The UK's new Chancellor, Rishi Sunak, made coronavirus planning the lead item in his first Budget, as he promised to do "whatever it takes" to support the economy. With announcements of major infrastructure spending and a package of measures for small businesses, there was still room for some surprises for large businesses (including a change on intangibles taxation and another new tax reporting requirement). The Chancellor also decided not to abandon Entrepreneurs' Relief but significantly reduce the lifetime limit. Probably his most notable announcement, however, was that the UK's digital services tax will go ahead next month as planned.
In this update, we cover the following areas:
- Digital Services Tax
- Corporate Tax
- Capital Gains Tax
- Financial Services
If you would like to discuss any of these developments, please don't hesitate to get in touch with your usual contacts at Baker McKenzie.
Digital Services Tax: Going ahead from 1 April 2020
The Chancellor has not departed from the Government's decision to introduce the UK's digital services tax (DST) with effect from 1 April 2020 (as originally announced back in Budget 2018). We are not expecting final legislation until 19 March 2020, but there are no indications that anything has changed in terms of scope and application from the draft legislation published last year.
The new 2% tax will apply to all revenues exceeding certain thresholds that are derived from UK users in relation to the provision of a social media service, internet search engine or online marketplace by a group (and includes the carrying on of any associated online advertising service). Notably, taxable revenues will include any revenue earned by the group which is connected to the social media service, search engine or online marketplace, irrespective of how the business monetises the service. The Government is predicting year on year growth in the collections under the DST, reaching over £515 million per annum in 2025.
The UK is one of a growing number of countries introducing their own DST, including France, Italy, Spain and Austria. The UK's DST largely stands alone in the way in-scope provisions have been defined and in applying a 2% rate, which is lower than many others. However, the resultant effect is broadly similar to the other regimes. Some of those countries have agreed to delay collection of tax due under their DSTs, allowing time for the OECD to try and find international consensus on a new global system for taxing digital revenues by the end of the year. France, for example, agreed to do so in the face of threatened trade sanctions by the US. The Government have made no comment on how the introduction of the DST might affect the independent UK-US trade negotiations. However, notably no tax will in any case be payable under UK DST until at least 2021 (9 months and one day after the company's first accounting period to end after 1 April 2020).
The Government also confirmed that it strongly supports the G7, G20 and OECD discussions on long-term reform and that it is committed to disapplying the DST once an appropriate international solution is in place. That being said, it suggested no change to the current draft legislation, which only includes a commitment to review the legislation in 2025.
Corporate tax: A few surprises
Corporation tax rate remains at 19%.
As pledged in the Conservative party manifesto for the 2019 general election, the planned reduction in the rate of corporation tax to 17% has been reversed. The Government will legislate to maintain the rate at 19% for the next two financial years (beginning 1 April 2020 and April 2021).
Large business notification of any position HMRC is likely to challenge.
A new "large business notification" requirement has been announced, which is intended to take effect from April 2021. From this date, large businesses will be required to notify HMRC where they take a position that they anticipate HMRC will likely challenge. This new notification requirement is similar to the "uncertain tax positions" disclosure rule that applies in the US. It is entirely separate from, and will be in addition to, notification by intermediaries of cross-border tax arrangements required under the UK's implementation of the EU DAC 6 regime. The Government intends to hold a consultation on the details of the new requirement, suggesting the basis on which uncertain tax provisions are recognised under international accounting standards will inform how the reporting threshold is defined. This could potentially have a significant impact on accounting for uncertain tax positions under IAS 12 (as clarified by IFRIC 23) as overly cautious provisioning could become self-fulfilling if it triggers a notification requirement.
A single regime for taxing intangible assets at last.
