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Review of Finance (No. 2) Act 2015

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18 November 2015
Card image Claire Hooper
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The Summer Finance Bill has now completed its progress through Parliament, receiving royal assent on 18 November, passing as Finance (No. 2) Act 2015. In the course of its progress, there have been a number of amendments to the Bill, notably at report stage, and we have highlighted those amendments in recapping the key provisions. We also touch on the progress of measures such as the reform of the taxation of ‘non-doms’, the new regime for dividend taxation and the new payment regime for large companies which were announced in the Summer Budget but which will be addressed in future legislation. 

 

Business taxes

 

Corporation tax rates

 
The main rate of corporation tax, which applies to all companies subject to corporation tax except for those within the oil and gas ring fence, will be reduced to 19% from 1 April 2017 and 18% from 1 April 2020 (s 7). As both the 19% and 18% rate are included within the Act, then for accounting periods ending after the date of substantive enactment (26 October 2015) or enactment (18 November 2015) as appropriate, companies will be required to measure deferred tax at differing rates depending upon when deferred tax will reverse. Scheduling of the reversal of timing and temporary differences may therefore become more important as groups aim to quantify the tax impact in future periods.
 
The reductions to the corporation tax rate help the UK maintain the competitiveness of its tax system and deliver on its aim to have the most competitive business tax regime in the G20. However, it will potentially have an adverse impact on the controlled foreign company (CFC) status of UK subsidiaries of certain non-UK parented groups as well as focusing attention further on the differential between corporation tax and diverted profits tax, currently charged at 25%.
 
At report stage, a new clause was introduced (now s 38) providing that payments of restitution interest will be chargeable to corporation tax at a special rate of 45%. This will impact both direct and indirect tax claims. Broadly, restitution interest will arise in situations where a claim has been brought by way of an action for restitution in respect of a tax matter and interest is recovered from HMRC (either by agreement or an order of a court) and that interest is not limited to simple interest at a statutory rate. A receipt of compound interest under actions for breaches of EU law will therefore fall within the definition and the whole amount of the interest (not just the excess over the statutory interest) will be taxable at the 45% rate. No reliefs, such as losses, can be offset against the taxable restitution interest. The new charge will have effect in respect of awards of restitution interest that are finally determined or agreed on or after 21 October 2015. In addition, there is an obligation on HMRC to withhold tax on any payments of restitution interest made after 26 October 2015. On first review, the efficacy of the proposals seems subject to challenge – and given the amounts at stake we expect challenges to be made.
 

Corporate debt and derivative contracts

 
A key purpose of the corporate debt and derivative contract changes in the Act (Sch 7) is to clarify the relationship between tax and accounting and to align taxable loan relationship profits with accounting profit and loss entries. 
 
The majority of changes will have effect from accounting periods commencing on or after 1 January 2016. In addition the new and enhanced reliefs for companies in financial distress will now have effect for transactions from 1 January 2015 rather than transactions from royal assent as originally envisaged. These reliefs disapply the deemed release rules in CTA 2009 ss 361 and 362 for certain corporate rescue situations. Both these rules deem that a loan has been released, thus crystallising a taxable profit, in certain situations. Currently, there is no such exception from s 362 and the exception from s 361 requires a change in ownership of the debtor company in the period between one year before and 60 days after the acquisition of the debt. The change in ownership condition is no longer required for the exception from s 361, although there is a similar condition attached to the new s 362 exemption. The old debt-for-debt exception to s 361 has been repealed but the equity-for-debt exception remains. As a result of the new and enhanced reliefs, the anti-avoidance rule in s 363A, that was to have been repealed, is now retained. 
 
However, the new ‘principles-based’ targeted anti-avoidance rule still has effect only from 18 November, the date of royal assent. This new rule seeks to counter arrangements that are entered into with a main purpose of achieving a tax advantage under the loan relationship or derivative contract rules.
 

Restrictions on use of UK losses against a CFC charge

 
From 8 July 2015, CFC charges can no longer be reduced by the losses of UK companies, whether the losses are brought forward or from the current year, or losses surrendered as group relief from elsewhere in the group (s 36). For CFCs with an accounting period that straddles 8 July 2015, the rules will apply to profits treated as accruing from that date on a just and reasonable apportionment. In addition, the rules introduced in FA 2015, which restrict losses in cases involving tax avoidance, are amended to make clear that they also apply to transactions involving CFCs (s 37).
 

