The Budget contained a number of surprising developments that could affect the financial services sector. These include changes to long-term resident non-doms, a decrease to capital gains tax rates and plans to force users of disguised remuneration arrangements to settle their tax disputes. Detail of the changes can be found below:
Capital gains tax rates
Although no increase was announced in the capital gains tax (CGT) annual exemption, the chancellor announced a reduction in the actual rates of CGT. As a result, from 6 April 2016, the 28% and 18% rates will be reduced to 20% and 10% respectively. There are however a number of exemptions under which the rate will remain at 28%, particularly for carried interest (see below) and on chargeable gains accruing on the disposal of residential property.
Three measures were announced in the Budget which affect the operation of entrepreneurs’ relief. Broadly, these reverse changes made in Finance Act 2015 affecting structures involving joint ventures and corporate members of partnerships, and certain associated disposals of assets held privately which are sold along with the business to family members. The changes are backdated to apply from 18 March 2015. Finally, the restriction on claims to entrepreneurs’ relief on the sale of goodwill will also be relaxed in certain circumstances.
In a surprise move, the Chancellor has extended the 10% capital gains tax rate to long term investors in shares in unquoted companies, without the investor having to be involved in the business and without a minimum shareholding requirement. There will be a lifetime allowance of £10m of gains which will qualify under this new investor’s relief. There are four main conditions which will need to be met in order for this allowance to be available:
- the company must be an unlisted (including AIM) trading company or an unlisted holding company of a trading group;
- the investment must be in newly issued ordinary shares;
- the investment must be made on or after 17 March 2016; and
- the shares must be held continually for at least three years from 6 April 2016. Therefore the earliest date on which qualifying shares could be sold would be 6 April 2019.
A new individual lifetime limit of £100,000 on gains eligible for CGT exemption through the Employee Shareholder Status (ESS) will be implemented. This limit will apply for arrangements entered into on or after 17 March 2016, so existing awards issued prior to this date will be unaffected by these changes.
Change to corporation tax rate
The rate of corporation tax will reduce to 17% from 1 April 2020. As previously announced, the current corporation tax rate will reduce from 20% to 19% for financial years beginning 1 April 2017, 2018 and 2019.
Asset managers performance linked rewards
Following consultation on draft clauses published on 9 December 2015, legislation will be introduced in Finance Bill 2016 to confirm the circumstances in which performance-related rewards (carried interest) paid to asset managers may be charged to income tax rather than being charged to tax as capital gains. The change will apply in relation to sums arising to managers on or after 6 April 2016.
Under this legislation, eligibility for CGT treatment will be determined by the length of time for which the underlying scheme holds its investments on average. Full CGT treatment will apply where the average hold period is 40 months or more (rather than 48 months specified in the draft legislation published on 9 December 2015). Additional bespoke calculation rules will also be introduced for additional asset classes, including venture capital and real estate, alongside a number of other minor technical changes. The draft legislation published in December 2015 included a tapering mechanism where the average holding period was between 48 and 36 months, however, it is not clear whether any form of tapering will be included in the final legislation, or whether HMRC has listened to industry concerns surrounding the complexity of the draft holding period calculations.
Capital Gains Tax rate on carried interest
As noted above, the reductions in the CGT rates will not apply to the receipt of carried interest. Where carried interest is eligible for capital gains tax treatment, the 28% and 18% rates will continue to apply.
Offshore funds reporting regime
Whilst there were no specific announcements with respect to the offshore funds regime, with the reduction in CGT rates, the differential between income tax rates and CGT rates has widened significantly for UK resident individuals. A high earner would be liable to income tax rates at 45% but will only suffer tax on chargeable gains at a rate of 20%. In certain circumstances, offshore funds which are non-reporting funds, may become increasingly unattractive for UK resident individual investors. Any gains will be taxable as offshore income gains and subject to income tax rather than capital gains tax. Some offshore funds may consider applying for reporting fund status so that individual UK resident investors can benefit from capital gains tax rates on disposal of their investments in the funds.
Tax deductibility of corporate interest expenses
There will be a consultation on new rules limiting tax relief for large multinational enterprises in respect of interest expenses.
A fixed ratio rule will be introduced limiting corporation tax deductions for net interest expense to 30% of a group’s UK earnings before interest, depreciation and amortisation (EBITDA). Recognising that some groups may have high external gearing for genuine commercial purposes, the UK will also be implementing a group ratio rule based on the net interest to EBITDA ratio for the whole worldwide group. This should enable businesses operating in the UK to continue to obtain deductions for interest expenses commensurate with their activities. There will be a de minimis group threshold of £2 million net of UK interest expense.
