction of the annual residential property charge and the proposed extension of the capital gains rules. Full details of this latter measure will become clearer in January 2013 but the government has announced that the new charge is only intended to apply to gains which accrue from 6 April 2013. There are also measures to restrict tax relief in certain circumstances, most notably the promised cap on income tax reliefs to the greater of £50,000 or 25% of income, and the restriction of pension tax relief announced in the Autumn Statement.

Clarification measures

In addition to a focus on growth and tax avoidance, the draft clauses contain provisions which clarify and simplify the operation of tax law in a number of areas. Examples include:

• the introduction of a statutory residence test with the draft clauses containing revised legislation from that proposed;
• the abolition of the concept of ‘ordinary residence’ for most tax purposes, with effect from 6 April 2013;
• provisions that where a company uses a non-sterling functional or designated currency, it must calculate chargeable gains on a disposal of shares in that currency. It is disappointing that the new rules do not apply to all assets;
• the confirmation that tier two capital issued by a bank is treated as normal debt for corporate tax deductibility and group relief purposes;
• the new contractual mechanism for providing certainty to companies in the UK Continental Shelf over tax relief for decommissioning costs; and
• changes recommended by the Office of Tax Simplification to the rules governing the four tax-advantaged employee share schemes.

European law obligations

There are also changes aimed at bringing certain existing tax provisions into line with European law obligations. The changes to rules on transfers of assets abroad and gains on assets held by foreign companies, in response to infringement proceeding brought by the European Commission have been consulted upon previously. The draft legislation includes two further measures which are introduced to respond to judgments of the Court of Justice of the European Union (CJEU).

Firstly, legislation will be introduced to allow the deferral of the payment of exit charges when a UK company transfers its place of management to another EU Member State. In the case of National Grid Indus BV (CJEU Case C-371/10), the CJEU ruled that where a company transfers its place of effective management to another Member State, then, to ensure its rules do not infringe the right of the freedom of establishment, a Member State should offer a choice between immediate payment or the option of deferral of exit charges, subject to certain conditions.

Legislation is now to be introduced in response to this judgment. Where a company incorporated in the UK or another EEA territory becomes a resident of, and established in, another Member State of the EU (or EEA), it will be able to manage the corporation tax charges that arise in respect of specified unrealised chargeable gains or income profits under an exit charge payment plan. For these purposes, an exit charge is one that arises under the following tax provisions: TCGA 1992 ss 185 and 187 (chargeable assets), CTA 2009 ss 859–860 (intangible fixed assets) and CTA 2009 s 609 along with CTA 2009 s 333 (loan relationships and derivative contracts).

There are two options for deferral. The first spreads the total tax over six equal annual instalments. The second allocates the tax due on an asset by asset basis. For intangible assets, derivative contracts and loan relationship profits, tax is spread in equal annual instalments over the useful life of the asset. Tax related to exit charges on any other assets may be deferred for up to a maximum of ten years, or until the disposal of the asset, if sooner.

The amounts deferred under either of the above options will be subject to interest. Security may be demanded by HMRC. This measure will allow companies to opt for deferred payment arrangements from the publication of the draft legislation.

Secondly, following the 6 September 2012 ruling of the CJEU in the Philips Electronics case (CJEU Case C-18/11), legislation will be introduced to amend the restrictions on the surrender of losses as group relief by UK branches of companies resident in the European Economic Area. In the Philips Electronics case, the CJEU held that UK group relief rules constitute an unlawful restriction on the freedom of establishment principle. This is insofar as they preclude the transfer of losses by a UK permanent establishment of a non-UK resident company to a UK resident company within the same group relief group.

In particular, CTA 2010 s 107 will be amended so that companies resident in the European Economic Area will be able to surrender as group relief losses arising in their UK branches on or after 1 April 2013. This will be subject to restrictions where the losses are actually used against non-UK profits. Where a loss that has been surrendered is later used against non-UK profits, then the benefit of the UK group relief will be withdrawn to the extent that the loss has been used elsewhere. Section 107 will not be amended for non-UK resident companies resident outside the EEA.

It remains to be seen whether, given the reasoning adopted by the CJEU in Philips Electronics, the new proposals will be acceptable to the CJEU.

Next steps

The 2013 Budget has been announced for 20 March 2013. This date would be consistent with a Finance Bill timetable similar to 2012 with substantive enactment in late June or, more likely, early July and Royal Assent in July. For UK GAAP and IFRS purposes, whilst the tax accrual will only need to be amended for changes if the proposals have been substantively enacted, there may be a need for disclosure of the impact of the changes, where the impact is expected to be significant.

Chris Sanger is head of tax policy at Ernst & Young

Mike Gibson is a director at Ernst & Young