New restrictions on CT relief for business goodwill amortisation 

 
Tax relief is no longer available for amortisation of goodwill and customer-related intangible assets acquired or created by a company, with effect from 8 July 2015 (s 33). Furthermore, any debits arising on the realisation of such assets will be treated as non-trading in nature. The effect of this and other recent changes is that there will be limited ways in which such debits can be utilised, other than in the year of realisation.
 
The definition of goodwill and customer-related intangible assets is widely drafted. It includes information which relates to customers or potential customers of a business, a relationship (whether contractual or not) that the transferor has with one or more customers of a business, an unregistered trademark or other sign used in the course of a business, together with a licence in respect of any of the above. This mirrors legislation introduced in FA 2015 (which is now superseded) that restricted relief for goodwill and customer-related intangible assets acquired on incorporation of a business.
 
The changes do not apply in a case where a relevant asset is acquired before 8 July 2015 (or afterwards provided the acquisition is pursuant to an unconditional obligation existing prior to that date). However, notably no such limitation applies to relevant assets created before 8 July 2015.
 

Taxation of banks

 
The new bank corporation tax surcharge of 8% is introduced with effect from 1 January 2016 (Sch 3). For banks with an accounting period that straddles 1 January 2016, a notional accounting period whose profits will be subject to the surcharge will be treated as starting on that date. The surcharge will be charged separately from corporation tax and the taxable profits for the purposes of the surcharge will not be capable of being reduced by pre-January 2016 losses, non-banking losses or group relief from non-banking companies. An annual surcharge allowance of £25m is available to groups and individual banking companies. For groups containing two or more banking companies, it will be necessary to appoint a nominated banking company who will submit a group allowance allocation statement for each period. 
 
There are rules addressing the offset of foreign tax credits against the surcharge, as well as anti-avoidance provisions. Consequential amendments are also made to the diverted profits tax legislation in order to take account of the introduction of the surcharge. The final legislation clarifies that the research and development expenditure credit is excluded from the surcharge and so maintains its value for banks. 
 
In amendments made at report stage to the surcharge provisions, the rules on transferring chargeable gains and losses around banking groups are changed to ensure that gains made by banks are subject to the surcharge, even if they are reallocated by election within the group to non-banks. The definition of a bank is also modified to exclude certain asset management companies from having to pay the surcharge. Finally, the anti-avoidance measure to prevent banking profits being transferred to a CFC is tightened.
 
The Act contains provision for the announced reduction in bank levy rates in 2016 and further reductions each year from 2017 to 2021 (Sch 2). However, it does not take forward the Summer Budget announcement that in 2021 the taxable base will be redefined to exclude non-UK balance sheets.
 
With effect from 8 July 2015 (15 July 2015 in respect of firms with a corporate partner), a tax deduction will not be allowed for expenses incurred by banking companies, wherever located, which relate to relevant compensation payments (s 18). Furthermore, where a company suffers such a disallowance it is also required to bring into account a notional receipt of 10% of the relevant sum in order to reflect the costs associated with making the compensation payment. For the deduction to be disallowed, a disclosure condition must be met. This condition will be met where, broadly, a relevant document indicates that the company is, has been, or will become liable to pay compensation in respect of a particular matter. This reflects an amendment at report stage to narrow the look-forward element so that the disclosure condition is only met where there is a statement that the bank ‘will’ rather than just ‘may’ become liable to pay compensation. Further amendments to the disclosure condition clarify that the condition is not met in the case of a single error in relation to a single customer and limit the look back period for the disclosure condition to five years ending in the period of account in which the expenses are booked (the definition of the relevant period is accordingly constrained to this five year window as well).
 
There are exclusions from the compensation provisions for certain expenses and for certain companies. 
 

Other measures in the Act

 
Some of the other measures included in the Act are set out below, together with the date they are effective from. 
 
