T AX NEWSLET T ER - DECEM BER 2017
11 DEC 2017
Budget 2017
Anyone listening to Philip Hammond's speech this afternoon would be forgiven for thinking that, from a tax perspective at least, this was a relatively quiet Budget. However, tucked away in the published documents, were a number of important changes – most notably those relating to the taxation of non-residents disposing of UK real property for whom this Budget will be a game-changer. As a result, much of this briefing relates to those changes so please be aware that if property is not your area of interest you will, unfortunately, need to scroll down some distance…
Real estate – gains by non-residents In a surprise move, the Budget announced dramatic changes to the UK tax environment that impact offshore investors investing in UK commercial real estate. These will have profound implications for the way in which investment structures and funds are established in the future and may lead to a number of restructurings. The new changes all seek to impose UK tax on certain types of capital gains ultimately deriving from UK real estate. Currently at least, there are no proposals to extend the scope of SDLT to sales of real estate-rich vehicles. Gains made by non-residents on disposals of UK commercial real estate Gains made on disposals by non-residents of UK commercial real estate held as an investment are currently outside the scope of UK capital gains tax and corporation tax. The Government has today announced that, very broadly, gains that accrue on or after April 2019 on UK real estate (or indirect interests deriving their value from UK real estate) will be brought into the charge to UK tax. Technically this is only a consultation but the direction of travel is clear and we expect that these rules will be introduced in due course. There will effectively be "rebasing" up to April 2019. What that means is that increases in value up to that date will generally fall outside these tax charges, with only increases in value as from that date coming into charge. These are fundamental changes and affect not just direct disposals but certain indirect disposals too. Direct disposals There are two main changes proposed for sales of UK real estate in the consultation document: (a) gains on disposals of UK commercial property will become subject to UK tax where the disposal occurs after April 2019. As noted above, only that part of the gain that accrues after this date will become subject to tax; and (b) the existing charge to tax on gains on disposals of residential property by non-residents will be extended to include gains on disposals by widely-held non-resident companies after that date (currently outside the scope of the charge to tax on gains on residential real estate). This is likely to have a significant impact on, for example, funds which own a Build to Rent portfolio. Indirect disposals In addition, the proposal is that gains on indirect disposals of UK real estate will also be subject to UK tax from April 2019. The idea here is to capture gains on sales of Propcos, JPUTs and similar. However, the rules are widely crafted and will charge gains on disposals where two conditions are satisfied: (a) the entity being disposed of is a "property rich" entity. That is broadly defined as meaning that at the time of disposal 75% or more of the entity's value is derived, directly or indirectly, from UK land. The test is a gross-value test and so ignores any liabilities such as debt secured on the assets. A market value test at the time of disposal is proposed to be applied for these purposes; and (b) the non-resident making the disposal must hold directly or indirectly at least 25% of the property-rich entity (or must have held that amount at some point in the five years ending on the date of the disposal; this is an anti-avoidance rule to avoid fragmented disposals falling outside the scope of the tax. The amount of the gain will be calculated on the basis of the proportion of the interest being disposed of in the transaction. As with direct disposals, there will be rebasing to April 2019. Where there are multiple levels in a corporate holding structure, one could imagine that there could potentially be gains at a number of levels. So far there is no word whether there will be any rules to ameliorate multiple charges. Residential UK real estate A series of changes over the last couple of years had already brought most, but not all, residential real estate within the scope of UK tax on gains. However, those changes only captured actual sales of residential real estate and not, for example, sales of Propcos owning residential real estate. Post April 2019, the position for residential real estate will mirror that for commercial real estate set out above. There are a number of differences in detail between the commercial and residential