Kingston Smith

Autumn Statement 2016: Corporate and Business Tax

The corporate and business tax measures announced (or re-announced) by the Chancellor in many cases represented a vote of confidence in his predecessor’s direction of travel. The previously announced reductions in the rate of corporation tax were confirmed, and various other changes were announced which will increase the competitiveness of the UK regime. That said, some restrictions were announced that will make things slightly more difficult for some companies. Whilst some will be pleased that there were no significant announcements, others will see a missed opportunity for radical reform and simplification of the system.

Corporation Tax

The Chancellor affirmed that there would be no change to the headline rates of Corporation Tax provided for in recent Finance Acts. The main rate for the current financial year (2016) is 20%, and this will reduce to 19% for the years 2017 to 2019, and to 17% for 2020.

Companies falling foul of the Diverted Profits Tax (DPT) regime will continue to pay DPT at 25%, and there will therefore be an increasing incentive for these companies to volunteer Corporation Tax at the lower rate on profits that might in the absence of the DPT escape the UK tax net.

KS Comment: Companies will benefit from the Chancellor’s commitment to maintaining one of the lowest headline rates of tax on corporate profits in the G20. Clearly the hope is that this will weigh significantly in international companies’ decisions as to whether to invest in the UK, regardless of Brexit.

Research and Development Tax Credits

The UK tax regime for companies investing in R&D is extremely favourable, but even so the chancellor has promised that “the government will review the tax environment for R&D to look at ways to … make the UK an even more competitive place to do R&D.”

KS Comment: These changes can only be positive and we look forward to further information in due course.

Reform of Substantial Shareholdings Exemption (SSE)

Under the current rules, the SSE allows UK resident companies, which have a 10% or greater shareholding in a trading company and which dispose of shares in that company, to secure a full exemption from UK corporation tax on any gain made on those shares where certain conditions are met.

Following a detailed consultation on the exemption over the summer, the Chancellor announced today that changes to the rules will be introduced from 1 April 2017. We do not yet have full details of these changes but early indications are that the Government will simplify the rules, remove certain requirements and provide a wider exemption for qualifying institutional investors.

Update – 5 December 2016: The Government has now confirmed that from 1 April 2017:

  • The availability of the relief will no longer depend on whether the company making the disposal (or its group) is “trading”;
  • It will now be easier for a company to qualify for the relief when they sell their shareholding in multiple tranches;
  • It will no longer matter whether the company whose shares are being sold is “trading” immediately after disposal;
  • There will be a broader exemption for companies owned by qualifying institutional investors.

KS Comment: This proposal is to be welcomed. The current SSE rules are very complicated to apply in practice and the restrictions can bite unfairly in certain situations. A liberalisation of the SSE rules should bring the UK more into line with other international tax regimes (including those within the EU), and in this respect these changes should underline the message that Britain is open for business.

The end of the small owner-managed limited company?

The Chancellor referred in his speech to the “growing cost to the Exchequer of incorporation”. The principal “cost to the Exchequer” referred to here is presumably that the profits of these businesses that are retained in the company after suffering corporation tax, whereas if they were taxed in the hands of the proprietors they would be subject to much higher rates of income tax and National Insurance. There will be a consultation document on this issue in the coming months.

KS Comment: “One man bands” and small businesses that choose to operate through the medium of a limited company do so for a number of reasons. Their principal motivation is more often than not to protect their personal assets from the claims of creditors in the event of business failure and/or to increase commercial “substance”. However, there can be tax advantages, and we will wait to see what, if anything, the government is proposing to do to remove these. Those currently considering incorporating may wish to wait for further developments in this area.

Tax deductibility of corporate interest expense and reform of loss relief

The Chancellor confirmed a major change to the manner in which UK resident companies obtain tax relief for interest expense from 1 April 2017.

The new rules have been expected for several months now and will limit tax deductions for interest expenses where these exceeds £2million, where the net interest expense exceeds 30% of UK taxable profits and where the net interest to earnings ratio in the UK exceeds that of the worldwide group.

