UK Summer Budget 2015-8 July 2015

The first Conservative budget for 18 years promised to be a ‘big’ budget that delivered on the promises made during the election campaign and it was certainly noteworthy. With speculation growing in the days leading up to his speech and the now customary policy leaks, by the time George Osbourne took to the stage expectation was high.

As anticipated, cuts to the benefits system took the headlines, but this was balanced by significant changes to the non-domicile regime and increases to the taxation of dividends. However further reductions in corporate tax will be welcomed by business as the UK strives to compete on the world stage.

The financial sector and in particular investment management got more than just a mention with removal of base cost shifting by private equity managers and a consultation over the coming months on the taxation of performance fees. The fine detail of the immediate measures will be released in the Summer Finance Act on 15th July 2015, but below is a short synopsis of the key points.

Business

• Investment Management

Private equity managers will no longer have the benefit of base cost shifting when realizing investment carry. This arose previously due to the application of the HMRC statement of practice D12. Now all of the gains will be subject to capital gains tax. The move will not otherwise affect statement of practice D12.

Also released was a consultation on performance rewards to investment managers. This is intended to stop carried interest structures being adopted “inappropriately” by fund managers. The perception is that some managers are trying to fit their structures into private equity models to enable them to achieve capital gains tax treatment on receipt of the performance fee. The consultation discusses whether there should be a statutory basis to determine whether a manager’s interest in the performance of fund assets should be treated as investment or trading.

It is stated that it will not affect the treatment of investors, the investment management exemption, co-investment, etc. however it continues to be unsatisfactory that something is considered trading or investing for one piece of legislation and the opposite for another. HMRC refer to the uncertainties of the “badges of trade” and the desirability of getting clarity on the trading/investment divide. The consultation document suggests tests that might be applied; the nature of the investment; whether a controlling interest is taken; or the holding period of investments. The consultation is open until September 2015 with legislation to take effect from 6 April 2016.

• Corporation Tax Rates and Payments

From 2017-18 corporation tax will be reduced from 20% to 19% and further still to 18% from 2020-21. This continues the trend in recent years differentiating the UK from other major economies and will be welcomed across the board by business. The move places the UK’s corporate tax rates at less than half of that in the US, over a third less than European rivals in Germany and France and within touching distance of the rates found in Hong Kong and Singapore.

However for companies with annual taxable profits in excess of a £20 million threshold (divided by the number of companies in the group) the speed at which corporate tax will be collected will accelerate by approximately four months placing an additional funding requirement on business.

Quarterly instalment payments will now be in the third, sixth, ninth and twelfth month of their account period, i.e. in the last month of each quarter, as opposed to the seventh, tenth, thirteenth and sixteenth month as is currently the case. Businesses whose profits are unevenly distributed through the year, e.g. investment managers with annual performance fees, will further struggle to estimate and pay liabilities as they fall due.

• Annual Investment Allowance

From January 2016, the Annual Investment Allowance will be set permanently at a level of £200,000. In recent years, it has ranged from £25,000 in 2013 to £500,000 in April 2014.

• National Insurance

The National Insurance Contributions (NICs) Employment Allowance will increase by £1,000 to £3,000 a year. This will come into effect from April 2016. As a result of this change, up to 90,000 employers will see their employer NICs liability reduced to zero. This is combined with an anti-avoidance measure to tackle a scheme highlighted in the media exploiting the policy. From April 2016, single person companies where the director is the sole employee will no longer be able to claim the Employment Allowance in relation to Class 1 National Insurance Contributions.

• Goodwill Amortization

Corporation tax relief on the amortisation of goodwill will not be available upon the acquisition of a business from 8 July 2015 onwards. Businesses were previously able to claim corporation tax relief when goodwill or intangible assets were written off for accounting purposes and also had the opportunity to elect for a fixed 4% rate of amortisation. Businesses will be able to continue to claim this relief with respect to acquisitions made before 8 July 2015.

• Banks

A banking surcharge will be introduced on profits in excess of £25m, set at a permanent rate of 8%. This will come into effect from 1 January 2016. A phased reduction of the bank levy rate is also to be implemented. It currently stands at 0.21% but is set to fall to 0.10% by January 2021. There will also be a change in the bank levy’s scope from 1 January 2021, meaning that UK headquartered banks are levied on their UK balance sheet liabilities.

Personal

• Non-domiciled individuals

Explaining that the relief for non-domiciled individuals was meant to be a temporary relief and not a permanent one, the Chancellor announced that an individual who has been resident in the UK for 15 out of the last 20 years will be considered from 6 April 2017 to be domiciled in the UK. As a result, they will no longer be able to access the remittance basis of taxation, i.e. not be taxed on foreign income and gains not remitted to the UK.

