The UK Budget 2017
On Wednesday 8 March 2017, Philip Hammond delivered the UK’s first Budget since the Brexit vote, the first under Theresa May’s leadership and his first as Chancellor of the Exchequer signalling his intention to build a strong and stable platform for Brexit negotiations. Consequently, there were relatively few announcements that will have a significant impact on the financial services industry and tax changes were kept to a minimum reflecting the Government’s intention not to overhaul the tax system too frequently. As previously announced future Budgets are scheduled for the Autumn with the promise of limited changes throughout the rest of the year.
In the days running up to the speech, much of the attention was focused on the tax gap between employees and the self-employed. Whilst the Chancellor acted to better align the national insurance contribution (NIC) rates at lower levels of income, profits subject to taxation at higher and additional rates remain largely unchanged, no doubt much to the relief of businesses operating through LLPs. The case was the same for the taxation of dividends in the hands of individuals, which was predicted to again increase but was instead only subject to a cut in the annual tax-free allowance.
The next round of detail is due on 20 March 2017 when the latest version of the Finance Bill 2017 will be released. In the meantime, please find below a summary of the key tax proposals as they impact the asset management and the wider financial services industry.
Income and NICs
The Chancellor announced that the Government will legislate to increase the main rate of Class 4 NICs from 9% to 10% with effect from 6 April 2018 and from 10% to 11% with effect from 6 April 2019. The 2% rate on profits over £43,000 remains unchanged, as does the Government’s previously announced intention to abolish Class 2 NICs with effect from April 2018. Those accusing the Chancellor of a U-turn on the Conservatives’ manifesto promise not to raise NICs obviously did not read the small print that excluded a possible increase in the class 4 NIC made by self-employed individuals.
As part of a drive to reduce the tax differential between individuals who work through a company compared to those who are directly employed, the Government announced that they will reduce the annual tax-free allowance for dividend income from £5,000 to £2,000 from 6 April 2018.
The personal allowance and higher rate threshold will rise to £11,500 and £45,000 respectively in 2017/18, reaching £12,500 and £50,000 by 2020/2021.
Pensions and Savings
The Autumn Statement 2016 warned that the Government was looking closely at foreign pension schemes with a view to aligning these to the UK domestic pension regime. It was announced that with immediate effect transfers to Qualifying Recognised Overseas Pension Schemes (‘QROPS’) after 9 March 2017 will be subject to a 25% tax charge unless both the individual and the pension savings are in the same country, both are in the EEA, or the QROPS is provided by the individual’s employer. The tax charge will be payable by the administrator or scheme manager before making the transfer. Any subsequent payments made from the QROPS after 6 April 2017 will be subject to UK tax rules for five years after the transfer, regardless of where the individual is resident. HMRC is due to publish further guidance on how the tax charge will work.
As announced previously, the Government is going ahead with the clamp down on the recycling of pensions savings by the over 55s accessing pension freedoms and will reduce the money purchase annual allowance for those still in work from £10,000 per year to £4,000.
The Government also intends to extend taxing rights over recently emigrated UK residents’ foreign lump sum payments from funds that have had UK tax relief, from 5 to 10 years. In addition, they will update the eligibility criteria for foreign schemes to qualify as overseas pension schemes for tax purposes.
There was also confirmation that the annual ISA limit will increase from £15,240 to £20,000 from April 6 2017.
The Government remains committed to removing the UK’s concept of permanent non-domiciled status from 6 April 2017. Individuals will become deemed domiciled for tax purposes if they have been UK resident for 15 of the past 20 tax years. As previously announced, non-domiciled individuals who have a non-UK resident trust set up before they become deemed-domiciled in the UK will not be taxed on income and gains arising outside the UK and retained in the trust. Rebasing of foreign assets held by an individual who becomes deemed domiciled on 6 April 2017 to 5 April 2017 values is a generous concession.
Following a further issuance of draft legislation, it has been confirmed that rebasing also applies to offshore funds regardless of whether they are reporting funds. Non-domiciled individuals with mixed funds can elect to cleanse these funds within a 2-year window by rearranging those held offshore and separating the income, capital gains and the clean capital elements. For assistance with the changes to the non-domiciled rules, please see our Non-Dom Surgery.
Offshore Funds and Capital Gains Tax
Regulations have now been published updating the Offshore Fund Rules. Whilst the capital gains tax (‘CGT’) treatment will be maintained, excess reportable income could increase in some circumstances as the Government has legislated to restrict the deduction of performance fees against income. More of the income generated within a reporting fund will be taxed annually at the higher income tax rates. In short, investors will be paying more tax and paying it sooner. However, investment managers who invest in fee-free share classes will not be impacted. This measure will apply to reporting periods beginning after 1 April 2017.
On a positive note, no changes to the main rate of CGT were announced. This will remain at 20% (28% on residential property and carried interest) for higher rate tax payers; as it has been since 6 April 2016. Reporting fund status is increasingly relevant given differential between CGT (20%) and income tax rates (45%).
