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Business and company tax

ICAEW Tax Faculty provides analysis of the announcements relating to business and company taxes in the 2018 Budget.

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New digital services tax

The Chancellor has always said that he would prefer to take collective action with other countries to ensure that international digital businesses pay an appropriate amount of tax but that he would be prepared to take unilateral action if needs be.

He now proposes to take action and introduce a digital services tax (DST) with effect from April 2020. There will be a consultation shortly to consider the details of the new regime. Legislation will be in FB 2019-20.

The Red Book scorecard indicates that the government anticipates that the new tax will raise £275m in the first year, 2020/21, rising to £440m in 2023/24: a total of nearly £1.5bn over four years.

The proposal

The government will introduce a new 2% tax on the revenues of certain digital businesses to ensure that the amount of tax paid in the UK reflects the value they derive from their UK users. The tax will:

  • apply to revenues generated from the provision of the following business activities: search engines, social media platforms and online marketplaces;
  • apply to revenues from those activities that are linked to the participation of UK users, subject to a £25m per annum allowance;
  • only apply to groups that generate global revenues from in-scope business activities in excess of £500m per annum; and
  • include a safe harbour provision that exempts loss-makers and reduces the effective rate of tax on businesses with very low profit margins.

Businesses covered

DST will apply to specific digital business models where the revenues are linked to the participation of UK users. The tax will apply to search engines; social media platforms; and online marketplaces. This is because the government considers these business models derive significant value from the participation of their users.

The DST is not a tax on online sales of goods – as a result it will only apply to revenues earned from intermediating such sales, not from making the online sale.

DST is also not a generalised tax on online advertising or the collection of data. Businesses will only be taxed on the revenues derived from these services to the extent they are performing one of the in-scope business models, which are the provision of a search engine, social media platform or online marketplace.

Financial and payment services, the provision of online content, sales of software/hardware and television/broadcasting services will not be within scope of the DST. The government will explore with stakeholders during the consultation whether further exemptions should be made.

Businesses will need to generate revenues from in-scope business models of at least £500m globally to become taxable under the DST. The first £25m of relevant UK revenues are also not taxable. This means that small businesses will not be within the scope of the tax.

Safe harbour provisions

Businesses will be able to elect to calculate their liability on an alternative basis, which will be of benefit to those with very low profit margins. The outcome is that those making losses under this calculation will not have to pay the DST and those with very low profit margins will pay a reduced rate of tax. The government will be consulting on the precise design of the safe harbour which is intended to ensure that DST is proportionate.

Links with existing tax system

The DST will be an allowable expense for UK corporate tax purposes under ordinary principles. However, given that DST will not be within the scope of the UK’s double tax treaties, it will not be creditable against UK corporate tax.

Sunset clause

There will be a formal review in 2025 to ensure the tax is still required following international moves to come up with a coordinated approach. The government will disapply DST if an appropriate international solution is in place prior to 2025.

Annual investment allowance

The annual investment allowance is to be increased temporarily from £200,000 to £1m. The increased allowance will apply for two years, for qualifying expenditure incurred from 1 January 2019 to 31 December 2020. The legislation will be in FB 2018-19 which means that the measure is expected to apply before the legislation receives Royal Assent; this introduces an element of political risk.

Very few businesses make annual investments of more than the current limit of £200,000 so this measure is aimed at the largest businesses. Businesses will need to take great care to time their investments to make best use of the allowance, particularly where the business does not have a 31 December year-end. Where a business does not have a December year-end it will typically have a three-month period in which only £50,000 of expenditure will be covered by the allowance.

New structures and buildings allowance

Industrial and agricultural buildings allowances were abolished many years ago. The Chancellor announced a new structures and buildings allowance (SBA) which has some of the characteristics of the former reliefs.

SBA will provide relief for qualifying capital expenditure on new non-residential structures and buildings. Expenditure on office accommodation (not within a dwelling) is expected to qualify but expenditure on land or residential buildings will not.

Relief will be given at 2% on a straight line basis and will apply to contracts for physical construction works entered into on or after 29 October 2018.

