On 5 December 2016, the UK Government published the draft clauses for the UK Finance Bill 2017 along with responses to a number of the consultations released over the spring and summer.
This Alert focuses on some of the key developments coming out of the documents rather than being a comprehensive list of all the issues covered in the various documents. Some of those main developments will require more in-depth analysis of the proposals and the practical consequences. Detailed alerts on complex changes like the restriction of interest deductions and the use of brought forward corporate tax losses will follow.
This Alert also includes a section highlighting the material that is still outstanding. Some of this is due to be issued by the end of January 2017 but there are documents which will only be provided with the first Budget of the year in March 2017.
The draft legislation is open for consultation until 1 February 2017. It is the detail of the legislation, rather than the policy behind the measures, that the Government is looking for comment on. The complexity and wide scope of the provisions being introduced mean that it is important to consider the potential application of the rules in detail as the provisions may have some unexpected implications. At the same time, the consultation process may allow more clarification to be obtained on the operation of the proposed rules.
As confirmed as part of the Autumn Statement, new rules to restrict interest deductions in line with the recommendations in the G20/Organisation for Economic Co-operation’s (OECD’s) final report on Base Erosion and Profit Shifting (BEPS) Action 4 are to be introduced with effect from 1 April 2017. The draft legislation published appears to be broadly in line with the proposals set out in the May consultation document on the detailed design of the regime (restricting interest expense above a de minimis amount based on a fixed ratio or a group ratio rule and tightening the worldwide debt cap rule so that it is based on net interest), although there are some areas where changes are being made as a result of the representations received.
The rules apply to expenses related to loan relationships, derivative contracts relating to financial assets and financing costs implicit in amounts payable under relevant arrangements (e.g., finance leases, debt factoring or similar transactions). However, the rules are complex and will require a number of notifications and elections to be made, some of which are irrevocable. Groups will therefore need to look at the rules in detail and model the potential impact.
The changes announced include bringing the commencement of the modified debt cap rules in line with the start of the interest restrictions (i.e., applying from 1 April) and extending the ability to carry forward surplus capacity to five years rather than three. In addition, the rules will now cap the group ratio rule at 100% of the tax earnings before interest, taxes, depreciation and amortization (EBITDA), exclude impairment losses and introduce adjustments to the calculations of group interest and group-EBITDA to align these more closely with UK tax rules. While it will be possible to recognize pension costs on a paid basis, pension costs will still need to be taken into account despite several representations being made on this.
The consultation response also announces a widening of the Public Benefit Infrastructure Exemption to protect investment in such assets, as well as limited grandfathering provisions for some public benefit infrastructure projects where loans were agreed prior to 12 May 2016 (although there is no grandfathering for other loans).
While a large proportion of the proposed legislation has been published as part of the draft clauses, there remain outstanding areas which are not expected to be released until the New Year. These areas include:
- The definitions needed for the group ratio rule, including how it will apply to joint ventures, rules concerning related parties and the Public Benefit Infrastructure Exemption
- Rules for particular industries and issues such as the Patent Box and other tax incentives, leasing, Real Estate Investment Trusts and securitizations
Reform of corporation tax loss relief
The Government is proceeding with its planned reform of the corporation tax loss rules, being:
- An expansion of the type of profits against which brought forward losses incurred on or after 1 April 2017 can be offset, and
- A restriction, in relation to profits incurred on or after 1 April 2017, of the utilization of brought forward losses to 50% of profits (above a £5 million allowance per group)
The consultation response document released on 5 December confirmed that the Government remains committed to implementing these reforms from 1 April 2017.
Many of the key elements underpinning the calculation of the 50% restriction remain unaltered following the consultation, however changes include:
- Companies can now choose how to allocate current year reliefs against trading and non-trading profits
- Post-April 2017 losses can be used in preference to pre-April 2017 losses in certain circumstances
- A ”group” for the purposes of the £5 million allowance will now be based on the group relief definition but with some modification
- The loss buying rules and loss refresh rules will be expanded
- Additional provisions will deal with trades ceasing or becoming small or negligible
- When a company ceases to trade, it will be entitled to use the remaining carried forward trading losses against the profits of the final 36 months without restriction
The detailed rules need to be carefully considered on a case by case basis as the rules can still result in less than 50% of total taxable profits being offset by brought forward losses. A number of provisions, including anti-avoidance measures, are still to be published and are expected by the end of January 2017. It is somewhat of a concern, therefore, that with only four months until the reforms take effect, their full impact is still not yet known.
Substantial shareholding exemption
The draft clauses contain provisions relaxing the conditions applying to the substantial shareholdings exemption (SSE). The changes have effect for disposals of substantial shareholdings on or after 1 April 2017.
The first change, applicable to all, removes the requirement for the company making the disposal to be a sole trading company or a member of a trading group at any time before or after the disposal. It also extends the period during which the investing company can satisfy the substantial shareholding from 12 months within the two years before the disposal to 12 months within six years before the disposal. Finally, it removes the general requirement that the company invested in must be a qualifying company immediately after the disposal. This requirement will only continue to apply in cases where the disposal is to a person connected with the investor company.
The second change introduces a new third subsidiary exemption within SSE for companies that are wholly or partly owned by certain institutional investors. The clause provides for an exemption without regard to the nature of the business activities of either the company making the disposal or the company in which it has a substantial shareholding. While full exemption is given where the interest of qualifying institutional investors in the ordinary share capital of the company making a disposal is greater than 80%, proportionate relief is given where the holding is between 25% and 80%.