The Chancellor confirmed that the Government remains committed to reducing the corporation tax rate to 19% from 1 April 2017 and 17% by 2020/2021. However, in the Autumn Statement the Chancellor did note that higher levels of incorporation are driving down income tax and NIC receipts. As such, the Government intends to have a consultation on what action can be taken and has previously hinted taxing income on a ‘look-through’ basis. This is particularly ominous noting the impact of the disguised investment management fee (‘DIMF’) legislation that came into effect from April 2015 – see below.
The Government previously confirmed its intention to implement the reforms to the use of interest expense as part of the BEPS initiative from 1 April 2017. The rules adopt OECD’s recommendations of best practice and restrict each group’s net deductions for interest to 30% of EBITDA taxable in the UK or, if higher, to an amount based on the net interest to EBITDA ration for the worldwide group. The existing debt cap legislation will be repealed and replaced by a modified debt cap ensuring that the net UK interest deduction does not exceed the total net interest expense of the worldwide group.
From the same date two new rules will be introduced in relation to corporation tax losses. Firstly, companies will be able to group relief carried forward losses. However, the second change restricts the amount of profit that can be offset against losses carried forward to 50% of the available profit if profits exceed £5m.
To further support the UK’s pro-innovation stance, the Government will make administrative changes to Research and Development tax relief (‘R&D’) decrease the administrative burden and to increase the certainty around claims.
Disguised Remuneration Rules
The draft Finance Bill 2017 released last December contained the detailed provisions expanding the disguised remuneration rules. A charge to income tax will be imposed on both employed and self-employed individuals who have loans outstanding as at 6 April 2019. This charge will also apply where individuals seek to repay the loans or they are written off in an attempt to avoid a tax charge. Whilst not strictly retrospective legislation, it will in some cases act to impose a tax charge to historic remuneration structures not previously subject to UK taxation. The extension of the rules to self-employed individuals will also mean that partners in LLPs will need to assess the impact of the rules for current and historic remuneration structures particularly where relevant benefits are taken after 6 April 2017.
DIMF and Carried Interest
Unfortunately, no further clarity was provided on the DIMF and carried interest legislation. The final guidance is long overdue given that the legislation applied for the fiscal periods commencing 5 April 2015 onwards but the Chancellor remained silent on this subject. The legislation can potentially look through corporate structures to tax individual UK-based investment managers on income as it arises despite a corporate structure sitting between them and the income. An informal consultation closed on 13 January 2017 and HMRC are yet to release anything further. The draft guidance released as part of the process confirmed that the legislation is far wider ranging than first envisaged and impacts 2015/16 personal tax returns meaning taxpayers may need to re-submit. The legislation is extremely complex and could potentially capture a number of commercial scenarios leaving individuals with an unexpected tax liability.
Partnership Taxation Changes
As announced in the Autumn Statement 2016, legislation will be introduced to clarify and improve certain aspects of partnership taxation. The legislation will seek to ensure that profit allocations to partners are calculated fairly for tax purposes, with the Government proposing to legislate for the basis of allocation for tax adjusted profit to be the same as the allocation of the accounting profit/loss between the partners. Legislation is promised in early 2017 therefore likely to be included in the next draft Finance Bill 2017 released on 20 March 2017.
The Government is also seeking greater transparency on the underlying partners when multiple partnership structures are used and the ability to look through to the ultimate partner when levying tax. This proposal could present a significant administrative challenge for private equity managers who use tiered partnership structures. We await further detail on the practical application of this transparency requirement.
Offshore Property Developers
The Chancellor announced that legislation will be introduced in Finance Bill 2017 to the effect that all profits from dealing in or developing land in the UK that are recognised in the accounts on or after 8 March 2017 will be taxed. This will be the case even if the contract for disposal was entered into before 5 July 2016. The UK property market continues to be a focus for developing tax policy on several fronts and is expected to be a changing landscape in the future.
Business Tax Rates
The next business rates revaluation comes into effect in England on 1 April 2017. The Government announced a further £435 million in measures which aim to ease the burden for businesses facing significant increases in their business rate bills. This includes a transitional relief cap for businesses losing Small Business Rate Relief. The Government also reaffirmed its commitment to deliver more frequent revaluations of properties and announced that the revaluation approach will be set out in Autumn Budget 2017.
Tax Avoidance and Evasion
The Chancellor announced further action against promoters of tax avoidance schemes and reiterated the intention to introduce a new penalty for enablers of tax avoidance arrangements that are later defeated by HMRC. The defence of having relied on non-independent advice as taking ‘reasonable care’ when considering penalties for a person or business that uses such arrangements will also be removed. In doing so the Government continues to demonstrate that it will not tolerate those seeking to use aggressive tax planning techniques to avoid UK tax liabilities.