In addition, there will be restrictions to the tax relief for carried forward trading tax losses from 1 April 2017. From that date, where carried forward losses are £5m or more, the use of losses in an accounting period will be restricted to 50% of the net trading profits. At the same time, however, greater flexibility will be introduced on how losses can be put to use.

KS Comment: There have in recent years been some restrictions on the tax relief for interest expense – the Worldwide Debt Cap – but this new blanket provision marks a real departure from what the UK has known until now, and is likely to have a profound impact on how some companies structure their affairs.

Given the fact that the recipients of interest payments are likely to be suffering tax on their interest income, this proposal looks to be giving rise to a form of economic double taxation, and it may well drive a future preference for equity rather than debt financing.

At a more general level, these new restrictions could tarnish the impact of the messages being given by the competitive headline rate of UK corporation tax.

Patent Box rules

The Chancellor has announced that certain changes will be made to the Patent Box rules for accounting periods commencing on or after 1 April 2017. These will cover situations where the Research and Development was undertaken by two or more companies under a ‘cost-sharing agreement’ and will ensure that companies participating in such arrangements are neither penalised nor advantaged by such arrangements.

KS Comment: These changes will come as welcome news to companies that may have been wrong-footed in the past, having used a perfectly normal cost-sharing structure to shoulder what can be a very cost intensive process. More generally, the ability of the UK to shape R&D tax relief and Patent Box rules have been restricted by EU law relating to the granting of ‘State Aid’, but as the UK leaves the EU, we may well see the rules becoming even more generous.

Clarification of tax treatment of partnerships

Partnerships, including Limited Partnerships and Limited Liability Partnerships, have been the focus of a recent HMRC consultation to which we as a firm have responded. The Chancellor has promised legislation to “ensure profit allocations to partners are fairly calculated for tax purposes”, which implies that HMRC believes that they are currently not, at least in some instances.

Many of the questions raised in the consultation gave the impression that partnership profits were not being properly taxed, or in some cases not taxed at all; in principle, taxable profits are calculated for the firm as whole and then shared amongst the partners in accordance with their commercial “profit sharing arrangements” but there are of course a range of less than straightforward circumstances to be considered.

KS Comment: It is not yet clear exactly how the Government proposes to change the current rules and we will look forward to seeing exactly what the Government is planning to do in this regard.

Update – 5 December 2016: Draft legislation is now due to be published in early 2017.

Bringing non-resident companies’ UK income into the corporation tax regime

Currently, the only overseas companies liable for Corporation Tax are those carrying on a trading activity in the UK through a “Permanent Establishment” here, or those dealing in or developing land in the UK (although other companies with UK sourced income may be liable to income tax at the basic rate.)

The Government is now considering bringing all non-resident companies receiving taxable income from the UK into the corporation tax regime. Next year it will consult on the case and options for implementing this change.

KS Comment: The headline impact of this measure is, of course, the levelling of the playing field between resident and non-resident companies. However, the implications of the small amount of information we have on this proposal could be very significant and we will wait with interest for further indications as to how far exactly the Government is proposing to go.

Update – 5 December 2016: The latest update from the Government confirms that there will be a consultation following the Spring Budget. This will consider whether the restriction for deductibility of interest and loss relief rules, which apply to UK companies, should also extend to non-resident companies. These changes could also see non-resident companies falling within the charge to UK tax on chargeable gains, which will be of concern to overseas commercial property investors.

Tax-advantaged venture capital schemes

The Chancellor announced that he would amend some of the rules applying to the Enterprise Investment Scheme (EIS), the Seed Enterprise Investment Scheme (SEIS) and Venture Capital Trusts (VCTs). Specifically, there is going to be clarification on the EIS and SEIS rules for share conversion rights, a more flexible approach for follow-on investments by VCTs, and a power to enable VCT regulations to be introduced in relation to share for share exchanges. There will also be a consultation on HMRC’s advance assurance service.

KS Comment: While these proposals are all welcome, there is scope for additional flexibility – for example, in relation to the rules about the provision of replacement capital in VCTs. These minor reforms will hopefully be eclipsed by a wholesale reform of these regimes once we have fully left Europe as EU State Aid rules have made these schemes overly complex so we expect them to be largely rewritten in the future.