  • New s 39, introduced at report stage is intended to correct a technical defect in the legislation relating to corporation tax instalment payments for accounting periods beginning before and ending on or after 1 April 2015. The legislation seeks to ensure that the instalment regime applies as intended.
  • The removal of all requirements relating to the location of a ‘link company’ for the purpose of consortium relief (s 35). This change applies to accounting periods beginning on or after 10 December 2014, though case law would seem to dis-apply the previous provision for earlier periods in any event.
  • A new market value override on disposal of trading stock not in the course of a trade and intangible fixed assets not at arm’s length. From 8 July 2015, the market value is to be brought into account for transfers of trading stock or intangible fixed assets between related or connected parties. There is a related provision where trading stock needs to be valued for tax purposes on the cessation of a trade (ss 40–42).
  • A permanent level of £200,000 will be set for the annual investment allowance from 1 January 2016 (s 8). 
 

Measures highlighted around the Summer Budget but not in the Act

 
A number of key measures for business are not included in the Finance (No. 2) Act 2015:
 
  • Implementation of the country by country reporting requirements as part of the BEPS project. This has been taken forward by a draft statutory instrument as the enabling legislation was included in FA 2015. 
  • Plans to improve large business tax compliance. A consultation has been undertaken on new measures, which include a mandatory requirement for large businesses to publish their tax strategy and a voluntary code of practice setting out standards HMRC expects of large business in their relationship with HMRC, and we can expect developments in the next month. 
  • The acceleration of corporation tax payment dates for large companies with annual taxable profits of £20m or more (reduced for members of a group). Companies will be required to pay corporation tax in quarterly instalments in the third, sixth, ninth and twelfth months of their accounting period. The measure will apply to accounting periods starting on or after 1 April 2017 and we expect draft legislation as part of the draft 2016 Finance Bill clauses to be published on 9 December.
  • Details for a new private placement relief from withholding tax. A draft statutory instrument has been informally consulted on and it is expected that the regulations will come into effect shortly.
 

Employment taxes

 
Many of the employment tax changes outlined in the chancellor’s Summer Budget are not included in Finance (No. 2) Act but have since been subject to consultation. These include PAYE regulations which follow on from the primary legislation contained in FA 2015 and which are effective from the 2016/17 tax year. These measures were the abolition of the £8,500 threshold for benefits in kind, the introduction of a ‘payrolling’ facility to allow employers to voluntarily report and deduct tax from benefits in real time, and the replacement of the expenses payments ‘dispensation’ system with an exemption for qualifying business expenses. HMRC has also now published a consultation document setting out its proposals for amending the rules for tax relief on travel and subsistence for those working through employment intermediaries. It has also published a discussion document setting out a framework for discussions between HMRC and stakeholders to explore options to make the intermediaries legislation – commonly known as IR35 – more effective in protecting the exchequer.
 

Personal taxes

 

Personal allowance and higher rate threshold

 
The Act contains the tax lock pledged by the Conservatives in the run-up to the general election to prevent the rates of income tax from being increased in the life of the current Parliament (s 1). The lock to prevent the rates of class 1 NICs (for employers and employees) from being increased is contained in the National Insurance Contributions (Rate Ceilings) Act which is still passing through the House of Lords. The Act sets the income tax personal allowance and the income tax basic rate limit for the 2016/17 and 2017/18 tax years (ss 5 and 6). It also includes legislation which means that, once the personal allowance reaches £12,500, it will then increase in line with the annual equivalent of the prescribed national minimum wage rate for an individual, aged 21,working 30 hours per week (ss 3 and 4).
 

Pensions changes: high-income individuals

 
Measures to reduce the annual allowance for ‘high-income individuals’ are included in the Act (Sch 4). A high-income individual is defined as someone who has ‘adjusted income’ for the tax year of more than £150,000. This is the individual’s net income for income tax purposes, plus any pension inputs, less certain excluded receipts. However, this is subject to an income floor or threshold which applies the provisions only to individuals who have taxable income over £110,000. Anti-avoidance provisions address the impact of salary sacrifice arrangements which are made on or after 9 July 2015, in order to reduce threshold income.
 
From 6 April 2016, high-income individuals will have their pension annual allowance for the tax year reduced. The annual allowance will be reduced by £1 for every £2 of adjusted income over £150,000. Once adjusted income reaches £210,000, the annual allowance will be reduced to a minimum level of £10,000. 
 

