In his 2005 Budget, the Chancellor has built on the proposals included in the last Pre-Budget Report and legislation introduced in the Finance Act 2004 by announcing a package of measures aimed at tackling further perceived areas of tax avoidance.
These and some of the other principal proposals arising from the Budget Notes published 17th March 2005 are described in the following summary of headline points.
Further details will follow once the draft legislation is published under the Finance Bill, which is expected on 24 March 2005.
Tax Avoidance Measures
Avoidance through arbitrage
With effect from 16 March 2005 (subject to an amnesty period enabling unconnected parties to unwind affected arrangements) legislation will be introduced aimed at counteracting tax advantages arising under certain transactions involving hybrid entities or hybrid instruments where a main purpose of the transaction is the obtaining of the tax advantage or certain arrangements involving non-taxable receipts which are deductible for the payer but not taxable for the recipient.
The term “hybrid entity” is drawn widely and appears aimed at capturing entities which are recognised as a taxable person under one jurisdiction yet treated as tax transparent in another. To qualify as a “hybrid instrument”, the instrument in question must have one of a number of characteristics including where the tax treatment can be varied by election or where there is a reasonable expectation that shares will be converted into securities (or vice versa). In the case of connected parties any share other than an ordinary share will be a “hybrid instrument” for these purposes.
In the relevant circumstances, the Inland Revenue will issue a notice to the taxpayer company directing that the legislation applies. If the legislation applies, (i) a deduction for corporation tax purposes will be denied if more than one tax deduction is being claimed for the same expense or the recipient is not taxable on its receipt; or (ii) a receipt which would otherwise not be taxable will be subject to corporation tax as income.
The Revenue have published “worked examples” which are attached, but which require clarification.
The Revenue is also prepared to give advice about existing and contemplated transactions under an informal clearance procedure.
Double tax relief anti-avoidance
Measures have been introduced aimed at counteracting double tax relief (DTR) where the DTR claim arises under an arrangement with tax avoidance as one of its main purposes if the arrangement falls within one of five prescribed circumstances. Where the legislation applies, UK taxes will be reduced by a just and reasonable amount of credit for foreign tax.
The five prescribed circumstances are:
The foreign tax is not properly attributable to the source from which the income or gain is derived.
The payer of the foreign tax has not suffered the full economic cost of that tax against the relevant income or gain.
A claim, election or arrangement was made which increased the amount of credit for foreign tax where a claim, election or arrangement could have been made in another territory which would have reduced the amount of credit for foreign tax.
The foreign tax credit reduces the amount of UK tax to an amount less than would have been payable in the absence of the scheme or arrangement.
A source of income subject to foreign tax has been acquired wholly or partly as consideration for a tax-deductible payment.
Separate legislation is also introduced to combat other specific DTR arrangements relating to controlled foreign companies and credit for underlying taxes where a deduction is given overseas for a payment that is characterised in the UK as a dividend.
These measures are effective from 16 March 2005.
Legislation is being introduced to counteract the following arrangements which have come to the Inland Revenue’s attention under the Finance Act 2004 disclosure regime (effective dates are in brackets):
Avoiding income tax by individuals using stripped corporate bonds (effective from 2 December 2004).
Avoiding tax by companies acquiring debt securities by way of stock loans or repo agreements (effective from 2 December 2004).
Circumventing the change in ownership rules on carry forward of non-trading loan relationship losses (effective from 10 February 2005).
Generation of capital losses by companies using capital redemption bonds (effective from 10 February 2005).
Conversion by companies of interest-like income into either a capital gain or a tax nothing using shares or derivatives over shares (effective in relation to profits accruing on or after 16 March 2005).
Exploitation of the group continuity rules for loan relationships and derivative contracts to convert income into capital or take advantage of different accounting methods used by different group companies (effective in cases where a company ceases to be a member of a group on or after 16 March 2005).
Rent factoring schemes which exceed the 15 year rule (effective in relation to arrangements entered into on or after 16 March 2005; in addition for interposed lease cases where the finance arrangement was entered into after 20 March 2000 but before 16 March 2005 and to which the rent factoring rules did not apply, no deduction will be available for rent paid which relates to a period after 16 March 2005).
Obtaining reliefs for annuities and annual payments as charges on income (effective in respect of payments made on or after 16 March 2005).
