Since 2010, it has become the norm for draft tax legislation to be published late in the calendar year for eventual inclusion in the following year’s Finance Bill. This is published about a week after the chancellor’s Autumn Statement, and the publication date has generally become known amongst tax practitioners as ‘legislation day’ or ‘L-day’. This year, ‘L-day’ was on 10 December
Draft legislation can always be amended both before and after it is introduced to the House of Commons. As the general election will take place next May, it is therefore possible that not all of the draft legislation now published will make it to the statute book. The likelihood is that there will be a truncated Finance Act before the election followed by a further Finance Bill when the new Parliament is convened. There is even the possibility of three Finance Acts in one calendar year as was the case in 2010.
This guide focuses on four topics where there is now more detail than was available at the time of the Autumn Statement. (For the full guide examining other aspects of draft FB 2015, see our website.)
Companies may use special purpose share schemes (often called ‘B share schemes’) to offer shareholders the option to receive, instead of a dividend, a similar amount via an issue of new shares. The shares issued are subsequently purchased by the company or are sold to a pre-arranged third party. Under legislation to be included in the next Finance Bill, any amount thus received by a shareholder after 5 April 2015 will be charged to income tax as an ‘alternative receipt’.
A shareholder will have received an ‘alternative receipt’ if:
The receipt will be treated as a distribution made to the shareholder by the company in the tax year in which it is received. It will qualify for a dividend tax credit to the same extent that an actual distribution by the company to the shareholder would have qualified.
It does not matter if the choice given to the shareholder is subject to any conditions being met or to the exercise of any power. Where a person is offered one thing subject to a right to choose another thing instead, he is treated as making a choice if he abandons or fails to exercise the right. For example, where a shareholder will receive a bonus B share if he so elects and a bonus C share if he fails to elect, a failure to elect counts as a choice to receive the C share.
If at any time a tax other than income tax (e.g. capital gains tax) is charged in relation to the alternative receipt, then in order to avoid a double charge to tax, the recipient may make a claim for consequential adjustments to be made in respect of the other tax.
A practitioner view
‘The first question that comes to mind when looking at the provisions dealing with “arrangements offering a choice of capital and income” – B share schemes to you and me – is “why now?”. B share schemes - which offer individual shareholders who are receiving a return of cash from a company, in effect, a choice between a return of capital or an income distribution - have been relatively standard planning for many, many years. Over time, they have increased in complexity and sophistication but, although there have been some indications of disquiet on the part of HMRC (see the GAAR guidance), they have been largely tolerated.
‘The new rules will impose income tax on “alternative receipts” received by income taxpayers who could otherwise have received an income distribution. Standard scrip dividend schemes should fall outside the new rules, but there is a risk of some collateral damage to demerger and asset extraction structures. It is yet another “patch” on our rather formalistic distribution rules when, perhaps, a wider more principled review would have been preferable. But there’s no time for that with an election looming.’
Ashley Greenbank, partner, Macfarlanes
The diverted profits tax will apply to diverted profits arising on or after 1 April 2015, with apportionment rules for accounting periods that straddle 1 April 2015. It is intended that this tax will deter multinational groups of companies from implementing aggressive tax planning which seeks to divert profits away from the UK, in order to minimise the group’s overall corporation tax bill.
The DPT effectively operates by applying a 25% tax charge on diverted profits relating to UK activity and applies to companies that:
The first rule comes into effect if a person is carrying on activity in the UK in connection with supplies of goods and services by a non-UK resident company to customers in the UK, provided that certain detailed conditions are met. However this rule will not apply if the PE and the foreign company are small or medium-sized enterprises or the sales revenues of the company and connected companies from all supplies of goods and services to customers in the UK are no more than £10m in a 12-month accounting period. Further if the PE falls within the independent status rules (CTA 2010 s 1142) or the alternative finance regime (CTA 2010 s 1144) they will not, subject to meeting certain conditions, fall within the DPT regime.
The second rule applies to certain arrangements which lack economic substance involving entities with an existing UK taxable presence. The primary function is to counteract arrangements that exploit tax differentials and will apply where certain detailed conditions, including those on an ‘effective tax mismatch outcome’ are met. This rule also will not apply where the two parties to the arrangements are SMEs.
