Page Pathway
- Home
- Newsletters
- UK Tax Update
- UK Tax Update February 2010
UK Tax Update February 2010
- Brief Overview
- Issue 18 of Simmons & Simmons newsletter on UK tax developments of international interest.
- Applicable Law
- UK
- Reviewed
- 08 February 2010
- Submitted
- 03 February 2010
Worldwide debt cap in force
The worldwide debt cap regime included in the Finance Act 2009 comes into force for periods of account of affected worldwide groups commencing on or after 01 January 2010. The debt cap will apply, broadly, where the aggregate net financing costs of UK group companies exceed the gross consolidated external financing costs of the wider group of which the UK companies form part. Excess financing costs within the UK group will be disallowed. Financing costs will include interest and other debt financing costs (other than costs relating to short term debt) and finance costs under finance leases and debt factoring arrangements.
The Government announced a number of late changes to the worldwide debt cap in November 2009 which are intended to "iron out" technical difficulties with the original worldwide debt cap legislation.
The main change is that securitisation companies will be excluded from the regime. This is intended to ensure the "tax neutral" status of these companies is not jeopardised and will avoid any adverse effect on their credit ratings. The financing costs of a "group securitisation company" will be excluded from the full debt cap calculations (though they will still contribute to the gateway test).
In addition, companies can be elected as "protected companies". Protected companies cannot have any disallowances allocated to them, unless it is not possible to allocate the whole of the disallowance against companies that are neither protected companies nor dual resident investing companies. This is intended to assist groups involved in whole business securitisations which need certainty of tax treatment in order to protect their credit ratings. Allocations of disallowances to dual resident investment companies are also restricted.
Finally, there are a number of technical changes, including changes to:
- remove accountancy mismatches in the application of the gateway test to ensure a consistent way of measuring liabilities is used in arriving both at the worldwide group's gross debt and the net debt of UK companies
- extend the definition of "financing income" to include guarantee fees
- clarify the meaning of "ancillary costs" relating to amounts borrowed, for the purpose of computing the available amount.
Most of these changes will be introduced in the Finance Bill 2010.
For further information concerning the worldwide debt cap, see "The worldwide debt cap".
CFCs and foreign profits reforms
CFCs
The proposals for the reform of the controlled foreign company (CFC) rules set out in the original 2007 foreign profits proposals were dropped pending a full review of the rules. That review is now in progress and, as promised in the 2009 Pre-Budget Report, a discussion document on the likely shape of the new regime has now been published.
The Government has decided, contrary to proposals released in 2007, that the new rules will retain the entity based approach (not an income stream approach). The reason is pragmatic, in that whilst it is recognised that the entity based approach can operate unfairly, it minimises compliance burdens. However, the Government envisages that much of the harshness of an entity based approach can be ameliorated by providing that "good" profits and income streams of CFCs otherwise caught by the rules may be exempted. Accordingly, the final form of the rules is likely, in practice, to be a mix of the entity based and income stream approaches.
It is also notable that the rules will, it appears, continue to be focused on "controlled foreign companies", rather than being replaced with a "controlled company" regime as originally proposed (which would also have applied to domestic subsidiaries for EU compliance reasons). Other aspects of the 2007 proposals, such as applying the rules where the level of ownership is ten per cent or more and limiting the rules to large and medium sized companies, are not addressed in the discussion document.
There will be a range of exemptions from the regime. Some will be similar to current exemptions, such as an exemption for trading subsidiaries albeit it is envisaged that intra group trading transactions will not necessarily exclude the exemption. Location in a tax jurisdiction comparable to the UK and commercial rationale will also form the basis of exemptions.
Specific consideration is given in the document to the treatment of monetary assets and intellectual property (IP) under the new regime. The good news here is that group treasury companies are likely to be excluded from the regime, though finance companies carrying out more wide ranging and structural transactions will be caught, especially where there is a substantial degree of equity finance from the UK. Overseas companies actively managing IP are also likely to be excluded from the rules. However, the Government is giving consideration to introducing some form of deferred tax charge where UK developed IP is transferred overseas at a point in time when it is difficult to value accurately the IP for transfer pricing purposes and that value later proves greater than originally suggested.
The consultation period lasts until 20 April 2010. The Government aims to release a further document on the proposals along with draft legislation later in 2010, with a view to legislating in Finance Bill 2011.
Foreign branch taxation
One major area of cross border taxation omitted from the foreign profits package of measures was the taxation of foreign branch profits. That was a deliberate decision at the time. However, the 2009 Pre-Budget Report indicated that the Government is now willing to engage with business to identify and explore issues relevant to potential future changes to the taxation of foreign permanent establishments (PEs). It seems likely that the focus of the discussions will be the possible introduction of an exemption regime. Not all businesses will be attracted by such a move. The current rules allow a UK company to set up an overseas PE and take advantage of any start up losses generated by that business in the UK and that ability is likely to be lost in an exemption regime. However, other businesses which use branches (in particular, banks) are likely to welcome a move to exemption.