Pensions changes: pension input periods

 
To support the new annual allowance rules for high-income individuals, Sch 4 of the Act aligns pension input periods with the tax year. Transitional rules will apply for 2015/16. The way these transitional rules will work ensures that nobody is worse off in 2015/16 and in certain circumstances individuals might benefit from an increased annual allowance for the current tax year.
 
Previous pension input periods open on 8 July 2015 will end on that date. A second period will then run from 9 July 2015 to April 2016 and all subsequent periods will be for tax year starting with 6 April 2016 to 5 April 2017.
 
The tax year 2015/16 will be treated as consisting of two years, for annual allowance purposes: the pre-alignment tax year, 6 April 2015 to 8 July 2015 and the post-alignment tax year, 9 July 2015 to 5 April 2016. For the pre-alignment tax year the annual allowance is set at £80,000. For the period starting on 9 July, the annual allowance is the unused part of the £80,000 annual allowance from the first period but capped at a maximum of £40,000. 
 
To simplify the calculation of pension input amounts for defined benefit and cash balance arrangements during 2015/16, the pension inputs will be based on a time apportionment of the increase in pension rights across the combined pension input periods ending in 2015/16. For defined contribution schemes the pension input amounts will continue to be the total of any pension contributions paid in each pension input period.
 

Pensions changes: lump sum death benefits

 
Provisions are also included to remove the 45% tax charge on prescribed lump sum death benefits paid from a registered pension scheme directly to an individual beneficiary (s 21). 
 
New provisions apply where payments to qualifying beneficiaries are made in situations where the pension holder dies over the age of 75 or where the pension holder died under the age of 75 but the scheme administrator did not pay the lump sum within two years of being aware of the death. In those situations tax will be payable at the recipient’s marginal rate of income tax instead. The change has effect for lump sum death benefits paid on or after 6 April 2016. If the pension holder dies under the age of 75, then except in the situation above, lump sum benefits will be exempt from tax.
 
Lump sum death benefits withdrawals taxed in this way include those taken when a recipient beneficiary has been ‘temporarily’ resident outside the UK but returns within five years of becoming non-resident. The Act also ensures that taxable lump sum death benefits from foreign pension schemes are outside the scope of PAYE (s 22). 
 
An amendment introduced during committee stage of the Bill ensures that a lifetime allowance tax charge cannot arise where a member receives a taxable payment because the pension holder died under the age of 75 but the scheme administrator did not pay the lump sum within two years of being aware of the death, to prevent the possibility of double taxation.
 

Inheritance tax on residential property

 
Included in the Act are provisions introducing an additional nil rate band, known as a ‘residence nil rate amount’ where an individual has an interest in residential property which is inherited by a direct descendent (s 9). The property must have been the individual’s residence at some point when it formed part of their estate (subject to an exemption for those with job-related accommodation) and a direct descendant is widely defined to include, for example, step children and foster children. The additional nil rate band will be £100,000 in 2017/18 rising in increments to reach £175,000 by 2020/21, from which point it will increase in line with the consumer prices index (CPI). The residence nil rate band will be tapered once an individual’s estate is valued at £2m, with £1 being withdrawn for every £2 of value over that amount.
 
Legislation to allow individuals to ‘bank’ the residence nil rate amount when they dispose of a property is expected to be included in Finance Bill 2016.
 

Other inheritance tax measures

 
New rules designed to prevent the use of multiple trusts, often known as ‘pilot trusts’ as an IHT planning strategy are included in Sch 1 of the Act. The rules apply where property has been added to more than one trust on the same day, such that the value of this property is aggregated when calculating IHT charges for each trust. 
 
The new rules will apply to all charges arising on or after 18 November (the date of royal assent) in respect of trusts created on or after 10 December 2014. The provisions will also apply to trusts created before 10 December 2014 where value is added after this date and the additions exceed £5,000. However, there will be a period of grace so the rules do not apply to transfers on deaths before 6 April 2017, provided the will was executed before 10 December 2014.
 
The Act also includes further provisions regarding the passing of a life interest to a spouse or civil partner and the administration and calculation of IHT charges for trusts as well as provisions exempting heritage property from the ten year anniversary charge (ss 12 to 15).
 