For both rules it is provided that the DPT will not reflect any profits relating to transactions involving only loan relationships.
Draft legislation, explanatory notes and guidance were issued by HMRC on 10 December 2014. The HMRC guidance provides several useful examples as to what arrangements they anticipate will be caught by the new tax.
The initial onus to notify liability falls on the relevant company; it must notify HMRC if it is potentially within the scope of DPT within 3 months after the end of the accounting period. If the company does not notify liability it may potentially be liable to a penalty. However, and irrespective of any initial notification by the company, if HMRC have reasonable grounds for believing that the DPT will apply, they must issue a preliminary notice within 2 years of the end of the accounting period (extended to 4 years if the company had not made any initial notification). A preliminary notice will be issued explaining, among other things, the reasons, the amount of the charge and the basis on which it has been calculated (including the details of the amount of the taxable diverted profits).
The recipient has 30 days to make representations and the designated HMRC officer may consider certain specified matters within a further 30 day period before either issuing a charging notice on the original or a revised amount, or confirming that no charge arises. Where specific conditions are met and the designated HMRC officer considers that certain expenses otherwise deductible may be greater than they would have been at arm’s length; the diverted profit charge will initially reflect a 30% disallowance of those expenses. The charging notice will require the payment of the diverted profits tax within 30 days. Penalties will apply for late payment.
Following the due date for payment, there is a 12-month review period during which the charge may be adjusted based upon evidence. At the end of the review period the business has a further 30 days to appeal against any resulting charge. The review period can be brought to a conclusion earlier with the agreement of both parties. There can be no postponement of the disputed tax during the review period or due to any subsequent appeal.
A practitioner view
‘I cannot recall the last time I saw such an ill-considered proposal as the diverted profit tax. It is also a strange way to legislate, given that the OECD specifically wanted members to avoid unilateral action for fear it would undermine the BEPS process. The run up to elections is always a difficult time for policy makers, as they try to balance the desire to appeal to the masses with the long term benefits of sensible tax policy.
‘One could argue that the DPT is intended to encourage entities to incorporate in the UK and take advantage of the 20% corporation tax rate. But that assumes that the tax will not contravene any number of EU laws and indeed can be distinguished from typical forms of direct tax and therefore not cause issues with existing tax treaties. Something that will no doubt be clarified in due course. However, the legislation itself needs a lot of work, not least to clarify what an “avoided PE” is and how this interacts with the intended carve outs.’
Sandy Bhogal, head of tax, Mayer Brown
Legislation will be introduced to introduce a new Chapter 5E into ITA 2007 Part 13 to confirm the treatment of sums received by managers for investment management services.
The new chapter will provide that where an individual provides investment management services for a collective investment scheme through an arrangement involving partnerships, any sums received for those services will be treated as profits of a trade, unless already charged to income tax.
Sums will not be caught if they represent a return which varies by reference to profits on funds, or represent a return on investments by the managers.
Where one or more ‘disguised fees’ arise to an individual in 2015/16 or any subsequent tax year from one or more collective investment schemes, the individual will be liable for income tax in respect of the disguised fees as if he were carrying on a trade for the tax year and the disguised fees were the profits of the trade.
A ‘disguised fee’ arises to an individual in a tax year from a collective investment scheme if:
Any sum which arises to an individual directly or indirectly from a collective investment scheme under any arrangements is a management fee, except insofar as it:
‘Carried interest’ is broadly a sum paid to an individual from scheme profits after all (or substantially all) of the investments and ‘preferred return’ have been paid to participants in the scheme.
‘Preferred return’ is an amount at least equivalent to compound interest on an investment at 6% per annum for the whole of the period during which the investment was invested in the scheme.
In determining whether the above charge applies in relation to an individual, no regard is to be had to any arrangements a main purpose of which is to secure that the charge would not apply.
There is allowance for the avoidance of double taxation on sums charged as above. This enables the individual to claim a consequential adjustment if at any time income tax or another tax is charged under another tax provision in respect of the disguised fee. The consequential adjustment cannot exceed the lesser of the two charges.
Where the disguised fee arises to the individual by way of a loan or advance, there is similar allowance for avoidance of double taxation where tax is charged on an amount arising to the individual under the main arrangements for the purpose of enabling the individual to repay the loan or advance.