For further details, see "CFC discussion document released".
Possible UK patent box
It was announced in the 09 December 2009 Pre-Budget Report that the UK Government is considering introducing a patent box. It is proposed that the patent box will apply to UK based patent income and that income within the box will be taxed at a lower corporation tax rate of ten per cent. The intention is to consult on the detailed design of the patent box in time to enable legislation to be introduced in Finance Bill 2011.
Clearly, the eventual benefits of the patent box will very much depend on the outcome of the consultation. Currently, the potential scope of the box is quite confined. Accordingly, it is likely that there will be much lobbying to extend the box to encompass a wider range of income, including income from other types of intellectual property. In addition, the proposed limitation of the box to UK patent income may come under scrutiny from an EU perspective.
However, potential beneficiaries will have to wait until 2013 to take advantage of the lower rate as it is proposed that this patent box will only come into force for income from April 2013. In addition, the lower rate will only apply to patents granted after the relevant legislation is passed. In practice, however, the actual benefits of the patent box are unlikely to commence for several years more. It is usual for there to be a significant lead time from registration of a patent and flow of income.
The suggested introduction of a patent box is certainly welcome, following on from the introduction of similar regimes in the Netherlands, Belgium and Luxembourg. The transfer and holding of IP rights offshore has come under recent scrutiny and the suggested patent box will provide something of a carrot to retain patents and patent income onshore. Much will, however, depend on the outcome of the wider consultation on the taxation of controlled foreign companies (the stick) and, in particular, the application of the CFC rules to IP held by overseas subsidiaries (see CFCs and foreign profits reforms above).
Code of practice on taxation for banks
Following consultation in June 2009, the Government has introduced a controversial Code of Practice on taxation for banks requiring banks to "comply with the spirit, as well as the letter of tax law". The Code is voluntary, but the Government, perhaps optimistically, expects all banks (and any similar organisations undertaking banking activities) operating in the UK to adopt it from 09 December 2009 (or soon after).
The Code is broadly the same as that set out in the June 2009 consultation, however, a number of changes have been made as a direct consequence of responses to the consultation. Most welcome may be that HM Revenue & Customs (HMRC) have clarified that the test of whether arrangements are contrary to the spirit of the law must be judged according to the "reasonable belief" of the bank. This will certainly be helpful and indicates an acceptance that there may be more than one reasonable view as to how complex tax legislation is intended to work. As a result there should, in general, be no consequences for a bank that signs up to the Code but finds itself disagreeing with HMRC as to the intention underlying tax legislation, so long as the bank's view is reasonable.
Also helpful is that where there is doubt over whether a transaction is contrary to the intentions of Parliament, a bank will no longer be required to (although it may choose to) explain its plans in advance to HMRC. Clearly imposing such a requirement could have had a significant impact on the structuring and timing of transactions and could have had implications for the duty of confidentiality. The additional clarification that the "question of whether the tax results are contrary to the intentions of Parliament can be answered in practice by asking whether the tax consequences of a proposed transaction are too good to be true" is of more questionable value.
Changes have also been made to the way in which the Code operates. HMRC has announced that banks that are not managed within the Large Business Service will only need to adopt section 1 of the Code, some of the other aspects of the code being considered irrelevant to smaller banks. Considering that section 1 is the overview of the Code, it is unclear exactly how much difference this makes in practice to the obligations imposed on smaller banks. HMRC has, it appears, also removed its expectation that the Code be signed by a senior officer and clarified that the means of adopting the code should simply be in accordance with the internal governance procedures of the bank.
The consequences of failing to adopt or correctly implement the Code are also largely unchanged. HMRC has confirmed that the Code is voluntary but that a bank that does not adopt the code, or does not implement it properly, will not be considered as "low risk". In addition, HMRC may consider making a report to a professional body but only in "exceptional circumstances" where dishonesty is involved. Taking a commercial decision which HMRC "did not like" would not found a report.
HMRC has, however, clarified what will happen if a bank and HMRC disagree on the spirit of the law. HMRC may risk assess a transaction and open an enquiry to determine the correct tax treatment under normal principles and processes of tax law. There is however no scope for litigation to determine the spirit of the law, as the code of conduct is not itself law and is not subject to tax dispute processes. In the absence of any ability to enforce the code directly, HMRC's only remedy if it believes the code has been breached (eg by a bank taking an unreasonable view of parliament's intention, or pursuing a transaction known to be contrary to parliament's intention) is to increase its risk assessment of the bank and/or challenge the transactions under the normal letter of the law (or making a report to a professional body, as above, in exceptional cases of dishonesty).