The UK currently has two parallel systems for companies with intangible assets (such as patents, trademarks, designs, copyrights and associated rights). Older intangible assets created before 1 April 2002 (and some long-established companies still own such assets) are taxed under the corporation tax regime, so that chargeable gains or allowable losses arise when those assets are sold. For intangible assets created on or after 1 April 2002, a different tax regime applies. Companies are allowed an annual amortisation debit for the amount spent on new intangible assets, with any "gains" arising on disposal treated as credits in their accounts. The existence of two systems is cumbersome and in some cases results in less favourable treatment for companies with older assets. This measure will allow companies who acquire pre-1 April 2002 intangible assets from related parties on or after 1 July 2020 to bring them all within the post-1 April 2002 regime. Whilst welcome, the practical effect may be limited for many companies as the expected useful life of their intangible assets is less than 18 years.
A welcome consultation on the UK hybrid-mismatch rules.
The Government will publish a consultation on certain aspects of the UK hybrid-mismatch rules, which are aimed at counteracting tax mismatches where the same item of expenditure is deductible in more than one jurisdiction or where expenditure is deductible but the corresponding income is not fully taxable. The rules were introduced in response to the OECD's BEPS project and have been in force since 1 January 2017. To date, the mechanical operation of the rules has resulted in unexpected material disallowances for some taxpayers, in particular US multinationals with UK "check the box" entities, even in cases where there is no UK tax advantage being obtained. The consultation will therefore provide a welcome opportunity for taxpayers to engage with the Government to ensure that the hybrid mismatch rules work proportionately and as originally intended.
Increase in R&D expenditure credit to drive innovation in the economy.
From 1 April 2020 the rate of the RDEC will increase from 12% to 13% for large companies (and SMEs, in some cases) that carry out qualifying R&D. This will be a welcome release of cash flow for companies using the scheme. The Government will also consult on whether qualifying R&D tax credit costs should include investments in data and cloud computing.
Structures and buildings allowance rate increased to encourage investment in commercial construction projects.
This measure is relevant to businesses that incur qualifying expenditure on non-residential structures and buildings newly constructed, or renovated, on or after 29 October 2018. The annual rate of capital allowances available for qualifying investments to construct new, or renovate old, non-residential structures and buildings will increase from 2% to 3%. The change will take effect from 1 April 2020 for corporation tax and 6 April 2020 for income tax.
With the anticipated transition from London Interbank Offered Rate (LIBOR) to risk-free rate equivalents from 2022 onwards, the Government has announced a consultation exercise to understand the anticipated tax implications and to identify changes required to tax legislation where there are references to LIBOR. This presents a window of opportunity for taxpayers to examine their own positions and engage with HMRC to the extent they identify potentially adverse outcomes. In particular, the preservation of hedge accounting for tax purposes should be an area of focus as the breaking of hedges could result in tax volatility which may affect cash flow, as well as having potential secondary effects on interest deductibility. There will also likely be transfer pricing considerations as it is common practice to reference LIBOR within intra-group agreements.
Capital gains tax: A stay of execution for Entrepreneurs' Relief
As was widely speculated before the Budget, there are to be changes to the ER regime. The Chancellor ignored calls to abolish ER entirely, commenting that the Government should not discourage genuine entrepreneurs who rely on the relief. Instead, the lifetime limit on gains eligible for ER will be reduced to £1 million per individual (taking the limit back down to what it was when ER was first introduced in 2008). According to the Government, this is in response to evidence that "the relief has done little to incentivise entrepreneurial activity and that most of the benefit accrues to a small number of very affluent taxpayers".
Under the current (pre-Budget 2020) rules, ER reduces the amount of capital gains tax paid by individuals (it does not apply to companies) on disposals of qualifying businesses, shares in a personal company and shares from an Enterprise Management Incentive. At present, CGT is paid at 10%, up to a lifetime limit of £10 million of qualifying gains.
The revised limit applies to disposals made on or after 11 March 2020. It is important to note that rules will also apply the revised (£1 million) limit to certain arrangements and elections that seek to apply the earlier (£10 million) lifetime limit. These rules should only have practical effect where the arrangement seeks to obtain relief for chargeable gains that, when added with earlier gains, exceed the new £1 million lifetime limit.