Investment managers: CGT treatment of carried interest and changes to disguised investment management fee provisions

 
The Act sets out changes to the way that carried interest payments from partnerships will be taxed with effect from 8 July 2015 (ss 43 and 44). The changes affect those who provide investment management services as part of an arrangement which involves a partnership. When calculating taxable gains in respect of carried interest, such individuals will only be entitled to deductions for consideration actually paid (in other words, they will no longer be able to claim a deduction for base cost shift). 
 
HMRC published guidance on the proposed legislation on 21 July, pointing out that many of the concepts and terms used in the proposed legislation are based on those contained in the disguised investment management fees rules introduced by FA 2015 s 21. The guidance makes clear that any carry payment received by the individual will be subject either to the disguised management fee provisions or to capital gains tax under these provisions. This includes income amounts which might previously have been thought of as a return of capital. Any income receipts will remain subject to income tax, and a tax credit will be available to set against any capital gains tax due in respect of those amounts. 
 
In addition, any gains related to carried interest in foreign assets received by non-UK domiciled individuals will be taxable on the arising basis to the extent that they relate to services performed in the UK.
 
The Act also contains an amendment to the definition of a reasonable return on investments when determining whether amounts received by investment managers should be taxed as a disguised investment management fee.
 
Report stage amendments now included in the Act as s 45 include significant changes to the concept of ‘sums arising’, which will apply to both the disguised investment management fee provisions and the new provisions on carried interest. It was previously understood that these provisions would only apply where amounts were actually received by individuals. However, the new amendments extend the meaning of ‘arise’ from 22 October 2015 to include amounts arising to connected parties, including trusts of which the individual providing investment management services is either a settlor or a beneficiary, as well as companies and individuals with whom the individual is connected. However, further amendments to the carry provisions do prevent amounts subject to escrow or similar deferrals from being treated as ‘arising’ and, therefore, taxable before the individual is able to enjoy them.
 
The legislation is not intended to affect the treatment of performance linked rewards paid to investment fund managers that are charged to tax as trading income. 
 

Residential property lettings

 
Restrictions on the amount of financing costs which can be deducted by individuals, partnerships, trusts and personal representatives when calculating their income from a property business are included in the Act (s 24). The amount of mortgage interest or similar which can be deducted is restricted to 75% in 2017/18, then 50% in 2018/19, 25% in 2019/20 and to nil from 2020/21 onwards. Individuals will receive a basic rate tax reduction in respect of financing costs which cannot be deducted as a result of these measures. A committee stage amendment to s 24 ensures that companies chargeable to income tax are not subject to these restrictions (because companies generally are outside these provisions), and to enable trustees to claim the basic rate tax reduction in certain circumstances. A report stage amendment then clarifies that relief for interest on a loan to invest in a partnership is restricted where the partnership uses that investment for carrying on a UK or overseas property business that consists of residential property.
 
The withdrawal of the wear and tear allowance announced in the Summer Budget and its replacement with a relief for costs actually incurred is to be included in Finance Bill 2016. The proposed increase to rent a room relief with effect from 6 April 2016 has now been made by statutory instrument.
 

EIS and VCTs

 
The Act includes changes to the eligibility criteria for enterprise investment schemes (EIS) and venture capital trusts (VCTs) as well as some amendments to the interaction between seed enterprise investment schemes (SEIS), EIS and VCTs (Schs 5 and 6). The original Bill Schedules proposed changes to the rules for EIS and VCTs to bring them into line with new state aid rules. Technical amendments were made at report stage to both Schs 5 and 6 to ensure that the proposed rules work as intended and work correctly with the existing provisions. The amendments include clarification that the provision to allow follow-on funding in older companies that receive their first risk finance investment after the age limit is focused on the situation where investments are used only for activities that effectively constitute a new business activity. The amendments to VCTs in Sch 6 also specify certain investments a VCT may make for liquidity management as part of its non-qualifying holdings.
 
New s 37 makes changes to exclude companies from qualifying within the SEIS, EIS and VCT rules if their activities involve making available reserve electricity generating capacity, including any later utilisation of the capacity to generate electricity. The changes take effect for EIS, SEIS and VCTs in relation to shares or holdings issued on or after 30 November 2015.
 