rules; one being the date when assets are rebased to (which very broadly will always be the date when the relevant interest first fell into one of the offshore CGT rules). Impact on existing structures on particular classes of investor Investors that sell before 1 April 2019 will not directly feel the impact of these changes. However, they could find that their exit proceeds are prejudiced by the impact of these changes on potential buyers' financial modelling. Many of the usual historic structuring precepts have disappeared. The structures for new investments need careful thought. These new rules will have a significant effect on offshore commercial property funds, particularly open-ended or listed funds. From April 2019: (a) it will no longer be possible to reinvest gains from a property disposal on a tax-free basis. Any such gains will be subject to UK tax, as set out above. This is significant, particularly if it was assumed when the fund was established that it would be possible to reinvest on a tax-free basis; and (b) it is likely to introduce an additional layer of tax into such investment structures – and for exempt investors, e.g. UK pension funds, they could be in a much worse position than if they had invested direct, where any gains would typically be exempt. REITs and PAIFs, which can (depending on the precise structure they use) often reinvest on a tax-free basis, are likely to become more attractive as a result. Indeed, some offshore funds may therefore consider converting to REIT/PAIF status. The rules on indirect disposals are so wide that investors in property funds may not want to hold more than 25% of the interest in those funds. It is not all plain sailing for UK REITs though. Although a company that is a member of a group REIT is exempt from tax on direct disposals of a property, many disposals are structured as share sales where a nonresident company that is a member of UK REIT disposes of the shares in another non-resident group member. In that case, under current law the disposal is exempt by virtue of the vendor company's nonresident status, rather than a specific exemption in the REIT rules. Where, as is almost certain to be the case, the entity being disposed of is treated as a "property-rich" entity, the disposal will become subject to UK tax after April 2019 under the rules proposed today. Other defences and anti-forestalling Not quite all offshore structures will be caught even after April 2019. We think that for those investors with multiple tier Luxco structures, the position may be better. More particularly, there seems to be protection under the UK/Luxembourg treaty if a Luxembourg holding company is able to sell a subsidiary Propco. We think that it is a nervousness around this that has driven a so-called anti-forestalling rule. The anti-forestalling rule will apply as from today (assuming these provisions are enacted) and seems designed to stop people using such a double tier Luxembourg structure. Whether that is an EU-law compliant provision is a particularly interesting question under the circumstances. Third party reporting obligations The government is clearly aware that there will be significant compliance requirements where, for example, an interest is disposed of many levels further up the chain of ownership from the underlying "property-rich" entity. It is therefore considering the imposition of a reporting requirement on UK-based advisors who have received fees for advice or services relating to a transaction that could fall within the ambit of the charge to tax on indirect disposals where the advisor cannot reasonably satisfy themselves that the transaction has been reported to HMRC. Late or non-reporting of such disposals in these circumstances will be subject to penalties.
Real estate – income received by non-residents Non-resident companies charged to tax on income from UK real estate The other key change made in the property context had been widely trailed. Currently, income that non-resident companies receive from UK real estate is subject to income tax rather than corporation tax. From April 2020 the position will reverse and income that non-resident companies receive from UK real estate will be chargeable to corporation tax rather than income tax. On the face of it that is good news given that the current rate of corporation tax is 19% (and is scheduled to reduce to 17% by 2020) rather than the current basic rate of income tax of 20%. However, bringing those companies into the charge to corporation tax will also mean that they become subject to the UK's rules on interest deductibility restrictions and restrictions on the amount of brought-forward losses that can be used to offset current year profits. These changes were largely expected although it is surprising that the introduction date has been postponed to April 2020.
