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LET'S FACE IT, this Pre-Budget Report wasn't really about the details of the tax system. The main focus for commentators in the press and on television was whether the Chancellor's figures for receipts and spending actually stacked up. The consensus seems to be that the Chancellor might still meet his fiscal rules, but that his anticipated £8 billion margin is very tight. Prudence, it seems, has been unceremoniously dumped as too high-maintenance in the run-up to an election.
However, from a tax practitioner's point of view, the documents accompanying the report do seem to provide the framework for a sensible discussion between the profession and the Treasury on technical issues. On matters where it is proposed that legislation will be introduced in the 2005 Finance Bill, there are generally detailed proposals or draft legislation; where documents are issued for discussion it seems that they offer scope for genuine influence over decisions that have yet to be made.
Below are some initial reactions to some of the key proposals in the report. We will be returning to it in the first issue of the New Year, 6 January, which will have more comprehensive articles commenting on the implications of the report.
Mike Truman.
Discussion paper on small business issues
As foretold by paragraph 5.95 of the Budget 2004 Red Book, we have been given a discussion paper on small business tax issues. Entitled 'Small companies, the self employed and the tax system', it sets out over 24 pages an explanation of the quirks in the UK tax system that give rise to very different tax effects, depending on how a business is structured or on employment status.
The real nub is at the end where the Government invites comments on:
how it should balance tax and non-tax incentives for such businesses;
whether owner-managers of small businesses should be taxed in a different way to other company owners;
how to meet the need for reduced administration and compliance costs for businesses; and
how to manage the issue of providing certainty and simplicity to businesses with a desire to offer incentives.
Small businesses have been developing something of a 'persecution complex' over the last four years as they have taken the full force of a range of 'anti-avoidance' measures which have shifted the tax goalposts. Since 2000 they have had to combat the so-called 'IR35 rules', which potentially affect anyone who operates via an intermediary, such as a personal service company; the Inland Revenue's revised interpretation of the settlements legislation; and the introduction of a 19% minimum rate of corporation tax on distributions. Therefore there is some relief that this PBR does not include any knee-jerk or short-term reactions to perceived problems with the way small businesses operate.
The full discussion paper on small business is quite long on explanations but keeps its request for comments short. This paper is clearly a starting point for a much broader discussion on some of the key tax issues affecting small companies for which there are no easy wins or straightforward solutions. It should be welcomed that the Government is offering a chance for a wide-ranging discussion of the key areas.
There are some very difficult decisions ahead. Do businesses or individuals want potentially to give up some tax incentives in favour of clarity as to their tax position? For example, would someone who is currently self employed be happy to accept that employment status rules need to change so that they were treated less favourably, but at least they knew exactly what their tax position was? Any changes will bring winners or losers.
The paper does not attempt to address all the highly difficult issues that form the background to the existing tax problems with small businesses. For example, should there be a review of NIC, the tax-driver behind many business structures? Should there be an acceptance that the contributory principle is dead? This paper is just one step along a long road to potential future reform. However, it is good to see that at least that first step is being made.
Francesca Lagerberg,
National Tax Director, Smith & Williamson.
Employment-related securities
Following the Chancellor's Pre-Budget Statement on 2 December 2004 the Inland Revenue has published a Technical Note in which it sets out a number of changes to the legislation relating to the taxation of securities obtained by employees by reason of their employment.
The Inland Revenue made clear that the measures being implemented were aimed at addressing avoidance planning intended to defer or avoid the payment of income tax and NICs that would otherwise be due on employment-related remuneration. The changes will take effect from 2 December 2004 in relation to events of charge on or after that date regardless of the date of acquisition of the securities in question.
Specific changes include:
provisions which served to defer an income tax charge on the acquisition of employment-related securities under any arrangements will be disapplied where the main purpose, or one of the main purposes, of the arrangements in question is the avoidance of income tax or NICs. In such circumstances a charge to tax will arise at the time of acquisition of the employment-related securities and will be based on their unrestricted market value at that time;
where convertible securities are acquired as part of an arrangement to avoid tax or NICs an immediate charge to tax will arise with the market value of the securities being determined as if there was an immediate and unfettered right to convert;
the exemption for redeemable securities from the restricted securities legislation will be repealed; and
the definition of 'securities' (which was already widely drawn) has been extended to include rights under contracts of insurance, although exclusions remain for annuity policies linked to employee pension provision and certain general insurance policies, and those long-term insurance contracts which have no surrender value.