The government has published a detailed technical note in advance of draft legislation, which will be included in FB 2018-19. The government is inviting comment on a number of aspects of the SBA (details and a contact email address are included in the technical note). The legislation in the Bill is expected to be largely enabling; the detailed rules will be included in secondary legislation which will be published for technical consultation before being laid before parliament after the Bill receives Royal Assent.

Capital allowances special rate reduction

Special rate expenditure includes expenditure on long-life assets, thermal insulation, integral features and expenditure incurred on or after 1 April 2018 on cars with CO2 emissions of more than 110 grams per kilometre driven. The capital allowances rate applying to this asset pool is to be reduced from 8% to 6% from April 2019.

Enhanced capital allowances

The lists of energy efficient and environmentally beneficial technologies and products which are eligible for enhanced capital allowances (the energy technology list and water technology list) are to be updated. The measure will also end the first-year allowance for products on these lists, including the associated first year tax credit, from April 2020 onwards.

The government is taking a different approach to enhanced capital allowances for electric vehicle charge points – the enhanced allowances are to be extended for four years and will now cover expenditure incurred up to 31 March 2023 for corporation tax and 5 April 2023 for income tax.

Costs of altering land for installing plant

Legislation in FB 2018-19 will clarify the scope of the relief given by Capital Allowances Act 2001 for altering land in connection with qualifying expenditure on plant and machinery. The measure is intended to put beyond doubt that land alteration expenditure can qualify for plant and machinery capital allowances only where the plant or machinery itself qualifies for capital allowances. The measure is effective from 29 October 2018.

R&D tax relief review

The government will consult on changes to the current research and development (R&D) tax relief for small and medium-sized enterprises (SMEs), with the aim of preventing abuse of the relief.

It proposes to introduce a limit on the amount of payable tax credit that can be claimed, which will be set at three times the company’s total PAYE and NIC liability for the period.

The change will have effect for accounting periods beginning on or after 1 April 2020. Any loss that a company cannot surrender for a payable credit can be carried forward and used against future profits.

Social investment tax relief

A call for evidence will be published in early 2019 to allow the government to understand why take-up of this relief is lower than anticipated and to consider the design and targeting of the relief.

The tax relief for social investment is similar to enterprise investment scheme (EIS) relief. There is a 30% income tax relief and capital gains can be deferred; the investment must be held for three years. It was designed to encourage individuals to support social enterprises and help the social enterprise to access new sources of finance.

EIS knowledge-intensive fund structure

Following consultation, the government will reform the EIS rules for approved knowledge-intensive funds. The amendments will be to:

  • require approved funds to focus on investments in knowledge-intensive companies;
  • give funds a longer period over which to invest fund capital; and
  • allow investors in approved funds to set their income tax relief against liabilities in the year before the fund closes.

Legislation will be in FB 2019-20 with the changes taking effect from 6 April 2020.

Non-resident companies: treatment of UK property income

UK non-resident companies are currently subject to income tax on their UK property income.

As previously announced, legislation in FB 2018-19 will change this so that non-UK resident companies that carry on a UK property business or have other UK property income or gains will be charged to corporation tax.

Draft legislation was published on 6 July 2018. Following consultation, the legislation has been revised to provide further clarity on how the loan relationship and derivative contract rules will apply, and revised legislation published on Budget day. In addition, a targeted anti-avoidance rule is introduced from 29 October 2018.

The changes will have effect from 6 April 2020.

Affected companies will need to prepare to submit corporation tax returns and accounts in iXBRL format. The government will issue guidance on the transitional rules as well as general guidance on corporation tax aimed at non-UK resident companies during 2019 and before the change takes effect.

Lease accounting changes: tax adjustments

As announced in Autumn Budget 2017 the government will legislate in FB 2018-19 to ensure that the tax legislation, including the long funding lease and corporate interest restriction rules, continues to operate as intended following the introduction of the new accounting standard for leases, IFRS 16.

The measures will have effect for periods of accounts beginning on or after 1 January 2019. Certain amendments to the long funding lease rules only have effect for leases entered into on or after 1 January 2019.

Corporate interest restriction rules

The government proposes to make changes in FB 2018-19 to ensure the corporate interest restriction regime works as intended. The draft legislation was published on 6 July 2018 and there are now some further amendments to take into account consultation responses.