A practitioner view
‘In labelling some payments to investment managers as “disguised fee income”, this is the latest example in a trend on the part of HMRC to label many perfectly commercial arrangements as some other type of arrangement ‘in disguise’ in order to collect a greater amount of tax. If this approach continues to become more widespread it will sow further uncertainty into our already over-complex tax regime. While the government’s confirmation that this legislation isn’t targeted at carry and other performance based arrangements is welcome, it appears from the draft legislation that its scope extends to payments that would not normally be viewed, from a commercial perspective, as fees.’
Ben Eaton, tax partner, Goodwin Procter
Legislation will be introduced in Finance Bill 2015 to restrict the proportion of annual taxable profits generated by banks and building societies which can be offset by certain brought forward losses that accrued prior to 1 April 2015. The stated aim of this legislation is to reduce the tax benefit received from the significant losses arising in the banking sector during the financial crisis, which could otherwise be utilised to eliminate the corporation tax payable on recovering profits.
Where a company’s accounting period straddles 1 April 2015, the accounting period is split into two notional periods, with the restriction applying to relevant reliefs accruing before 1 April 2015. Anti-forestalling rules apply though from 3 December 2014 to arrangements entered into from that date and target banking companies accelerating recognition of their own profits or the transfer-in of profits from a connected company.
The restriction will operate by limiting carried forward trading losses, non-trading loan relationship deficits and management expenses that accrued before 1 April 2015, such that they can only be offset against 50% of the relevant profits of the company.
A company has to perform the following calculation to establish its relevant profits:
Other reliefs brought forward (such as capital losses or UK property losses) are not included in the restriction and can be brought forward and relieved in full.
Note that the restriction does not enable the company to override the existing rules for the automatic use of reliefs brought forward. A company with trading losses or management expenses must use them up to the maximum restricted amount allowed by the calculation (albeit the maximum restricted amount may be reduced by claiming more relief against total profits than would normally be available).
The existing rules for claiming to carry forward non-trading deficits on loan relationships still apply.
This restriction has notable effect on the following existing rules:
Group relief
Under existing rules, group relief can only be claimed after all other reliefs of the current and previous periods. Under the restriction, however, the relevant reliefs can be effectively displaced by group relief. This means that a company under the restriction may potentially be able to claim more group relief, because at the stage it is claimed the company’s profits will not be reduced by the relevant reliefs. Doing so, however, will reduce the profit figure used for calculating the available amount of relevant relief. To the extent that a company surrenders any relief of the current period as group relief these amounts will not be reflected in that company’s profits when calculating the allowable reliefs it can bring forward.
Qualifying charitable donations
Under existing rules qualifying charitable donations can only be claimed after all other reliefs (apart from group relief and relief from future periods), and only to the extent that it reduces the profits to nil. Under the restriction, brought forward reliefs are given after relief for qualifying charitable donations. Similarly to group relief, this means that a company under the restriction may potentially be able to use more relief for qualifying charitable donations, because at the stage it is given the company’s profits will not be reduced by the relevant reliefs. The qualifying charitable donations will, however, reduce the profit figure used for calculating the available amount of relevant relief.
Management expenses
Management expenses brought forward are treated as management expenses of the period, and under the current rules relief is given for these before any other relief from total profits. As a consequence of this restriction, relief for most other reliefs from total profits could be given in preference over restricted management expenses brought forward, as described for group relief and qualifying charitable donations.
Draft legislation (for consultation) and a technical note, which contains detailed examples as to how HMRC envisage the restriction operating, were issued on 3 December 2014.
A practitioner view
‘The restriction on use of carried forward losses for banks is an unwelcome surprise for the sector. In the short term, it is likely to represent a significant cash tax cost, and the ongoing recognition of deferred tax assets will need to be considered. To put the point in context, last year major banks paid £2.2bn in bank levy in the UK. The chancellor hopes to raise an average of £800m a year from the measures on bank losses. Therefore, the revenue effect of the measure is similar to a 36% increase in bank levy in cash terms.’