The Paymaster General's subsequent statement confirmed the Government's determination to stamp out employment-related tax and NIC avoidance, and a willingness to backdate the changes to 2 December. Specific reference was made to the payment of City bonuses with City institutions and their employees clearly viewed as being significant beneficiaries of the avoidance industry. The Government estimates that up to £2 billion in bonuses could have been delivered tax and NIC efficiently through the 'ingenuity and inventiveness of the tax avoidance industry'.
Looking ahead, the Government also recognised the potential for the evolution of avoidance planning and committed itself to 'close down' any such arrangements as and when it becomes aware of them. The spectre of retrospective legislation will do much to focus the attention of interested parties going forward.
Andrew Jones,
Director — Reward Consulting, Chiltern plc.
Film reliefs and tax avoidance
Four areas of perceived avoidance are dealt with and all changes in law are effective from 2 December 2004:
Double claims for tax relief. The proposals say that
F(No 2)A 1992, s 42 or F(No 2)A 1997, s 48 relief will only be available once on any film. This stops a production partnership claiming relief on its production expenditure and doing a sale and leaseback deal with a lessor partnership in order to finance up to 15% of the film. There are grand-fathering provisions for films already committed to at 2 December, which come as a huge relief to the production industry.
The section also talks of legislation to restrict s 42 relief (on big budget films) to production expenditure in the same way that s 48 relief already is restricted. Our assumption is that this is to stop sale and leaseback deals on big budget films being based on the value of films rather than their cost.
Restricting film tax deferral to 15 years. The Revenue has so far accepted sale and leaseback arrangements where the lease period (and hence clawback of initial tax relief) is for no more than 15 years. There have recently been schemes promoted where the lease period (or period of income receipt where the arrangements are production and receipt of minimum guaranteed payments) is for, say, 20 years.
The proposed legislation will restrict sideways loss relief to that proportion which relates to 15 divided by the number of years over which guaranteed income is to be realised. No further relief will be given until after the 15- year period has ended.
Company 'exits' after film tax relief. These rules seem to extend the sale and leaseback anti-exit rules that came into effect as from 10 December 2003 to also include companies that act as film sale and leaseback lessors. We assume they will mainly apply to banks that enter into sale and leaseback deals with bigger budget (usually Hollywood) films.
Individuals in partnership. Partners' sideways loss relief is to be restricted to capital contributions for which partners are 'fully at risk'.
The rules apply fully to individuals that become partners after 1 December. Partners at 2 December will only have their loss relief restricted to the extent that the losses 'arise' (sic) after 1 December. However it would appear that partners accessing the statutory film reliefs could have their pre-2 December loss relief restricted if arrangements exist with effect from that date to reduce their loan obligations.
The rules seek to claw back loss relief previously given (in respect of periods prior to 2 December) to the extent that any part of a capital contribution is 'borne' by another person. It seems that these provisions will provide for the write-off of loans to partners in film and other trading partnerships to be taxable on those partners.
There are also provisions to provide for the clawback of loss relief to the extent of any loan outstanding after five years if the terms of the lending are not on 'ordinary commercial terms'.
Harry Hicks,
Head of Film and TV, Chiltern plc.
University spin-out companies
Among all this anti-avoidance stuff came a little ray of sunshine (or maybe just a break in the dark clouds) with the widely anticipated announcement about the tax implications surrounding university spin-out companies. It is only a consultation document (it is called a Technical Note but it is really a consultation document) but we should still be grateful — it's the thought that counts.
Apparently the Treasury was unaware (and didn't really believe anyway) that the income tax and NIC charges arising from participation in the spin-out company had a discouraging effect on research institutions. Academics did not want to take the risk of a socking income tax charge on the acquisition of their shares in a spin-out company when they had thought the eventual profit on the disposal of the shares would be subject to CGT with the benefit of full business taper relief and a liability of only 10%. The penny has dropped and we have a nicely complicated new idea which could just end up with the right result.
It goes like this. When intellectual property (IP) is transferred to a spin-out company by a research institution, employees who have worked on the creation of the IP and who hold or acquire shares which are employment-related securities in the company, will have the market value of their shares computed for the purposes of income tax and NIC as if the transfer of the IP had not taken place. This would obviously eliminate the income tax and NIC charge (including employers contributions) arising as a result of the value of the IP. So far, so good.