The current regime provides that from 1 April 2017 the tax-deductible finance costs of UK stand-alone companies or UK members of a worldwide group are restricted to 30% of their tax earnings before interest, tax, depreciation and amortisation (EBITDA) subject to:

  • a cap based on the worldwide group’s net finance costs; and
  • an option to apply a group ratio subject to a similar cap.

To the extent that companies/groups had UK tax-deductible finance costs of less than £2m in the period of the accounts, the restriction does not apply.

The proposed amendments are:

  • Changes to the relevant derivative contract rules – to ensure that debits and credits on derivatives hedging a financial trade that is not a banking business are not inappropriately excluded from tax-interest amounts.
  • Changes to the treatment of research and development expenditure credits (RDECs) amounts in the calculation of Group-EBITDA – so that this is aligned with the calculation of tax-EBITDA.
  • Changes to the definition of a group – so that this aligns with accounting standards and to ensure that otherwise unrelated businesses are not treated as a group for the purposes of these rules purely as a result of having a common asset manager.
  • Various changes to the public benefit infrastructure exemption (PBIE):
    -  ensuring that insignificant amounts of non-taxable income do not affect qualification for the PBIE;
    - confirming that if a third party acquires an asset from a qualifying infrastructure company, that third party is not automatically treated as having elected into the rules;
     - extending the deadline for making the PBIE election to the last day of the accounting period for which the election first applies; and
    - ensuring that the limitation on relief for related party interest expense cannot be avoided through the use of a conduit company.
  • Finally, an administrative change, so that when an interest restriction return is submitted, companies will be required to amend their company tax returns if their tax position is changed.

Corporate capital loss restriction

From 1 April 2020, the proportion of annual capital gain that can be relieved by brought-forward capital losses will be restricted to 50%. This is to ensure that large companies pay tax when they make significant capital gains.

To ensure the measure applies only to larger companies the restriction will not apply to the first £5m of carry-forward loss (whether capital or income-type losses). However, capital losses will continue to be streamed against chargeable gains, with the existing mechanism under s171A, Taxation of Chargeable Gains Act 1992 being retained to transfer gains/losses intragroup.

Companies will be required to split their 2020 accounting period into two notional periods, with net chargeable gains arising in the period up to 1 April 2020 not subject to restriction. Where there is a net chargeable gain in one notional period and a net capital loss in another notional period, these are aggregated before applying the carry-forward loss restriction rule to the whole period.

The government proposes anti-forestalling legislation to counteract arrangements designed to defer capital losses beyond the start date, or to accelerate capital gain crystallisation before the start date. Genuine third party transactions should not be caught by this, but artificial de-groupings or uncompleted contracts are likely to be counteracted.

A consultation Corporate Capital Loss Restriction: Consultation on delivery is open for comment until 25 January 2019, and legislation will be included in FB 2019-20.

The anti-forestalling measures will have effect from 29 October 2018.

Controlled foreign companies

As originally announced on 6 July 2018, the government will legislate, in FB 2018-19, to make two changes to the controlled foreign companies (CFC) rules. These changes relate to the definition of control and the treatment of certain profits generated by UK activity, and will ensure that the UK CFC rules comply with Council Directive (EU) 2016/1164, also referred to as the EU Anti-Tax Avoidance Directive (ATAD). The changes will take effect from 1 January 2019.

Hybrid mismatches

FB 2018-19 will include minor changes to the existing UK rules for hybrid mismatches. The changes include:

  • Specific provisions requiring the UK to counteract arrangements relating to permanent establishments of a company recognised by the jurisdiction where it is resident but not by the jurisdiction where the permanent establishment is situated.
  • Amendments to the current exemption for regulatory capital, to enable regulations to be made which can provide for a revised definition of regulatory capital. The current exemption will remain in place until the new regulations come into force.

The changes will be effective from 1 January 2020.

Hybrid capital instruments

There will be a new elective regime for the taxation of ‘hybrid capital instruments’.

In introducing these rules, the government seeks to provide certainty regarding the tax treatment of hybrid capital instruments that are, in essence, genuine debt instruments. These rules will apply to any UK-resident company that issues hybrid capital instruments, regardless of sector, and the existing regulations which apply to certain capital instruments issued by banks or insurance companies will be repealed.