Trustees and individuals
The Chancellor also introduced measures to prevent capital gains tax avoidance by UK-resident individuals and by UK-resident trusts. The schemes involve the taxpayer taking up residence in a low-tax jurisdiction in order to dispose of the relevant chargeable asset and claiming relief under the appropriate double tax agreement from UK tax, which would otherwise have been due in the case of trusts if they remained resident in the UK for domestic purposes, and in the case of individuals if they re-established residence in the UK within five years. In future, double tax agreements will not preclude such a charge, but a credit will be available in respect of the foreign tax on such disposal.
Location of assets
The rules governing the location of assets for capital gains purposes have been expanded to cover assets such as bearer shares, debentures, and intangible assets governed by non-UK law.
Previously the location of these assets was governed by common law, which could produce eccentric results and opportunities for avoidance (bearer shares, for example, were deemed to be located where the bearer instrument was situated at the time of disposal: whereas from now on they will be treated as being located where they are registered).
These changes will be of relevance to UK-resident but non-domiciled individuals and to persons with a permanent establishment in the UK, for whom the location of the asset is a determinant of whether a charge will arise.
The annual taxable turnover limit which determines whether a person must be registered for VAT has been increased from £58,000 to £60,000.
The VAT anti-avoidance disclosure rules introduced in last year’s Budget, are to be amended in several ways.
First, a loophole is closed so that the regime now applies to schemes giving a tax advantage which does not appear on a VAT return, for example a scheme to reduce irrecoverable VAT.
Two further schemes are prescribed for disclosure: (i) schemes exploiting the difference between the UK’s treatment of vouchers and that of other Member States; and (ii) schemes designed to circumvent the effect of an election to waive exemption on supplies of land and property (often referred to as the “option to tax”).
In addition, a new “hallmark” of avoidance is being introduced to require disclosure of schemes that make use of face value vouchers with low redemption rates.
Special partial exemption methods
Several measures have been introduced which affect the treatment of partially exempt businesses (i.e. businesses that make both taxable and exempt supplies for VAT purposes). In particular, the new rules affect special methods agreed between such businesses and HM Customs and Excise for the purpose of computing input tax recovery. The rules affect the extent, process and operation of such agreements.
HM Customs and Excise may currently use a defence of “unjust enrichment” to resist a claim for recovery of overpaid VAT in certain circumstances, for example where the repayment of VAT incorrectly charged by a business would not be passed on to the customer that has borne the tax economically. In future, the tax authority can now apply this defence in respect of all claims for VAT except claims for input tax or the recovery of duplicated payments of tax.
Refund time limit
The three year limitation period applicable to refund claims is to be calculated from an earlier date than at present, depending upon how the overpayment has arisen.
Double tax relief for trade receipts
With effect from 16 March 2005 for companies (and 6 April 2005 for individuals) legislation is introduced for determining the losses and expenses that should be taken into account when calculating the proportion of overall profits that is attributable to transactions giving rise to foreign tax. The purpose of these rules is to ensure that where double tax relief is calculated on the basis of profits, only those expenses that are incurred directly or indirectly in earning the relevant item of income are to be taken into account.
Corporate Intangible Assets
Certain changes will be made to the Finance Act 2002 corporate intangible asset regime which include (i) an amendment to the “related party” definition and (ii) a modification to the market value rule for transactions between connected persons. These changes take effect from 16 March 2005.
International Accounting Standards
Further to the legislation included as part of the Finance Act 2004 and regulations made in December 2004, technical amendments have been made to reflect recent developments in both International Accounting Standards and UK GAAP. The moratorium for certain UK securitisation vehicles using UK GAAP will be extended for all accounting periods beginning in 2005. A measure will also be introduced to prevent companies crystallising losses in advance of the 2006 transition to IAS.
Stamp duty and SDRT: extension of reliefs for intermediaries and repos/stock loans
The current stamp duty/SDRT reliefs for intermediaries and repo/stock lending transactions will be extended to members of specified Multilateral Trading Facilities as defined in the EU Markets in Financial Instruments Directive (2004/34/EC).
Stamp duty land tax and disclosure
The disclosure rules set out in Finance Act 2004 were narrowed by Regulations to tax advantages concerning income tax, corporation tax or capital gains tax. The scope of those rules has now been extended to cover certain transactions involving an SDLT advantage concerning property which is not residential property and which has a market value of at least £5m. This measure applies with effect for schemes and arrangements made available or implemented on or after 1 July 2005.