Anna Anthony, head of financial services tax, EY
Since 2010, it has become the norm for draft tax legislation to be published late in the calendar year for eventual inclusion in the following year’s Finance Bill. This is published about a week after the chancellor’s Autumn Statement, and the publication date has generally become known amongst tax practitioners as ‘legislation day’ or ‘L-day’. This year, ‘L-day’ was on 10 December
Draft legislation can always be amended both before and after it is introduced to the House of Commons. As the general election will take place next May, it is therefore possible that not all of the draft legislation now published will make it to the statute book. The likelihood is that there will be a truncated Finance Act before the election followed by a further Finance Bill when the new Parliament is convened. There is even the possibility of three Finance Acts in one calendar year as was the case in 2010.
This guide focuses on four topics where there is now more detail than was available at the time of the Autumn Statement. (For the full guide examining other aspects of draft FB 2015, see our website.)
Companies may use special purpose share schemes (often called ‘B share schemes’) to offer shareholders the option to receive, instead of a dividend, a similar amount via an issue of new shares. The shares issued are subsequently purchased by the company or are sold to a pre-arranged third party. Under legislation to be included in the next Finance Bill, any amount thus received by a shareholder after 5 April 2015 will be charged to income tax as an ‘alternative receipt’.
A shareholder will have received an ‘alternative receipt’ if:
The receipt will be treated as a distribution made to the shareholder by the company in the tax year in which it is received. It will qualify for a dividend tax credit to the same extent that an actual distribution by the company to the shareholder would have qualified.
It does not matter if the choice given to the shareholder is subject to any conditions being met or to the exercise of any power. Where a person is offered one thing subject to a right to choose another thing instead, he is treated as making a choice if he abandons or fails to exercise the right. For example, where a shareholder will receive a bonus B share if he so elects and a bonus C share if he fails to elect, a failure to elect counts as a choice to receive the C share.
If at any time a tax other than income tax (e.g. capital gains tax) is charged in relation to the alternative receipt, then in order to avoid a double charge to tax, the recipient may make a claim for consequential adjustments to be made in respect of the other tax.
A practitioner view
‘The first question that comes to mind when looking at the provisions dealing with “arrangements offering a choice of capital and income” – B share schemes to you and me – is “why now?”. B share schemes - which offer individual shareholders who are receiving a return of cash from a company, in effect, a choice between a return of capital or an income distribution - have been relatively standard planning for many, many years. Over time, they have increased in complexity and sophistication but, although there have been some indications of disquiet on the part of HMRC (see the GAAR guidance), they have been largely tolerated.
‘The new rules will impose income tax on “alternative receipts” received by income taxpayers who could otherwise have received an income distribution. Standard scrip dividend schemes should fall outside the new rules, but there is a risk of some collateral damage to demerger and asset extraction structures. It is yet another “patch” on our rather formalistic distribution rules when, perhaps, a wider more principled review would have been preferable. But there’s no time for that with an election looming.’
Ashley Greenbank, partner, Macfarlanes
The diverted profits tax will apply to diverted profits arising on or after 1 April 2015, with apportionment rules for accounting periods that straddle 1 April 2015. It is intended that this tax will deter multinational groups of companies from implementing aggressive tax planning which seeks to divert profits away from the UK, in order to minimise the group’s overall corporation tax bill.
The DPT effectively operates by applying a 25% tax charge on diverted profits relating to UK activity and applies to companies that:
The first rule comes into effect if a person is carrying on activity in the UK in connection with supplies of goods and services by a non-UK resident company to customers in the UK, provided that certain detailed conditions are met. However this rule will not apply if the PE and the foreign company are small or medium-sized enterprises or the sales revenues of the company and connected companies from all supplies of goods and services to customers in the UK are no more than £10m in a 12-month accounting period. Further if the PE falls within the independent status rules (CTA 2010 s 1142) or the alternative finance regime (CTA 2010 s 1144) they will not, subject to meeting certain conditions, fall within the DPT regime.
The second rule applies to certain arrangements which lack economic substance involving entities with an existing UK taxable presence. The primary function is to counteract arrangements that exploit tax differentials and will apply where certain detailed conditions, including those on an ‘effective tax mismatch outcome’ are met. This rule also will not apply where the two parties to the arrangements are SMEs.
For both rules it is provided that the DPT will not reflect any profits relating to transactions involving only loan relationships.
