The Chancellor of the Exchequer delivered the UK’s 2015 Budget today. This was very much a political pre-election budget with a combination of promises for the future if the Government is re-elected, measures designed to encourage economic growth and a number of tax anti-avoidance provisions.
The Finance Bill will be published on 24 March 2015 and will become law on or before 30 March. It is likely that there will also be a post-election Finance Act whoever wins the election containing provisions which are not yet in final form. Indeed in 2010 – the last time there was a change of Government - there were three Finance Acts.
The overwhelming majority of the substantive legislation expected to be contained in the Finance Bill was published in December in order to provide time for consultation on the draft legislation with a view to improving it. Much of it could reasonably be expected to be enacted in the form published then, with some minor amendments made as a result of the consultation process. However, some of the legislation published in December required significant amendment to ensure that it did not have unintended consequences, especially some wide ranging anti-avoidance rules. The concern is that if there is insufficient time to properly review the revised legislation before it becomes law, it may be difficult to persuade a new Government, whatever its composition, to amend the rules later.
The initial response from the private equity sector has been generally positive with Tim Hames, Director General of the British Private Equity and Venture Capital Association (BVCA) welcoming the fact that “the Chancellor shares our view that we need a recovery for the whole of the UK” and the “generous extensions to the Enterprise Investment Scheme and Venture Capital Trusts, with the investment limit for both extended from £15 million to £20 million for knowledge intensive-companies, as well as the employee limit raised from 250 to 499 - subject to state aid clearance - meaning more high growth businesses, in Manchester, Cambridge and indeed the whole country, will benefit from further investment, leading to more growth and more jobs.”
The main tax announcements of particular interest to the private equity and venture capital sector are summarised below.
In this issue
Funds and investment
Employment and Incentives
Funds and investment
Disguised fee income and investment managers
In December the Government announced that it will introduce legislation, with effect from 6 April 2015, to ensure that certain sums which arise to investment fund managers for their services (disguised fee income) are charged to income tax (and Class 4 National Insurance Contributions), especially arrangements which are designed to convert annual management fees from income receipts into capital receipts. While the rules were intended to exclude carried interest and returns from individuals’ investments in funds, the original drafting of these exclusions was very narrow, meaning that many such arrangements would potentially be caught. The exceptions to the provisions treating amounts as disguised fee income were narrowly defined and potentially caused problems for many arrangements where the return was in fact an investment return particularly in relation to debt funds, infrastructure funds, co-investment arrangements and venture capital funds for which carried interest is not always structured as a typical "2 and 20" model with a hurdle.
The Government stated today that, following the consultation process, the legislation has been revised to better reflect industry practice on performance related returns (e.g. carried interest and possibly also executive investment in funds) and to address concerns as to their application to non-UK resident executives.
However, it will not be until the revised draft legislation is published on 24 March (together with the accompanying guidance notes) that it will be possible to judge how satisfactorily these aims have been reflected. It appears likely that the revised legislation will be included in the March Finance Bill and thus will not be subject to detailed review. If there are still significant areas where the legislation could be improved then it may be hard to amend the legislation once enacted, especially if there is a change in Government.
It was confirmed that the changes will take effect in respect of sums arising on or after 6 April 2015, whenever the fund was set up or the arrangements were entered into i.e. it is not anticipated that there will be any grandfathering.
It was also announced that the scope of the disguised fee income rules discussed above would be extended from the original proposals so as to apply to managers of investment trusts, although it is not yet clear whether this is indeed an extension of the rules or simply a clarification.
Private Placements and Withholding tax
The Government has confirmed that it intends to introduce a new targeted exemption from withholding tax for interest on private placements which is a form of long-term non-bank debt financing for unquoted companies. The original proposals were widely seen as being unduly restrictive and again until the revised draft legislation is published it will be difficult to evaluate how useful it will be. The one change which has been confirmed is the removal of a condition relating to the minimum term of the security which had been seen as potentially making the exemption useless.
Amendments to rules for Enterprise Investment Scheme (EIS) and Venture Capital Trusts (VCT)
The Government confirmed that it will, subject to receipt of state aid clearance, amend the rules so as to require that all investments are made with the intention to grow and develop a business and that all investors are ‘independent’ from the company at the time of the first share issue. Additionally, it will introduce new qualifying criteria to limit relief to companies where the first commercial sale took place within the previous 12 years; and to cap the total investment a company may receive under the EIS and VCT regimes at £15 million, or £20 million for companies that meet certain conditions demonstrating that they are ‘knowledge intensive’. In addition the employee cap for knowledge intensive companies is to be increased from 249 to 499. With effect from 6 April 2015, it will longer be necessary for 70% of Seed Enterprise Investment Scheme (SEIS) money must be spent before EIS or VCT funding can be raised.