The clause sets out the types of investor that are qualifying institutional investors for the purpose of the new exemption and HM Treasury will be given the power to make regulations to amend the list.
The clause also provides that the requirement for a substantial shareholding to be at least 10% of the ordinary share capital of the company invested in is relaxed for the purposes of this new exemption if the shareholding, although less than 10%, was acquired for more than £50 million.
The draft clauses add specific provisions to the revised Patent Box rules introduced in Finance Act 2016. The new provisions cover the case where research and development (R&D) is undertaken collaboratively by two or more companies under a cost sharing agreement (CSA). The provisions are intended to ensure that companies are treated neutrally if they organize their R&D in this way.
The provisions will have effect for accounting periods beginning on or after 1 April 2017 with the legislation splitting periods which straddle that date split. It will apply to intellectual property (IP) assets which are brought into a CSA on or after that date as well as IP which at that date is already held in a CSA, where a new company subsequently joins the CSA after that date. However, there will remain the time from the commencement of the new Patent Box regime on 1 July 2016 to 1 April 2017 for groups to analyze their position, without the benefit of these new provisions.
Alongside the Autumn Statement 2016, the Government announced it would make two minor changes to the hybrid mismatch regime from 1 January 2017 (the commencement date for the regime). These changes will be introduced in Finance Bill 2017, but the draft legislation is not yet available. Instead a technical note has been published which explains that the changes relate to the following situations:
- Treatment of amortization deductions. The legislation refers to deductions which fall within the scope of the hybrid mismatch rules as ”relevant deductions.” As currently drafted, amortization would be treated as a ”relevant deduction” for the purposes of all chapters within the hybrid regime. The proposed change will ensure that amortization is only treated as a relevant deduction in certain circumstances.
- Permitted period claims. The hybrid mismatch regime allows mismatches to be disregarded if amounts are brought into account within a certain time period. However, it has been recognized that the claim requirement contained in the legislation brings with it a potentially sizeable compliance burden. Accordingly, the requirement to make a formal claim for each mismatch involving a financial instrument will be removed (by amending Chapters three and four of the legislation in TIOPA 2010).
Other business tax measures
Draft clauses were also published on the following business tax measures:
- Simplified capital allowances arrangements for co-owned Authorized Contractual Schemes (ACS) to apply from Royal Assent, and new tax information requirements for operators of ACS to provide to HM Revenue & Customs (HMRC) and investors
- Allowing small and medium enterprises to benefit from the proposed Northern Ireland corporation tax regime which is currently open to consultation
- Calculation of reportable income for offshore funds- performance fees will be disallowed and such expenses will instead reduce investors’ gains
Tax administration and avoidance
Partial closure notices
The draft clauses will allow aspects of HMRC enquiries into tax returns to be concluded ahead of the final closure of a tax enquiry. The provisions will apply from Royal Assent to Finance Bill 2017 in relation to enquiries open at that time, and to all future enquiries.
The provisions introduce the concept of a ”partial closure notice” which can be given by an HMRC officer in relation to any ”matter” to which the enquiry into the return relates, with a ”final closure notice” reserved for cases where the officer completes enquiries, or remaining enquiries, into the return. A partial closure notice in relation to a specified matter must state the officer’s conclusions and make the amendments to the return required to give effect to those conclusions. This will then be subject to equivalent safeguards as those currently available for closure notices, including the taxpayer’s right of appeal against the conclusions and amendments to the return specified in the partial closure notice, and the right to request postponement of any additional tax charged as a result. Subject to any postponement, tax will become payable or repayable in accordance with the amendments specified in the partial closure notice as if these were contained in a final closure notice.
HMRC has said that it will issue partial closure notices only in enquiries where a customer’s tax affairs are complex or where there is avoidance or large amounts of tax at risk, with the issue of partial closure notices overseen by existing HMRC governance arrangements. It seems open to taxpayers, however, to apply to the Tribunal for a direction requiring the issue of a partial closure notice in all cases of enquiries into returns.
What is still to come
In addition to the outstanding legislation on corporate interest restriction and the offset of corporation tax losses noted above, there are a number of other developments, where legislation has not currently been released.
- Making Tax Digital: The Government has noted that it will publish its response to all six consultations, together with draft Finance Bill 2017 legislation in January 2017
- Partnership taxation: Draft legislation, for inclusion in Finance Bill 2017, will be published in early 2017. It will include measures addressing the calculation of profit allocations to partners
- Re-scope of the bank levy: The Government will exempt liabilities relating to certain funding for UK banks’ overseas subsidiaries, as well as liabilities relating to the funding of UK banks’ overseas branches from the Bank Levy. The changes will take effect from 2021 and the draft legislation will be published in 2017 for inclusion in the Finance Bill expected to be enacted in spring 2018 under the new timetable
- Secondary adjustments: No response has been issued as yet to the consultation of 26 May 2016
Future consultations and draft legislation
As promised, the Government will publish draft regulations in early 2017 to improve and simplify the so called ”corporate streaming” rules that apply to investors in authorized investment funds.
At the first Budget in 2017, the Government will consult on the case and options for bringing non-UK resident companies, who are currently chargeable to income tax on their UK taxable income, within the scope of corporation tax. These companies would then be subject to the rules which apply generally for the purposes of Corporation Tax, including the limitation to corporate interest expense deductibility and loss relief rules.
EYG no. 04211-161Gbl
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