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Tax and the City: February '11 review

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Bank levy rates for the current year have been increased. HMRC seem to have taken on board some of the concerns raised in relation to the proposed new rules on disguised remuneration. Some avoidance cases are finally making it to the Supreme Court (DCC Holdings; Tower MCashback). Regulations fix tax problems caused for securitisation companies by a change in regulatory law. The worldwide debt cap rules have been amended to ensure that they work more fairly. The taxpayer win in RBS Deutschland has significance for cross-border VAT arbitrage.

Bank levy
The big story is the controversial surprise increase in the bank levy rate for the current year. The rate from 1 May 2011 is now 0.075% for short-term liabilities and 0.0375% for long-term liabilities (previously, the rates were 0.05% and 0.025% respectively). There will be a higher ‘catch up’ rate for 1 March to 30 April (0.1% for short-term liabilities and 0.5% for short-term liabilities), so that the overall yield for the first year is £2.5 billion – representing an £800 million rise from the previously announced target yield.
The levy comes into force from 1 January 2011 and is likely to affect 25 to 30 groups. Draft legislation published on 9 December 2010 reflects ongoing consultation over the autumn and includes changes to the chargeable base and anti-avoidance rules. There has also been some progress on double tax: regulations for France are expected imminently and discussions have taken place with Germany and the US.
Disguised remuneration
The proposed new rules on disguised remuneration (DR), as set out in a draft Finance Bill Schedule entitled ‘Employment income through third parties’ published for consultation on 9 December 2010, continue to trouble taxpayers and advisers. The main target of the DR code is clearly the sort of income tax and NICs planning involving employment benefit trusts (EBTs) and employer-funded unapproved retirement benefit schemes (EFURBS or EFRBS) of which HMRC have long expressed its disapproval. But the DR provisions – intended to form a new Part 7A of the ITEPA 2003 – are drafted in very wide terms (subject to certain narrowly drawn exceptions and some complex and unsatisfactory ‘no double counting’ rules) and would catch many arrangements not thought to be the target of the new code. Concerns include the following:
  • there is scope for overlap with the existing employment related securities (ERS) provisions in Part 7 of ITEPA 2003, and it seems that a combination of the regimes could result in tax charges on the full value of new shares or securities (including potentially carried interests) at acquisition, even to the extent that an employee actually pays for his or her shares or securities;
  • employees may be taxed upfront on loans despite the obligation to repay in due course;
  • whilst UK approved pension plans are carved out of the new regime, equivalent international plans are not (although there is a regulation-making power in relation to certain types of international pension plans);
  • it is unclear whether investment income and gains arising, or changes in the investment portfolio, within an EBT/EFRBS or other plan may lead to charges;
  • upfront tax charges would arise on deferred contingent bonus awards. This is of course a point of considerable importance to many individuals working in the financial services industry and their employers since the introduction by the Financial Services Authority (FSA) of an updated Remuneration Code designed to comply with the third Capital Requirements Directive (CRD3). The revised Code, which was published on 17 December 2010 and has effect from 1 January 2011, will require a significant proportion of the variable remuneration received by Code staff to be deferred, contingent and/or provided in the form of shares or share-like interests.
HMRC have received numerous representations on the draft provisions and they were discussed at some length at HMRC’s Finance Bill 2011 open day on 24 January. HMRC have also had a number of separate meetings with interested representative bodies. From the various discussions, it seems that HMRC have taken on board some of the concerns and accepts that the new regime should not catch for example the acquisition of shares and securities at market value or at an undervalue if the undervalue element is taxed under the ERS regime, or the deferral of bonuses pursuant to the requirements of the Remuneration Code. (Care will nevertheless be required to ensure that deferred remuneration does not attract upfront income tax and NICs charges under the existing ITEPA 2003 provisions.) HMRC are also understood to be considering a carve-out for existing pension funds and rights accumulated before 6 April 2011 outside registered and relevant non-UK schemes.
Some changes to the provisions can therefore be expected, with other points being likely to be dealt with in guidance. Frequently asked questions are expected shortly and may be available by the time this article is published. It is understood that HMRC intend to adhere to its existing approach of framing the provisions widely and dealing with things that should not be caught by way specific exemption, and that it has not been persuaded that an avoidance motive filter or ‘hallmark’ approach is a better way forward.