Draft legislation, explanatory notes and guidance were issued by HMRC on 10 December 2014. The HMRC guidance provides several useful examples as to what arrangements they anticipate will be caught by the new tax.
The initial onus to notify liability falls on the relevant company; it must notify HMRC if it is potentially within the scope of DPT within 3 months after the end of the accounting period. If the company does not notify liability it may potentially be liable to a penalty. However, and irrespective of any initial notification by the company, if HMRC have reasonable grounds for believing that the DPT will apply, they must issue a preliminary notice within 2 years of the end of the accounting period (extended to 4 years if the company had not made any initial notification). A preliminary notice will be issued explaining, among other things, the reasons, the amount of the charge and the basis on which it has been calculated (including the details of the amount of the taxable diverted profits).
The recipient has 30 days to make representations and the designated HMRC officer may consider certain specified matters within a further 30 day period before either issuing a charging notice on the original or a revised amount, or confirming that no charge arises. Where specific conditions are met and the designated HMRC officer considers that certain expenses otherwise deductible may be greater than they would have been at arm’s length; the diverted profit charge will initially reflect a 30% disallowance of those expenses. The charging notice will require the payment of the diverted profits tax within 30 days. Penalties will apply for late payment.
Following the due date for payment, there is a 12-month review period during which the charge may be adjusted based upon evidence. At the end of the review period the business has a further 30 days to appeal against any resulting charge. The review period can be brought to a conclusion earlier with the agreement of both parties. There can be no postponement of the disputed tax during the review period or due to any subsequent appeal.
A practitioner view
‘I cannot recall the last time I saw such an ill-considered proposal as the diverted profit tax. It is also a strange way to legislate, given that the OECD specifically wanted members to avoid unilateral action for fear it would undermine the BEPS process. The run up to elections is always a difficult time for policy makers, as they try to balance the desire to appeal to the masses with the long term benefits of sensible tax policy.
‘One could argue that the DPT is intended to encourage entities to incorporate in the UK and take advantage of the 20% corporation tax rate. But that assumes that the tax will not contravene any number of EU laws and indeed can be distinguished from typical forms of direct tax and therefore not cause issues with existing tax treaties. Something that will no doubt be clarified in due course. However, the legislation itself needs a lot of work, not least to clarify what an “avoided PE” is and how this interacts with the intended carve outs.’
Sandy Bhogal, head of tax, Mayer Brown
Legislation will be introduced to introduce a new Chapter 5E into ITA 2007 Part 13 to confirm the treatment of sums received by managers for investment management services.
The new chapter will provide that where an individual provides investment management services for a collective investment scheme through an arrangement involving partnerships, any sums received for those services will be treated as profits of a trade, unless already charged to income tax.
Sums will not be caught if they represent a return which varies by reference to profits on funds, or represent a return on investments by the managers.
Where one or more ‘disguised fees’ arise to an individual in 2015/16 or any subsequent tax year from one or more collective investment schemes, the individual will be liable for income tax in respect of the disguised fees as if he were carrying on a trade for the tax year and the disguised fees were the profits of the trade.
A ‘disguised fee’ arises to an individual in a tax year from a collective investment scheme if:
Any sum which arises to an individual directly or indirectly from a collective investment scheme under any arrangements is a management fee, except insofar as it:
‘Carried interest’ is broadly a sum paid to an individual from scheme profits after all (or substantially all) of the investments and ‘preferred return’ have been paid to participants in the scheme.
‘Preferred return’ is an amount at least equivalent to compound interest on an investment at 6% per annum for the whole of the period during which the investment was invested in the scheme.
In determining whether the above charge applies in relation to an individual, no regard is to be had to any arrangements a main purpose of which is to secure that the charge would not apply.
There is allowance for the avoidance of double taxation on sums charged as above. This enables the individual to claim a consequential adjustment if at any time income tax or another tax is charged under another tax provision in respect of the disguised fee. The consequential adjustment cannot exceed the lesser of the two charges.
Where the disguised fee arises to the individual by way of a loan or advance, there is similar allowance for avoidance of double taxation where tax is charged on an amount arising to the individual under the main arrangements for the purpose of enabling the individual to repay the loan or advance.