VCTs, SEIS and EIS and renewable energy
It was confirmed that companies benefiting substantially from subsidies for the generation of renewable energy will be excluded from also benefiting from EIS, SEIS and VCTs with effect from 6 April 2015. However, it is intended that community energy generation undertaken by qualifying organisations will be eligible for Social Investment Tax Relief (SITR) with the exception of community energy generation undertaken by qualifying organisations. There will be a transition period of 6 months following state aid clearance for the expansion of SITR before eligibility for EIS, SEIS and VCT is withdrawn in respect of community energy generation.
Social venture capital trusts
The Government has confirmed that it intends to legislate for Social Venture Capital Trusts in a future Finance Bill. The intention is to set the rate of Income Tax relief for investment at 30%, subject to state aid clearance. Investors will pay no tax on dividends received from or capital gains tax on disposals of shares in Social Venture Capital Trusts.
Exclusions from the proposed capital gains tax charge on residential property held by non-residents
It was confirmed that the capital gains tax rules will be changed from 6 April 2015 so that when a residential property is disposed of by certain non-resident persons any gain made after that date will be subject to UK capital gains tax. The charge will apply mainly to non-resident individuals, non-resident trustees, personal representatives of a non-resident deceased person and some non-resident companies disposing of UK residential property. When the rules apply there will be a mechanism requiring the seller to account for tax within a short period of time post sale.
Residential property will be defined as property suitable for use as a dwelling, and communal residential property will generally be excluded from the charge. In particular, care homes, nursing homes, purpose built student accommodation and residential accommodation for school pupils will be outside the charge.
In order to avoid an adverse impact on institutional investment in residential property, disposals of UK residential property made by diversely held institutional investors will not be subject to the charge. This will include widely held non-resident collective investment schemes, pension funds investing on behalf of large numbers of individuals, sovereign wealth funds and most financial institutions. Other non-resident companies will also not be subject to the charge provided that they are not a “narrowly controlled company”. This will be a modified form of the close company test and for these purposes members of a partnership will not be treated as connected with each other purely because of their common investment through the partnership. The detailed drafting of these exclusions will require careful consideration to ensure that they can be relied on in relation to any particular investment.
While it is currently intended that UK commercial and industrial real estate held as an investment by non-UK residents is to remain outside the charge to UK capital gains tax, this is an area which may be revisited depending on the result of the election.
Property investments funds and Stamp Duty Land Tax
It was reconfirmed that it is proposed to make changes to the SDLT rules for property authorised investment funds (PAIFs) and co-ownership authorised contractual schemes (CoACSs) so as to encourage the creation of such funds. If enacted, they will provide relief from SDLT on seeding PAIFs and CoACSs and an exemption from SDLT on the issue, transfer and redemption of units in CoACSs. There will be detailed anti avoidance provisions which will seek to prevent the reliefs being used for SDLT avoidance in the same way as the previous seeding relief for unit trusts. However, these changes will not be contained in the March Finance Bill.
Entrepreneurs' relief and academics
A consultation will be launched in relation to the tax treatment of capital gains made by academics on disposals of shares in 'spin-out' companies with a view to legislation being enacted in a future Finance Bill.
Individual Savings Accounts (ISAs)
It is intended that regulations will be introduced this Autumn, following consultation on technical detail, to enable ISA savers to withdraw money from their cash ISA and reinvest it back in the same year without it counting towards their annual ISA subscription limit for that year.
It was confirmed that legislation will be introduced in this year making changes to the charges paid by non-domiciled individuals resident in the UK who wish to claim the remittance basis of taxation. From April 2015, a new annual charge of £90,000 will be introduced for individuals who have been resident in the UK in at least 17 of the last 20 years, and the charge paid by individuals who have been resident in the UK in at least 12 of the last 14 years will increase from £50,000 to £60,000.
Employment and Incentives
It was confirmed that proposals announced in December to prevent tax relief from being claimed on reimbursed business expenses when they are paid in conjunction with a salary sacrifice scheme will be enacted. This is designed to counteract arrangements that connect travel and subsistence payments to salary sacrifice by converting salary into allowances or specific expense payments into benefits in kind that are neither taxable nor chargeable to Class 1 National Insurance Contributions.
Employee benefits and expenses
On 11 March 2015 it was announced that the Government was extending the closing date of its consultation on the tax treatment of travel and subsistence expenses to 1 May 2016 and so would not be reporting on this issue as part of the 2015 Budget process. This perhaps suggests that when the consultation finally closes it is anticipated that there will be significant changes to the regime and also to ensure that any resulting proposals do not give rise to new tax planning opportunities.
Rates of corporation tax
It was confirmed that from April 2015 the main rate of corporation tax will be reduced to 20% from 21%, although this may be reversed if the election returns a Labour Government.
Entrepreneurs’ relief and EIS/SITR investment
It was confirmed that capital gains tax entrepreneur’s relief would be extended to certain gains deferred into EIS or SITR which is to be welcomed.