Although the Government suggested in the Pre-Budget Report that it expects all banks operating in the UK to adopt the Code, indications are that many non-State controlled banks do not currently intend to do so.
For further information, see "Code of Practice on Taxation for Banks".
UK personal tax rates
In the 2009 Budget, the Chancellor announced changes to income tax affecting higher earners which will come into effect in April 2010. The top rate of income tax will increase to 50 per cent for those earning over £150,000 and the personal allowance will be subject to a single limit of £100,000 and will be reduced by £1 for every £2 above the limit to nil.
These changes are on top of a 0.5 per cent across the board increase in national insurance rates for employees, employers and the self employed announced in the 2008 Pre-Budget Report and taking effect from April 2011. The Chancellor announced a further 0.5 per cent increase on top of the previously announced increase in the December 2009 Pre-Budget Report. Accordingly, the main rates of national insurance from April 2011 will now be 12 per cent for Class 1 employee contributions, 13.8 per cent for Class 1 employer contributions and nine per cent for Class 4 contributions. The additional rate that applies over the Upper Earnings Limit will increase to 2 per cent.
Bank Payroll Tax
In the Pre-Budget Report on 09 December 2009, the Government announced a supertax on bankers' bonuses, in the form of a bank payroll tax. The tax, which at this stage only applies until 05 April 2010, appears to be aimed at encouraging banks to retain capital rather than pay it out to employees by way of bonuses (although with limited success if initial press coverage is to be believed). In the background, the Government also wishes to encourage the development of "sustainable long term remuneration policies that take greater account of risk and facilitate the build up of loss absorbing capital", so the tax may be extended until after the coming into force of those parts of the Financial Services Bill which require such behaviour.
The measures apply to banks who pay bonuses to employees in excess of £25,000 or make arrangements to pay such bonuses in the future. The bank payroll tax is charged at 50 per cent on the excess of such remuneration over £25,000, and is chargeable on the bank, by reference to particular employees. The tax is non deductible for the payer.
The definition of bank is widely drawn. However, additional guidance released by HMRC states that the Bank Payroll Tax is primarily intended to apply to retail and investment banks, building societies and banking groups, but that it does not apply to "non banking companies outside of banking groups (for example, insurance companies, asset managers, stockbrokers etc)".
The question of which employees of such organisations are caught is not entirely clear. A bonus to an employee is only within the rules if the duties of their employment are wholly or mainly concerned, whether directly or indirectly, with certain regulated activities, including the lending of money. Guidance is awaited on the concepts of "wholly or mainly" and "directly or indirectly", but it appears from a series of questions and answers subsequently published by HMRC that some banking employees won't be caught, for example those who work in investment management or investment advice. The employee either has to be tax resident in the UK in the current tax year or performing the duties of his employment wholly or partly in the UK during the tax year (although there will be a 60 day de minimis for this latter category).
The bank payroll tax applies to all forms of remuneration or benefit (other than certain types of excluded remuneration) awarded to employees from 09 December 2009 until 05 April 2010. "Excluded remuneration" is regular salary, wages or other benefits, shares and options awarded under certain approved share schemes and anything where the contractual obligation to pay or provide it arises before 09 December. It also applies to remuneration or benefits where there is a contractual obligation to pay or provide an amount which arises during the period 09 December 2009 until 05 April 2010, even if the amount is not due until after 05 April 2010. A contractual obligation to pay or provide an amount of remuneration or benefit is treated as arising if the amount is fixed or is capable of becoming fixed without the exercise of discretion by any person. The contractual obligation can arise in relation to "pool" arrangements even if such pools will be allocated on a discretionary basis.
The rules also contain widely drawn anti avoidance provisions. There is a general anti avoidance provision targeting arrangements which have as their purpose the reduction or elimination of a liability to the bank payroll tax. There are also specific anti avoidance provisions dealing with loans employers might otherwise make to affected employees and dealing with arrangements for future payments after the chargeable period. Delaying the payment of existing discretionary bonuses where discretion has already been exercised will not defeat the rules. It is less clear whether the deferral of any decision on bonuses until after 05 April 2010 will do so. It is unclear exactly what impact the tax will have - at this early stage, it appears from press coverage that bonuses will still be paid, albeit on a scaled down basis, with the tax being borne by a combination of the bank and the employees.
For further information, see "UK bank bonus super tax: FAQs".
For further information please contact Nick Cronkshaw or your usual contact at Simmons & Simmons.
This document is provided for information purposes only and does not constitute legal advice. Professional legal advice should be obtained before taking or refraining from any action as a result of the contents of this document.