A practitioner view
‘In labelling some payments to investment managers as “disguised fee income”, this is the latest example in a trend on the part of HMRC to label many perfectly commercial arrangements as some other type of arrangement ‘in disguise’ in order to collect a greater amount of tax. If this approach continues to become more widespread it will sow further uncertainty into our already over-complex tax regime. While the government’s confirmation that this legislation isn’t targeted at carry and other performance based arrangements is welcome, it appears from the draft legislation that its scope extends to payments that would not normally be viewed, from a commercial perspective, as fees.’
Ben Eaton, tax partner, Goodwin Procter
Legislation will be introduced in Finance Bill 2015 to restrict the proportion of annual taxable profits generated by banks and building societies which can be offset by certain brought forward losses that accrued prior to 1 April 2015. The stated aim of this legislation is to reduce the tax benefit received from the significant losses arising in the banking sector during the financial crisis, which could otherwise be utilised to eliminate the corporation tax payable on recovering profits.
Where a company’s accounting period straddles 1 April 2015, the accounting period is split into two notional periods, with the restriction applying to relevant reliefs accruing before 1 April 2015. Anti-forestalling rules apply though from 3 December 2014 to arrangements entered into from that date and target banking companies accelerating recognition of their own profits or the transfer-in of profits from a connected company.
The restriction will operate by limiting carried forward trading losses, non-trading loan relationship deficits and management expenses that accrued before 1 April 2015, such that they can only be offset against 50% of the relevant profits of the company.
A company has to perform the following calculation to establish its relevant profits:
Other reliefs brought forward (such as capital losses or UK property losses) are not included in the restriction and can be brought forward and relieved in full.
Note that the restriction does not enable the company to override the existing rules for the automatic use of reliefs brought forward. A company with trading losses or management expenses must use them up to the maximum restricted amount allowed by the calculation (albeit the maximum restricted amount may be reduced by claiming more relief against total profits than would normally be available).
The existing rules for claiming to carry forward non-trading deficits on loan relationships still apply.
This restriction has notable effect on the following existing rules:
Group relief
Under existing rules, group relief can only be claimed after all other reliefs of the current and previous periods. Under the restriction, however, the relevant reliefs can be effectively displaced by group relief. This means that a company under the restriction may potentially be able to claim more group relief, because at the stage it is claimed the company’s profits will not be reduced by the relevant reliefs. Doing so, however, will reduce the profit figure used for calculating the available amount of relevant relief. To the extent that a company surrenders any relief of the current period as group relief these amounts will not be reflected in that company’s profits when calculating the allowable reliefs it can bring forward.
Qualifying charitable donations
Under existing rules qualifying charitable donations can only be claimed after all other reliefs (apart from group relief and relief from future periods), and only to the extent that it reduces the profits to nil. Under the restriction, brought forward reliefs are given after relief for qualifying charitable donations. Similarly to group relief, this means that a company under the restriction may potentially be able to use more relief for qualifying charitable donations, because at the stage it is given the company’s profits will not be reduced by the relevant reliefs. The qualifying charitable donations will, however, reduce the profit figure used for calculating the available amount of relevant relief.
Management expenses
Management expenses brought forward are treated as management expenses of the period, and under the current rules relief is given for these before any other relief from total profits. As a consequence of this restriction, relief for most other reliefs from total profits could be given in preference over restricted management expenses brought forward, as described for group relief and qualifying charitable donations.
Draft legislation (for consultation) and a technical note, which contains detailed examples as to how HMRC envisage the restriction operating, were issued on 3 December 2014.
A practitioner view
‘The restriction on use of carried forward losses for banks is an unwelcome surprise for the sector. In the short term, it is likely to represent a significant cash tax cost, and the ongoing recognition of deferred tax assets will need to be considered. To put the point in context, last year major banks paid £2.2bn in bank levy in the UK. The chancellor hopes to raise an average of £800m a year from the measures on bank losses. Therefore, the revenue effect of the measure is similar to a 36% increase in bank levy in cash terms.’
Anna Anthony, head of financial services tax, EY
Since 2010, it has become the norm for draft tax legislation to be published late in the calendar year for eventual inclusion in the following year’s Finance Bill. This is published about a week after the chancellor’s Autumn Statement, and the publication date has generally become known amongst tax practitioners as ‘legislation day’ or ‘L-day’. This year, ‘L-day’ was on 10 December