Financial services: The banking surcharge and transferred losses
The rules dealing with the computation of profits subject to the surcharge on banking companies are to be amended to deal with an anomaly in relation to allowable losses transferred (under section 171A Taxation of Chargeable Gains Act 1992) from a non-banking company. The current legislation restricts potential surcharge arbitrage opportunities by disregarding group relief claimed from non-banking companies when computing profits subject to the surcharge, as well as disregarding the transfer of chargeable gains under section 171A to a non-banking company. However, it appears that the legislation does not currently prevent a loss arising on a capital disposal within a non-banking company from being transferred into the banking company and being used to offset chargeable gains arising during the year. The Government will legislate in Finance Bill 2020 to rectify this anomaly. Following this change chargeable gains arising to banking companies from 11 March 2020 onwards cannot be offset against allowable losses transferred in from nonbanking companies under section 171A.
The UK funds regime: Review to ensure competitiveness and sustainability
The review will cover a broad range of issues, such as the VAT charged on management fees and relevant areas of regulation. In addition, the Government launched a consultation on the attractiveness of the UK as a jurisdiction to set up intermediate holding vehicles through which funds invest in the underlying assets. The Government is primarily concerned that there are barriers leading to these entities being located outside the UK and is determined to address them through "low cost, targeted changes". The consultation will run until 20 May 2020. We expect that the review will prompt the Government to implement changes to its fiscal policy to make the UK even more attractive to the investment fund sector after Brexit.
Additionally, a new law taking effect from 1 April: (a) extends the scope of the VAT exemption to 'qualifying pension funds'; and (b) removes the restriction on the type of assets that a close-ended collective investment undertaking can invest in to qualify for exemption. See below for other VAT measures.
VAT on e-publications.
The Chancellor announced that new legislation will be introduced to apply a zero-rate to e-publications from 1 December 2020. Specifically, from the end of the year all 'e-books, e-newspapers, e-magazines and academic e-journals' will be subject to the same VAT treatment as their printed equivalents, which have always been in the scope of the zero-rating provisions in the UK.
The change is not unexpected given that in 2018, the European Council approved laws which allowed Member States to apply the same VAT rate to e-publications as for printed equivalents. Since that time, there have been a few developments in this area, including a high profile public campaign to end the 'reading tax' in the UK as well as a recent judgment in the Newscorp. litigation. It is currently unclear how the new law will affect that litigation, but it is advisable for businesses active in the e-publication sector to consider making a claim in order to protect their VAT position.
VAT Postponed accounting.
From 1 January 2021, all imports of goods from EU and non-EU countries will be subject to postponed accounting for VAT. This will ease cash flow for businesses importing goods into the UK, as it means that VAT can be accounted for on the UK VAT return using self-accounting, thereby deferring the payment of VAT.
This measure was initially put forward as a 'no-deal' Brexit scenario and so it is significant that it has been reconfirmed in the current Budget.
VAT on financial services.
The Government has confirmed that it will set up an industry working group to review how financial services are treated for VAT purposes. This follows similar statements from the EU last year, where the Group on the Future of VAT pointed out that the current rules relating to the financial services sector are outdated and lead to complexity and uncertainty.
Businesses in the Financial Services sector should closely monitor developments as there could be significant changes in the near future on how the exemption operates on a UK and EU level.
Other VAT measures.
Other updates in the Budget include two new measures that will be particularly relevant for the UK post-Brexit:
Long-term cross-border goods policy.
The Government will launch an informal consultation over spring 2020 on the VAT and excise treatment of goods crossing UK borders after the end of the Brexit transition period.
VAT Quick Fixes Directive.
The Government has already published draft legislation to introduce simplified rules for the VAT treatment of intra-EU movements of call-off stock, allowing businesses to delay accounting for VAT until the goods are called off. The legislation, once enacted, will apply to goods which are removed from a Member State on or after 1 January 2020.