Tax planning and disputes
HMRC continue to challenge avoidance arrangements and some cases are finally making it to the Supreme Court. In December 2010, DCC Holdings lost its long-running battle on gilt repo planning: the Supreme Court applied principles of purposive construction and the ‘fairly represents’ rule in the loan relationships code in concluding that the repo legislation applied symmetrically, resulting in a £2.9m debit being matched by a £2.9m credit (RCC v DCC Holdings (UK) Ltd [2010] All ER (D) 190 (Dec)). The appeal in the Tower MCashback case (a software licensing case involving questions of purposive construction, substantive recharacterisation and the extent to which HMRC should be tied to conclusions in closure notices) is due to be heard later this month by a full sitting of seven Supreme Court judges, suggesting that the case is one to watch (Tower MCashback LLP1 and another v RCC [2010] STC 809).
Outside the courts, HMRC are piloting alternative dispute resolution techniques, focussing on mediation, and package deals have been announced in some areas. Controlled foreign companies are among the most common area of dispute for multinational groups and HMRC have recently announced a new – and more flexible – package, involving settlements in the 65% to 90% range based on the application of the motive test.
A new study group chaired by Graham Aaronson QC has been established to look at the feasibility of a general anti-avoidance rule – the group reports back to HM Treasury by 31 October 2011.
Capital markets
Regulations (SI 2011/133) came into force on 16 February 2011 to reverse unintended consequences of changes made in February 2010 to the Financial Services and Markets Act 2000 (Regulated Activities) Order, SI 2001/544. The changes were intended to assist Islamic financing but inadvertently affected the tax, regulatory and insolvency treatment of certain unlisted / untraded debt securities. The Finance Bill 2011 will include retrospective legislation to preserve securitisation company treatment and related tax reliefs for the period from February 2010 to February 2011.
Worldwide debt cap
Following enactment of the Finance (No.3) Act 2010, certain well-trailed changes to the worldwide debt cap (WWDC) rules in Part 7 of the Taxation (International and Other Provisions) Act 2010 on 16 December 2010 are deemed always to have had effect. One of the changes is to include within the scope of ‘relevant assets’ and ‘relevant liabilities’ for the purposes of the gateway test financial assets and liabilities which are not strictly debt but which produce a return economically equivalent to interest. This is expected to result in many Private Finance Initiative projects being taken out of WWDC altogether. Other changes include removing securitisation companies from the scope of the regime and amending the definition of ultimate parent to prevent certain types of fund structures being treated more unfavourably than others. Regulations making some further changes came into effect on 13 January 2011.
The ECJ judgment in the case of HMRC v RBS Deutschland Holdings GmbH (case C-277/09) was a welcome win for the taxpayer. The case involved UK input tax recovery on the purchase of cars which were used for finance leasing in combination with a lessor put option. Germany, where the lessor was established, did not charge VAT because the leasing was regarded under German VAT law as a supply of goods and therefore as occurring in the UK. The UK did not charge VAT because it viewed the transaction, like leasing generally, as a supply of services and thus under the then applicable place of supply rules as occurring in Germany. Nonetheless, the lessor had a right to UK input tax recovery because it used the cars, under the UK view of the law, to make outbound leasing supplies which occurred outside the UK but which, had they occurred for VAT purposes in the UK, would have been taxable there. The ECJ firmly rejected an attempt by the UK to determine input tax recovery by reference to the lessor’s actual output tax treatment rather than by reference to the hypothetical UK output tax treatment which the Directive (and indeed UK legislation) treats as the relevant factor.  The ECJ also rejected an argument that the tax planning aspects of the arrangements was sufficient to bring the Halifax principle into play.
Whilst the particular planning opportunity involved in the case has been eliminated by subsequent fundamental changes to the place of supply rules for business-to-business services, the decision remains important for the appraisal of other types of VAT arbitrage, most obviously in cases where the extent of particular VAT exemptions, such as the exemption for fund management, varies greatly from one member state to another.
Helen Lethaby, Tax Partner, Freshfields Bruckhaus Deringer