This measure may have significant implications for the private equity industry where investments typically involve a high level of gearing. Such businesses will need to consider the impact on their businesses from 1 April 2017 when the new rules are expected to come into effect.
Reform of corporation tax loss relief
Two new measures apply to corporate loss relief from 1 April 2017.
Firstly, the current streaming rules will be made more flexible so that losses arising on or after 1 April 2017 that are carried forward can be used against profits from other income streams or other companies within a group. Secondly, from 1 April 2017, companies will only be able to use losses carried forward against up to 50% of their profits above £5 million. For groups, the £5million threshold will apply to the whole group.
The Government is due to consult on the design of these reforms in 2016 and will legislate for these measures in 2107.
Bank loss relief restriction
Restrictions apply to banking companies to limit the amount of brought forward pre-April 2015 losses that can be offset against current taxable profits. Currently, only 50% of losses can be offset, and this percentage is set to fall to 25% from 1 April 2016. This means banking companies will be further restricted on the utilisation of trade losses, non-trade loan relationship deficits and management expenses that accrued before 1 April 2015.
Further action on disguised remuneration
Plans to try and force the users of disguised remuneration arrangements to settle their tax disputes, particularly Employee Benefit Trusts, have been announced.
The first measure will remove transitional relief which currently prevents taxation on investment returns where tax is paid on the ‘earnings’ which were subject to the disguised remuneration. Legislation will be included in the Finance Bill 2016 and the relief will be removed after 30 November 2016, so settlements with HMRC before that date will be unaffected.
The more significant proposal is to introduce a tax charge on loans or other debts linked to disguised remuneration, where amounts are still outstanding as at 5 April 2019. This will include a ‘top up’ charge if an earlier liability (plus accrued interest) would be more than the new liability. Legislation will be included in Finance Bill 2017 following a technical consultation.
Overall, HMRC is sending a very clear message that it wants to clear the decks on disguised remuneration schemes by 5 April 2019 at the very latest.
Loan to participator tax rate
The tax rate payable by companies on loans to participators will increase from 25% to 32.5% from 6 April 2016. The loan to participator rules are designed to prevent individual investors gaining a tax advantage by extracting profits from a company through loans rather than remuneration or dividends. The change reflects the increase in the rate of income tax on dividends received by individuals from 6 April 2016, and will apply to loans advanced or benefits conferred on or after this date.
Corporation tax payment dates
The Summer Budget 2015 announced that corporation tax payment dates for companies with taxable profits over £20 million will be brought forward, requiring companies to pay tax in instalments in the third, sixth, ninth and twelfth months of the accounting period. The Government will delay the introduction of the new payment scheme by two years to enable companies to put measures in place to deal with this. It will now apply to accounting periods starting on or after 1 April 2019.
As announced at the Autumn Statement 2015, legislation will be introduced in Finance Bill 2016 to amend the transactions in securities rules and introduce a targeted anti-avoidance rule in order to prevent opportunities for income to be converted to capital in order to gain a tax advantage. Transactions including Members Voluntary Liquidations (MVLs), repayments of share capital and purchases of own shares by a company were specifically targeted.
The Government will shortly publish its response to the consultation concerning company distributions, which was published on 9 December 2015.
The Budget papers made limited, albeit potentially important, references to the impending changes to the treatment of long-term resident non-doms. These can be summarised as follows:
Partnership taxation – proposals to clarify tax treatment
- Non-doms who become deemed domiciled from April 2017 will benefit from an uplift in the cost basis of their non UK assets.
- Non-doms who become deemed domiciled will benefit from transitional provisions with regard to offshore funds to provide certainty on how amounts remitted to the UK will be taxed. This may give a measure of relief from the complex mixed fund rules.
- Confirmation that non-doms who establish offshore trusts before becoming deemed domiciled will not be taxed on income or gains retained within the trust. Previous updates have indicated that UK source income would remain taxable on the non-dom in these circumstances, but no reference is made to this in the Budget documents.
The Government will launch a consultation on how partnerships calculate their tax liabilities. This consultation will include a number of areas where the taxation of partnerships could be seen as uncertain, including an issue highlighted by the Office of Tax Simplification’s partnerships review. Any necessary legislation will be announced in a future Finance Bill.
Reform of the Substantial Shareholdings Exemption
The government announced a consultation on possible reform of the Substantial Shareholdings Exemption (SSE) for corporate Capital Gains. There have been significant developments in the UK and international corporate landscape since the SSE was introduced in 2002. The government will therefore consult on which the SSE is still delivering on its original policy objective of ensuring tax doesn’t act as a disincentive to commercial business sales or group restructuring. It will also look at whether changes could be made to its design in order to increase its simplicity, coherence and international competitiveness.
For further information, please contact Jacquelyn Kimber