The Budget did not contain any major surprises. The main points of interest so far as the City was concerned were the accelerated reduction in the corporation tax rate, confirmation that a General Anti-Abuse Rule will be included in the FA 2013, an amendment to the grouping rules to allow certain convertibles to qualify as normal commercial loans for grouping purposes and proposed consultations in relation to the computation of corporation tax on chargeable gains and losses in currencies other than sterling in certain circumstances and in relation to the taxation of capital gains made by non-resident non-natural persons on UK residential property.
There was not much in the recent Budget to surprise the City. Most of the relevant changes had either been the subject of prior public announcement or strategically leaked in the run-up to the Budget. However, on the whole, the Budget will have pleased the City.
Corporation tax rate
One of the simplest changes was the announcement that the main rate of corporation tax would be reduced to 24% for the financial year commencing 1 April 2012 and 23% for the following financial year. These accelerated reductions will be of great benefit to those corporates which are profitable and do not have the benefit of carried forward losses. However, those corporates which do have losses to shelter their profits as a result of the recent economic conditions are likely to find the change less welcome because of the adverse impact of the rate change on their deferred tax assets. Interestingly, our corporation tax rate is now sufficiently low for UK resident companies potentially to qualify as CFCs for the purposes of other tax regimes such as Germany.
The General Anti-Abuse Rule (GAAR)
As widely expected, the government has decided to accept the recommendation of the Aaronson report and will be proceeding with the introduction of a GAAR in the FA 2013. The GAAR is to be extended to cover SDLT, which is not surprising given the focus on avoidance in that area.
Welcome news is the fact that the draft legislation which is to be published for consultation will be based on the recommendations of the Aaronson report. In other words, it looks like the government has accepted that the GAAR should be confined to egregious tax avoidance and that uncertainty for taxpayers should be minimised by the use of supporting guidance and an Advisory Panel.
It will be interesting to see how the draft legislation published in the summer for the purposes of consultation differs from the draft legislation produced by Graham Aaronson’s committee. Commentators will doubtless be interested to pounce on any extension of HMRC’s discretion in this area. That was a major focus of the Aaronson report and it is vital that safeguards which are the same as, or equivalent to, those suggested by the Aaronson draft legislation are maintained.
Of course, many commentators still question whether a GAAR is needed in the first place, given the existence of the disclosure regime and the fact that the courts have generally been able to counteract egregious tax schemes by adopting a certain latitude in construing the law. When those features are added to the fact that the government clearly feels able to adopt retrospective tax legislation in the case of what it perceives to be abusive tax avoidance, there is scope for wondering what gap the GAAR is intended to plug.
Non-sterling capital assets
An announcement which will have been widely welcomed was the proposal to consult over the summer on whether to allow a company with a non-sterling functional currency to compute its capital gains and losses in its functional currency. The fact that capital gains and losses have been required to be calculated in sterling has been an irritant for some time. The problem has been exacerbated by the fact that exchange gains and losses on loan relationships and derivative contracts fall to be taxed as income items, thereby creating a mismatch in circumstances where a company with capital assets denominated in a non-sterling currency which is also its functional currency for accounting purposes chooses to fund itself with debt in the same currency (or swaps its debt into that currency).
The legislative trend in recent years has been to facilitate the calculation of taxable income in currencies other than sterling. For example, just last year, legislation allowing a UK resident investment company to elect to calculate its taxable income in a currency other than its functional accounting currency was enacted. In that context, the continuing requirement to convert into sterling for the purposes of calculating capital gains and losses was even more anomalous.
The recent change in the value-shifting rules has also contributed to the problems in this area. It used to be possible to mitigate this problem in the context of non-sterling-denominated shares held in an issuer by paying a dividend out of the issuer prior to the relevant disposal in order to reduce the sterling value of the issuer to the sterling base cost. However, following the recent changes to the value-shifting rules, it would seem that HMRC does not accept this as a viable mitigation strategy. So it is to be hoped that this consultation process bears fruit in the FA 2013.
Grouping
Another welcome change was the announcement that the grouping rules would be amended to exclude from the categories of ‘equity’ that are relevant to the various grouping tests loan notes carrying a right of conversion into shares or securities of quoted unconnected companies. There is clearly no policy reason why such loan notes should be characterised as ‘equity’ for those purposes and therefore this is a sensible change which should facilitate indirect investment in quoted equities.
A point to note is that the change announced by the press release merely relates to the prohibition on rights of conversion into (or rights to acquire additional) shares or securities. No mention is made of the requirement in CTA 2010 s 162(4) that a normal commercial loan cannot entitle the creditor to interest which is dependent to any extent on the results of all or part of the issuer’s business or the value of any of the issuer’s assets. Presumably, this means that, in order to avoid equity treatment for the relevant convertible, the borrower will not be able to pay interest which is quantified in any way by reference to the underlying shares pending conversion.
The press release announcing this change has a puzzling reference to the relevant loan’s constituting new consideration for the underlying shares. It is hard to understand how this can ever be the case given that the issuer of the underlying shares will necessarily be a company that is different from the borrower under the relevant loan and that the shares are likely already to be in issue at the time when the relevant loan is made.
Regulatory capital
It was slightly disappointing to see that the government appears to be no further forward in reaching a conclusion on the tax treatment of regulatory capital instruments issued in accordance with the Basel III and EU Capital Requirements Directive IV proposals. This is an area in which substantial consultation has already taken place and it would have been helpful to have some guidance on the extent to which deductions will be available for payments on those instruments. The relevant press release merely states that the FA 2012 will ‘introduce a power to determine the tax treatment of [such instruments]’ and leaves the exercise of that power to a later day.
CGT for non-residents
The announcement that the government is to consult on the introduction of a CGT charge on residential property owned by non-resident non-natural persons with a view to introducing legislation in the FA 2013 is interesting in a number of respects.
First, there is a question as to whether the UK should be seeking to tax capital gains made on UK real estate regardless of the identity of the disponor and regardless of whether the real estate is residential or commercial in nature. It might fairly be said that real estate in the UK is a finite resource and that it would be entirely appropriate for the UK to benefit from capital gains made on it. This is the approach adopted by most, if not all, of our neighbours in the EU – a straw poll reveals that disposals by non-residents of real property in each of France, Italy, the Netherlands and Germany are all potentially subject to tax in the relevant jurisdiction.
On the other hand, taxing all UK real estate gains made by non-residents might well have a depreciatory effect on the market as a whole and the REIT regime would seem to indicate that the government has set its face against generally taxing non-residents on capital gains deriving from UK real estate.
The proposed consultation therefore represents an exception to that policy and, at first sight, it is a little hard to understand what the exception is trying to catch. After all, a non-resident company owned by a resident individual is likely to fall within the ambit of TCGA 1992 s 13 so that a capital gain made by such a company would be taxable in the hands of the individual in any event. Conversely, a non-resident company owned by a non-resident individual is in the same position as the non-resident individual himself – currently, neither of them is subject to tax on capital gains.
Perhaps the fact that the consultation is to proceed in conjunction with the SDLT enveloping annual charge may give a clue to the thinking in this context. As announced in the Budget, the SDLT enveloping charge will apply only to properties which are transferred to a company on or after 21 March 2012.
That still leaves outside the 15% charge a great number of residential properties which were already within a corporate envelope on that date. It may well be that the proposed capital gains tax charge is intended, along with the annual SDLT charge, to discourage the continued use of such vehicles.
Tony Beare, Tax Partner, Slaughter and May