Real estate – general SDLT relief for first time buyers A stamp duty land tax (SDLT) relief for first time buyers of residential properties costing no more than £500,000 has been introduced. First time buyers will pay no SDLT on the first £300,000 of the purchase price, with the remainder being charged at 5%. No relief will be available where the total consideration exceeds £500,000. SDLT: changes to the filing and payment process It has been confirmed that the reduction in the SDLT filing and payment window from 30 days to 14 days will apply to land transactions with an effective date on or after 1 March 2019. Improvements are planned to the SDLT return which aim to make compliance with the shorter time limits easier. Mixed use property still benefits from lower SDLT rates In transactions where non-residential property (such as a small piece of industrial land) is parcelled up in the same transaction as residential property (even where geographically unconnected), it can be argued that the purchase is "mixed use" and, therefore, liable to lower rates of SDLT than would otherwise be payable on residential property. It had been expected that the government would introduce anti-avoidance legislation (such as an apportionment rule on a just and reasonable basis) to counter this kind of SDLT planning. However, there is nothing in the Budget to suggest that the government is currently seeking to do so.
Digital economy Taxing value generated from the UK market The government has issued a position paper on the digital economy. Essentially, this reaffirms the government's commitment to ensuring that the UK corporation tax payments of a multinational group are commensurate with the value they generate from the UK market and specifically the participation of UK users. That position is quite a change to current international tax principles and, if enacted, could potentially end up with materially higher tax charges arising for such providers in the UK. As to how it hopes to achieve that, HMRC will continue to push for wider multilateral reforms to the international tax framework. In addition, the government will explore interim options such as a tax on the revenues that businesses generate from the provision of digital services to the UK market. As part of this approach, there will be an extension of UK withholding tax to cover royalties paid in circumstances where a multinational group's profits are derived from selling products and services to UK customers, but where those profits have been transferred to an entity in a low-tax country which has been awarded ownership of the group's intangible assets. These rules will apply from April 2019 and will apply regardless of where the payer is located. VAT liability for online sales HMRC already have a power to make online marketplaces jointly and severally liable for certain overseas traders on their platform. Currently though, that joint and several liability only applies once HMRC has issued them with a notice identifying the relevant trader. The proposal is to extend this to cover all traders on the marketplace (including UK) traders. However, that rule still only applies where HMRC have issued that notice. Going forward, online marketplaces will also be held jointly and severally liable for any VAT that a non-UK business selling goods on their platforms fails to account for, where the business was not registered for VAT in the UK and the online marketplace should have known that business should have been so registered. That will require some active monitoring by the online marketplace. The government is also continuing to look at a new VAT collection mechanism for online sales on online marketplaces, using payment technology to allow VAT to be extracted directly (and go directly to HMRC) from transactions at the point of purchase (known as 'split payment'). Implementing this proposal would result in a cash-flow disadvantage to those affected but has again been prompted by offshore vendors selling through online marketplaces failing to comply with their VAT obligations. There will be further detail of how it is proposed that this be implemented in light of responses to the previous Spring 2017 HMRC consultation. EIS and VCT The Treasury has been looking at how to encourage long term investment into UK growth companies. Part of the existing incentivisation package is provided through tax reliefs provided to UK tax resident individuals who invest in companies that qualify as venture capital trusts (VCT), enterprise investment schemes (EIS) or seed enterprise investment schemes (SEIS). These have become increasingly popular, particularly since the pension contribution rules were tightened up. The recent policy document "Patient Capital Review" recommended that some retargeting of those three reliefs be considered. That has led to a number of proposed changes, most of which are expected to come into force with effect from 6 April 2018. Many of the changes are designed to ensure that investments will only qualify if they really are providing growth capital to companies where there is a real risk of a capital loss. Until now, some of these schemes (particularly VCTs) had effectively allowed a portion of secured loans with relatively low risk of loss to qualify in certain cases. Perhaps the tightening up around some of these requirements is not that surprising given that background. However, the rules for these entities are already overly complicated. Whilst some of the requirements are being relaxed, even the cheerleaders for this legislation could not say it was being simplified. That seems a missed opportunity to us.