They will also, at the time of becoming deemed UK domicile, be subject to IHT on gifts and on death on their worldwide assets. An individual who has been deemed domiciled in the UK can only lose that status by being non-resident for 5 years. The £30k and £60k remittance basis charges of RBC remain but the increased £90k charge becomes redundant once the new legislation is introduced.
Rules will also be introduced for a returning UK domicile. This will apply to individuals who had a UK domicile at their date of birth, who leave the UK, establish a domicile of choice elsewhere and then return to the UK. These individuals will be treated as UK domiciled from the moment they return to the UK and become UK resident. They will also lose the tax benefit of trusts and offshore vehicles established whilst they were non-resident. If the individual subsequently leaves the UK again they can become non-domiciled immediately provided they haven’t returned for 15 years and they haven’t acquired an actual (rather than deemed) UK domicile during their time in the UK.

These changes will be legislated in Finance Bill 2016. Irrespective of when someone arrives in the UK, these rules will apply from 6 April 2017 and there will be no grandfathering rules for current UK residents.

Trusts established prior to becoming deemed domicile will continue to not be taxed on trust income and gains retained in a trust but new rules will be introduced to tax trust benefits received which will need to be carefully considered.

The Chancellor also intends to bring all UK residential property into charge for IHT purposes even where it is owned indirectly through offshore vehicles by reforming the excluded property rules. These proposals are intended to reflect the 2015 change to CGT for non-resident owners of UK property and remove the incentives for enveloping property which HMRC tackled through the ATED legislation. A consultation will be issued towards the end of the summer and it is envisaged that legislation will be included in the Finance Bill 2017 and be effective from 6 April 2017.

Income Tax Rates and Banding

As promised there were no changes to the headline income tax rates and increases to the personal allowance have been brought forward, rising to £11,000 for 2016-17 and £11,200 in 2017-18. Also the higher rate threshold will increase to £43,000 in 2016/17 and £43,600 in 2017/2018.

• Dividends

In an unexpected step, the Chancellor announced an overhaul in the dividend tax regime, removing the current 10% tax credit from April 2016 and increasing the rate for additional rate taxpayers. Although the loss of the tax credit is replaced by a dividend tax allowance of £5,000 per year it will still represent an increase in the effective tax rate for most taxpayers on dividend income, a somewhat surprising move given pre-election assurances made with regard no increases to income tax.

Currently when the tax credit is taken into account, higher rate and additional rate tax payers currently pay (based on rates of 32.5% and 37.5%) an effective tax rate of 25% and 30.56% respectively. From April 2016, this will increase to 32.5% and 38.1%. This equates to an absolute increase of 7.5%.

For owner managed business the changes to both the dividend tax regime and corporate tax rates will again lead to a reassessment of the most suitable structure. Both partnerships and corporate entities come with their own uniquely complex set of anti-avoidance rules that require careful consideration, but a direct comparison based on the new rates the profit extraction routes available to individuals are as follows:

Caution is urged in simply comparing the rates as a practical understanding on how the underlying legislation applies to a business model is paramount. The ability to retain profits at corporate tax rates remains a significant factor.

• Business Investment Relief

To promote economic growth the Government is keen to offer generous tax incentives to encourage private investment into small UK companies however the new EU state aid rules required amendment to the criteria to be satisfied to access these reliefs. Legislation will be published in Summer Finance Bill 2015 on a host of subjects to make a number of changes to the EIS, SEIS and VCT rules.

• Pensions

The lifetime allowance for pension contributions will be reduced from £1.25 million to £1 million from 6 April 2016 and be indexed annually from 2018. Transitional protection for pension rights already over £1 million will be introduced alongside this reduction to ensure the change is not retrospective. Additionally individuals with ‘adjusted income’ of over £150,000 (including pension contributions) will from April 2016 have a reduction on their annual allowance of £1 for every £2 over the £150,000 limit, up to a maximum reduction of £30,000.

• Buy-to-Let

Individual buy-to-let investors who are higher or additional rate taxpayers will no longer receive full relief on mortgage interest from April 2017. At present landlords can deduct all of their finance costs from their property income to arrive at their taxable property profits. Under the new measure they will instead receive only a basic rate reduction on their income tax liability for the finance costs.
This restriction will be brought in slowly, with 75% relief still being available in 2017-18 and a reduction of 25% in the following three years until 2020-21 when all finance costs incurred will be given as a basic rate reduction. Furthermore, the wear and tear allowance system will also move to an actual basis from April 2016. With residential property widely regarded as a stable long-term investment and a popular alternative to complement retirement savings investors will want to reappraise their investment models.

• Inheritance Tax

From 2017-18, there will be an additional nil-rate band over and above the current nil-rate band of £325,000 when a residence in passed upon death to a direct descendant. It will be £100,000 in 2017-18, rising to £125,000 in 2018-19 and £150,000 in 2019-20. Any unused nil-rate band will be transferrable to a surviving spouse or civil partner; however the additional band will be tapered at a rate of £1 for every £2 over a £2m property. Technical details will be consulted on in September with legislation expected in the Finance Bill 2016.