Deductible VAT relating to foreign branches
It was announced that changes will be made to the VAT partial exemption rules so that supplies made by foreign branches will no longer be taken into account when working out how much VAT incurred on overhead costs can be deducted in the UK. This will affect partially exempt businesses (especially financial businesses), and they will have to implement the change from the beginning of their next partial exemption tax year falling on or after 1 August 2015.
Bank loss restrictions
The Government confirmed that it will introduce legislation announced in December 2014 restricting the ability of banks to set certain carried forward losses against taxable profits arising after 5 April 2015 to 50 percent of such losses arising prior to that date. However, where a group is headed by a Building Society there will be an allowance of £25 million reducing the carried forward reliefs that are subject to the restriction.
Amendments to entrepreneurs’ relief in relation to management companies
With immediate effect, the Government has announced restrictions on the availability of entrepreneurs’ relief in circumstances where individuals do not hold a “significant stake in a genuine trading business”. Entrepreneurs’ relief allows shareholders in trading companies or owners of trading businesses to potentially only be subject to 10% tax on the first £10m of gains on the sale of qualifying shares or business assets and is potentially worth up to £1.8m. The proposed change means that the relief will be available only to those holding a 5% stake directly in a trading company which will affect some deal structures, designed to enable minority shareholders, such as management teams investing through a management company structure, to benefit from entrepreneur’s relief. While the policy behind the legislation makes it clear that it is not intended to apply to direct 5% shareholdings in holding companies of a trading group which own 100% (or the overwhelming majority) of the underlying trading companies, the detail of the legislation will need to be carefully reviewed to ensure that it does not impact adversely on such structures.
Entrepreneurs' relief in relation to goodwill on the incorporation of businesses and disposals of personal assets
It was also confirmed that proposals to deny entrepreneurs’ relief for certain disposals of goodwill on the incorporation of businesses will be enacted, although often it will be possible to defer any gain by relying on incorporation relief. The legislation has been revised to allow entrepreneurs’ relief to be claimed by partners in a firm who do not hold or acquire any stake in the successor company e.g. partners who leave the business at the time of the incorporation.
In addition, the Government will also prevent individuals from claiming entrepreneurs’ relief on the disposal of personal assets used in a business carried on by a company or a partnership unless they are disposed of in connection with a disposal of at least 5% of the shares in the company or a 5% share in the partnership assets. This latter change has immediate effect.
Corporation tax loss refresh prevention
It was announced that legislation will be introduced with effect from today targeted at contrived arrangements to increase access to carried-forward corporation tax reliefs. The change affects arrangements that create profits to use the carried-forward relief whilst also creating newer and more versatile relief ('refreshing' the loss).
Following a consultation last year, there will be various changes to the disclosure of tax avoidance schemes (DOTAS) rules designed to strengthen the regime. These include updating existing scheme hallmarks, adding new hallmarks, and removing the ‘grandfathering’ provisions for the future use of schemes that were excluded by those provisions. It is also proposed to establish a DOTAS taskforce to ensure that the DOTAS rules cannot be circumvented.
Accelerated payments and group relief
It was confirmed that legislation would be introduced to counteract avoidance schemes designed to give rise to losses to be surrendered by way of group relief by bringing such schemes within the accelerated payments regime so that groups of companies do not enjoy the cash flow benefits of not paying tax pending a decision on whether or not the scheme works. This is in part designed to deter companies from entering into such arrangements in the first place.
International tax and multinationals - Country-by-country reporting
The government confirmed its commitment to the Base Erosion and Profit Shifting (BEPS) initiative by the Organisation for Economic Co-operation and Development and the G20. This initiative is a reaction to the widespread political and public concern that multi-nationals are able to avoid paying their "fair share" of tax by moving profits to low tax jurisdictions and that the international tax system is no longer fit for purpose. It should be assumed that whatever the result of the next election that this will remain a priority. These changes are potentially wide ranging and are likely to require most standard international investment structures to be revisited over the next few years.
It was confirmed that legislation will be introduced this year that gives the UK the power to implement the OECD model for country-by-country reporting. The new rules will require multinational enterprises to provide high level information to HMRC on their global allocation of profits and taxes paid, as well as indicators of economic activity in a country.
Diverted profits tax
It was confirmed that a new tax (the so called Google tax) seeking to counteract artificial arrangements used to divert profits overseas in order to avoid UK tax will be introduced with effect from 1 April 2015. While there have been some changes in detail from the original draft legislation, it appears that the rules have remained fundamentally in line with the draft rules published in December. Where the rules apply, the rate of tax will be 25% rather than the 20% which would have applied had the profits being subject to tax in the UK under the corporation tax rules. This differential is designed to encourage businesses to bring their activities within the charge to UK tax rather than risk the provisions applying and without HMRC having to apply the legislation in practice. The Government and HMRC have taken steps to seek to reduce the risk of challenge under EU law and the terms of double tax treaties and, while there is legitimate disagreement about how successful this has been, any group seeking to rely on the counterarguments in court will need to ask themselves whether such a challenge is advisable in the current climate.