Employment The government remains concerned about the inappropriate use of personal service companies (PSCs) by individuals in order to reduce their tax bill. Under longstanding legislation, known as IR35, individuals who are in substance employees should be taxed accordingly but there is a perception of widespread noncompliance. In part that is thought to be because under IR35 it is the PSC (rather than the ultimate employer) that has to comply with IR35. As widely expected, one suggestion is that recent public sector reforms in this area should be extended to the private sector. Essentially, these reforms shifted the responsibility of determining whether the individual is effectively working as an employee, and paying the correct tax, to the body paying the PSC. A consultation is due to be published early next year, but any business employing contractors through a PSC may wish to take advice on how the extension of this change to the private sector might affect them. More generally, the government is proposing to issue a discussion paper exploring the case and options for reform of the employment status tests for tax (and employment rights) purposes. This is not surprising given the publication in July of the Taylor report on modern working practices, and the clear desire to equalise the tax paid by individuals doing similar work even if through different structures.
Business Hybrids Complex rules which came into force at the beginning of this year deny a deduction for certain payments, or bring into the charge to tax certain receipts, in circumstances involving "hybrid entities" or "hybrid instruments" i.e. those which are treated differently for tax purposes in different jurisdictions. Yet more tweaks are being made to this set of rules which are already causing great difficulties for multinational businesses. The changes are highly technical but are a mixture of positive changes (for example the clarification that interest disallowance in funds will be proportionate to the number of investors causing the hybrid rules to apply – see Fund Managers section below) and negative, such as the removal of an assumption which some had seen as creating a safe harbour where payments were being made to or received in jurisdictions with a zero rate of tax (as opposed to no tax). At this point we are merely flagging that further changes are being made. Clearly the level of complexity here does not lend itself to a general briefing, but we are happy to come and speak on the relevance of these rules in specific areas at any time. Accounting changes for leases The IASB's new lease accounting standard (IFRS16) will necessitate changes to the existing tax rules for the leasing of plant or machinery. Under IFRS16, lessees will use only one form of accounting and so, unlike lessors, will no longer classify their leases as being "finance" or "operating" leases. This means that the allocation of capital allowances as between lessor and lessee, which is currently made by reference to these concepts, would not operate correctly. The government is no longer considering wholesale reform of capital allowances in the leasing context and instead will shortly publish consultations (i) on how to ensure that the tax regime for leased plant and machinery continues to work as currently, and (ii) evaluating options for the tax treatment of lease payments under the new corporate interest restriction rules. Calculating chargeable gains The indexation allowance, which is applied when companies make a capital gain in order to determine the amount of the gain chargeable to tax (essentially giving relief for inflation), is being removed as from 1 January 2018. Any disposals taking place on or after this date will benefit from indexation only up to the end of next month. Business Rates Following major reforms announced at Budget 2016 and Spring Budget 2017, further changes to business rates include: Bringing forward by two years (to 1 April 2018) the planned switch in indexation from RPI to CPI. Reinstating the valuation practice in multi-occupancy buildings which prevailed prior to the Supreme Court judgment that resulted in the so-called 'staircase tax' and allowing affected businesses to recalculate valuations based on the original practice, backdated to April 2010. Increasing the frequency of revaluations of non-domestic properties to every three years, following the next revaluation currently due in 2022. Oil & gas The government has confirmed that, from 1 November 2018, it will be possible for oil and gas companies to transfer their ring fence corporation tax payment histories to the buyer alongside the relevant asset. This would allow the buyer to carry back decommissioning losses against tax previously paid by the seller (with the obvious corollary of seller being unable to claim a refund against the tax history transferred). This should expand the market for late life assets and provide more options for structuring such transactions. Oil and gas companies will be keen to see that any measures introduced to prevent abuse of the regime will be proportionate and do not unduly complicate the proposed regime, particularly since these issues were discussed extensively during the consultation period. Draft legislation will be published in spring 2018. The government has also committed to introducing legislation in Finance Bill 2019 allowing decommissioning