New provisions will define a hybrid capital instrument as being a loan relationship on which the debtor is allowed to defer or cancel interest payments, and which has no significant equity features.

The provisions are expected to provide that coupons on the instruments are potentially deductible under the loan relationship rules, even if recognised in equity rather than in the profit and loss account. A number of other measures are expected, including a specific exemption from all stamp duties for instruments falling within the rules. The election for the rules to apply will be ineffective where there are arrangements, the main purpose, or one of the main purposes, of which is to obtain a tax deduction for any person.

Offshore receipts in respect of intangible property

At Autumn Budget 2017, the government announced it would introduce measures to tax income derived from intangible property held in low-tax jurisdictions to the extent that it related to UK sales.

The government published a consultation on 1 December 2017 and Tax Faculty responded in February 2018 ICAEW Rep 26/18 Royalties Withholding Tax. The government has now published a summary of responses to that consultation along with proposed draft legislation and explanatory notes.

In our representation we were concerned that any changes need to take account of the way that particular industries currently operate, giving the music industry as an example.

The new provisions will take effect from 1 April 2019. However, collection of the tax will be by direct assessment on the owner of the intangible property, rather than via a withholding tax on payments made to the intangible property-owning company by other persons.

Also, the scope will be broadened to include embedded royalties and income from the indirect exploitation of intangible property in the UK market through unrelated parties. De minimis thresholds and exemptions will be introduced, including a de minimis threshold for UK sales of £10m, an exemption for income that is taxed at what is deemed to be an acceptable rate and an exemption where the intangible property owner is considered to have sufficient local substance.

In common with other similar provisions introduced in recent years, there will be anti-avoidance provisions, applicable from 29 October 2018, targeted at arrangements that seek to circumvent the application of these rules.

Intangible fixed asset regime

The government carried out a consultation between February and May 2018 into the fixed asset regime introduced in 2002, to determine how to make the regime more competitive and easier to administer. Two problems were the fact that the regime did not apply to intangible assets in existence at April 2002 and the changes to the de-grouping rules in 2011. ICAEW submitted its views in ICAEW Rep 53/18.

From the statement in the Red Book, para 3.30, it would appear that the government will address both these issues. However, we believe there is a need to adopt a more fundamental approach to the regime compared with earlier reviews which have concentrated on eliminating abuse of the system or have sought to cut the cost of the regime.

A restriction on the ability to amortise goodwill for UK corporation tax purposes on the acquisition of a business was introduced with effect from July 2015. The government proposes that tax relief will be available for the amortisation of goodwill on the acquisition of businesses with eligible intellectual property with effect from 1 April 2019.

In common with the chargeable gains regime, the intangible fixed asset regime provides for a de-grouping charge if a company leaves a group holding an asset that was transferred to it on a tax neutral basis in the prior six-year period. However, the intangible fixed asset regime was not been reformed at the same time as the chargeable gains regime.

This was to enable the exemption of this de-grouping charge from tax where the company that holds the asset at the time of the de-grouping qualifies for the substantial shareholding exemption. The rules will now be aligned, which should enable a more flexible approach to transact the carve-out, sale and purchase of businesses.

UK definition of permanent establishment

The OECD Base Erosion and Profit Shifting (BEPS) project published the Action 7 Report Preventing the Artificial Avoidance of PE Status in October 2015. The report recommended changes to Article 5 of the OECD Model Tax Convention (MTC) that are included in the 2017 version of the MTC.

One of the changes is an anti-fragmentation rule, which the UK will adopt in its tax treaties through the multi-lateral instrument which was signed in June 2017 and which entered into force for the UK on 1 October 2018. The UK now needs to replicate this change in UK domestic law to make the change to tax treaties effective.

The purpose of the anti-fragmentation rule is to prevent a foreign business from fragmenting complementary functions, otherwise forming part of a cohesive business operation, between locations or among related companies. This was previously done by companies to claim that each of the fragmented operations were preparatory or auxiliary and did not create a permanent establishment (PE) in the UK. The new rule requires the activities to be considered together to determine whether a PE exists.