Measures highlighted in the Summer Budget but not in the Act

 
  • Dividends: From 6 April 2016, the dividend tax credit will be abolished and a tax-free annual dividend allowance of £5,000 will be introduced. The dividend tax rates will also be amended to 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers and 38.1% for additional rate taxpayers. Dividends received in ISAs and pensions will continue to be tax-free.
  • Non-UK domiciled individuals: The scale of the changes proposed to the ‘non-dom’ tax regime in the summer Budget is extensive. From 6 April 2017, the following significant changes will apply. Non-UK domiciled individuals will be deemed domiciled in the UK for tax purposes once they have been resident in the UK for more than 15 out of the past 20 tax years. The general law position will remain the same and, therefore, any children’s domicile status will not be impacted by their parent’s deemed domicile position. Once an individual has become ‘deemed domiciled’ in the UK, he or she will remain so for five years after leaving the UK. Where an individual born in the UK with a UK domicile of origin has acquired a non-UK domicile of choice and returns to the UK for a limited period, then with effect from 6 April 2017, such individuals will be deemed domiciled in the UK from the date they return. Where such individuals have returned to the UK before 6 April 2017, they will be deemed domiciled from 6 April 2017. Consultation on the proposed changes closed on 11 November and we expect to hear more in response to this on 9 December.
  • Lifetime allowance for pension contributions: The lifetime allowance for pension contributions will be reduced in Finance Bill 2016 from £1.25m to £1m, with effect from 6 April 2016. This will include transitional protection for pension rights that are already over £1m. The lifetime allowance will then be indexed annually in line with CPI from 6 April 2018.
 

Indirect taxes

 
The Act contains the tax lock to prevent the standard rate or reduced rate of VAT from being increased in the life of the Parliament (s 2). The following changes are also confirmed in the Act:
 
  • The standard rate of insurance premium tax increases from 6% to 9.5% with effect from 1 November 2015 (s 47).
  • The climate change levy exemption for renewable electricity is removed for electricity generated on or after 1 August 2015 (s 49).
  • The legislation that suspended exemptions from aggregates levy with effect from 1 April 2014 is repealed. All exemptions apart from shale are restored in full (s 48).
  • Cars registered on or after 1 April 2017 will be subject to a new vehicle excise duty banding system (s 46).
 

Tax administration

 

Direct recovery of debts

 
The Act provides for a new power to allow HMRC to recover debts due to it (including tax and tax credit debts) directly from the bank and building society accounts (including individual savings accounts) of debtors (Sch 8). 
 
This power can only be used to recover debts of more than £1,000. Only debtors who have received a face-to-face visit, have not been identified as vulnerable, have sufficient money in their accounts and have still refused to settle their debts will be considered for debt recovery through this mechanism. Debtors affected by this policy will have 30 days to object before any money is transferred to HMRC. HMRC must always leave a minimum of £5,000 available to the debtor, across the debtor’s accounts, over and above the amount that has been ‘held’ by the deposit taker for HMRC. If debtors do not agree with HMRC’s decision, they will be able to appeal against this to a County Court on specified grounds, including hardship and third party rights.
 

Duties on financial intermediaries

 
The Act contains legislation giving the government the power to require financial intermediaries, tax advisers and other professionals to contact customers informing them about measures being taken to combat offshore tax evasion (s 50).The legislation is being introduced to require notification in respect of the common reporting standard, the new time-limited disclosure facility to be launched in 2016 and the new range of penalties and offences for offshore tax evasion.
 

HMRC debtor and creditor rates

 
The Act amends the interest rate payable in tax litigation cases where HMRC is either a debtor or creditor (s 52). The new provision replaces judgment interest (at 8%) with the much lower late payment interest rate on amounts payable to HMRC (currently 3%) and bank base rate +2% for amounts payable by HMRC.
 

Next steps

 
The draft clauses for the next Finance Bill are due for publication on 9 December. At the same time (and possibly with some trailing in the Autumn Statement on 25 November), we expect to see the publication of summaries of responses to a number of the consultations launched after the Summer Budget. 
 
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