relief for PRT purposes for a former licence holder. This should enable decommissioning liabilities to be retained by sellers on an asset sale without losing valuable PRT relief for the costs. Legislation to be introduced in the next Finance Bill will extend the definition of "tariff receipt" to ensure that licence holders who receive tariff income from non-PRT fields are subject to ringfence corporation tax and the supplementary charge. This is intended to be a helpful change as this should ensure that tariff income can benefit from Investment Allowances and Cluster Area Allowances. VAT The Office of Tax Simplification has been reviewing aspects of the VAT regime and has recently reported concerns that the UK's VAT registration threshold of £85,000 is creating a distortion of competition between those businesses required to register and those that are not. The UK has the highest registration threshold in Europe by a considerable margin, but the Chancellor has confirmed that this threshold will remain unchanged for two years from 1 April 2018 while the government consults on the level and design of a new threshold. From 1 October 2019, a domestic reverse charge mechanism will apply to payments for supplies of labour within the construction sector. This involves shifting responsibility for paying the VAT along the supply chain, e.g. to the principal contractor, in order to combat supply-chain fraud. A consultation earlier this year proposed limiting the services to which this would apply (i.e. only to those services within the constructions operations definition of the construction industry scheme) and to include thresholds to limit the instances in which it must be applied by small businesses. A further technical consultation will follow early next year. The VAT treatment of vouchers, including the point at which they become subject to VAT and in some cases their value for tax purposes, is to be simplified with effect from 1 January 2019. This has traditionally been a confused area of VAT and corporate retailers will be pleased to see clarification.
Fund Managers Real Estate The introduction of a tax for non-residents on all UK real estate gains from April 2019 may have a significant effect on offshore commercial property funds (see above). From that date: it will no longer be possible to reinvest gains from a property disposal on a tax-free basis. Any such gains will be subject to UK tax, as set out above. This is significant, particularly if when the fund was established it was assumed that it would be possible to reinvest on a tax-free basis; and it is likely to introduce an additional layer of tax into such investment structures – and for exempt investors, e.g. UK pension funds, they could be in a much worse position than if they had invested directly, where any gains would typically be exempt. As mentioned above, REITs and PAIFs, which can reinvest on a tax-free basis, are likely to become more attractive as a result. Indeed, some offshore funds may therefore consider converting to REIT/PAIF status. General – Hybrid Rules One positive change proposed to the hybrid rules in a funds context is clarification that where one investor in a fund regards one or more of the investment vehicles as transparent and another regards one or more of those vehicles as opaque, any disallowance of interest costs under the hybrid rules will be done on a pro rata basis, rather than by reference to the cliff-edge test which the legislation as currently drafted seemed to suggest. A cliff-edge test could have resulted in all interest payable to a fund by an investee company being disallowed if investors regarded the investment vehicles in the fund differently from a tax perspective. Carried Interest The carried interest capital gains tax charge introduced in July 2015 did not capture carried interest arising in connection with the disposal of a fund's assets before that date. This transitional relief is to be repealed. As a result, all carried interest arising to UK resident individuals will, subject to the complex rules for nondomiciliaries, now be subject to the full carried interest capital gains tax charge of 28% irrespective of when the assets giving rise to the carry were disposed of.
Tax avoidance/evasion and compliance Although fewer than in previous Budgets, there were still some measures aimed at counteracting specific avoidance schemes and strengthening HMRC's powers to deal with those involved with such schemes. These are quite technical and will not generally be applicable to our clients. It is worth noting, however (i) that the time limits within which HMRC can challenge non-deliberate offshore non-compliance have been extended to 12 years, and (ii) HMRC's confirmation that it intends to take forward its proposal to require designers of certain offshore structures that could be misused to evade taxes to notify HMRC of these structures, and of the clients using them. We hope you find the above summary of the key measures helpful but, if you have any comments or queries, please feel free to give any of us a call.
Key Contacts
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The information provided is not intended to be a comprehensive review of all developments in the law and practice, or to cover all aspects of those referred to. Readers should take legal advice before applying it to specific issues or transactions.