The shares are still going to be within the scope of the income tax charge in respect of everything other than the relevant IP so it may be necessary to do a bit of segregation of the various rights just in case. There could still be a charge in respect of value arising from anything else which may lurk within the company. In addition, because this relief is intended only to apply on acquisition, the increase in value on the lifting of restrictions could give rise to a charge — so there will be an automatic election under ITEPA 2003, s 431 to prevent a charge arising on that occasion.
The capital gains position is said to be unaffected so that presumably the normal rules apply and the employee can look forward to benefiting from business asset taper relief and the effective 10% rate of tax on the ultimate sale.
Inevitably there will be anti-avoidance provisions to prevent the application of the provisions where the main or one of the main reasons of any arrangements is to avoid tax or NIC or where commercial organisations attempt to abuse the provisions for their employees.
Although this is only a consultation document, these seem to be quite serious proposals because they are intended to be effective for spin-outs after 2 December 2004. I guess they will get a pretty favourable response.
Peter Vaines,
Haarmann Hemmelrath.
Business premises renovation
Having personally advised on a substantial regeneration project in Manchester and seen the impact not only on the site in question but also on the surrounding area, it is difficult not to get enthusiastic about measures of this kind . . . should it become law. It has to be said at the outset that European Commission approval is required for this measure before it can be introduced and, although draft legislation has been released, no implementation date has been announced.
The so-called 'Business Premises Renovation Allowance' (BPRA) is limited to some 2,000 designated disadvantaged areas known as enterprise areas. A list of these areas is available from the Inland Revenue's stamp duty website www.inlandrevenue.gov.uk/so/disadvantaged.htm. The intention is that 100% of the capital cost of converting or renovating certain business premises which have remained vacant for at least one year will be eligible for 100% capital allowances. The object of the expenditure must be to bring business premises back into productive business use.
BPRA will apply not only to traders incurring expenditure on premises they occupy but also to landlords. The BPRA will fall due to whoever incurs the qualifying expenditure and this presumably will allow for complex financing arrangements to be structured in respect of larger schemes. Approved pension schemes will not benefit from this measure. Expenditure incurred demolishing and rebuilding commercial premises will not qualify.
Under the current proposals, 100% of the expenditure can be allowed in the year it is incurred but the taxpayer may elect to claim a reduced rate of allowance leaving a balance to be carried forward which will be relievable by way of a 25% writing down allowance. Here again the taxpayer can elect to reduce the writing down allowance to less than 25%.
In the event of the relevant interest in the building being sold or a long lease (duration over 50 years) being granted within 7 years after the premises being first used or suitable for letting as qualifying business premises, the allowance will be clawed back.
Although the 100% allowances can be made whenever the expenditure is incurred, if the taxpayer elects for the reduced rate of writing-down allowances, these will not be available until the building is complete.
A conflict arises with the tax break available for the decontamination expenditure in respect of land and buildings. Under the BPRA proposals as they currently stand, if expenditure potentially qualifies for both the 100% allowance under the BPRA and the 150% allowance under the decontamination tax break (see FA 2001, Sch 22), a claim will automatically be debarred under the decontamination relief provisions. The same position applies in respect of certain buildings qualifying as industrial buildings for capital allowances purposes, see Taxation, 7 October 2004, page 18.
On a practical note, potential investors, either as landlords or traders, should start to look at the list of enterprise areas referred to above. The areas in question are quite specific and, as the Revenue's website shows, are dealt with by reference to postcodes. Now is the time for potential investors to start considering their options.
Kevin Slevin,
Solomon Hare LLP.
Other changes
The normal inflation-based increases in personal allowances were announced; the full table will be published in a later issue of Taxation. The Chancellor almost, but not quite, promised to extend the ISA limit to £7,000 until 6 April 2009 — no doubt the formal announcement is being reserved for the Budget.
The Child Trust Fund was again trailed, with consultation on the amounts to be paid at age 7 — although this is an area where it seems unlikely that the figures will be changed much by the consultation process.
There are proposed changes to the CGT treatment of options where they have been used for avoidance purposes — for example, to bypass the market value rule when assets are transferred to connected persons.
Finally, it should be noted what was not covered, at least not until you delve right into the depths of the full report itself. It appears that real estate investment trusts are on the backburner — consultation in 2005 but no legislation. Planning gain supplement does not even rate a mention. Domicile and residence are yet again reported to be 'under review' based on the principles of the 2003 discussion paper, and with the prospect of a consultation paper at some unspecified time in the future. The next few months are obviously not a time when the Chancellor intends to frighten the voters.
Mike Truman.
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Specialists in Senior Appointments. Contact us at www.integralsearch.co.uk
