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Tax Changes Ahead
Introduction »
BUSINESS TAX
Corporation tax rates
As previously announced the main rate of corporation tax, which generally applies to companies with profits of more than £1.5 million, is to reduce from 28% to 27% from 1 April 2011. There will be further graduated reductions so that the main rate will be 24% by 1 April 2014. Legislation will be introduced to reduce the main rate of corporation tax to 26% from 1 April 2012. The government is considering whether legislating for all the remaining pre-announced reductions to the main corporation tax rate in Finance Bill 2011 would provide greater certainty to businesses.
The small profits rate of corporation tax, which generally applies to companies with up to £300,000 of profits, is to reduce from 21% to 20% also with effect from 1 April 2011.
The effective marginal corporation tax rate for profits between £300,000 and £1.5 million will therefore be 28.75% from 1 April 2011.
Associated companies for corporation tax rates
The upper and lower limits for corporate tax rates are divided equally between a company and its ‘associated’ companies. A company is associated with another company if one of them has control of the other or if both are under the control of the same company or person(s).
The shares of direct relatives, business partners and some trustees can be attributed to the person for the control test. So even if a husband owns no shares in a company, he may be deemed to own the company via his spouse’s shareholding.
A change to the associated company rules will be included in the Finance Bill 2011 with effect for accounting periods ending on or after 1 April 2011.
It is proposed to amend the circumstances in which rights held by linked persons are attributed between them to establish control. Attributions will only be made where there is ‘substantial commercial interdependence’ between the businesses being run in the companies.
When considering whether there is ‘substantial commercial interdependence’ HMRC will have regard to the degree of financial, economic or organisational links which exist, or have existed, or might be expected to exist between the relevant activities/companies involved.
Comment
This is a welcome proposed change in the law. If for example a husband and wife each own a company and there is little connection between the businesses run by each company, the two companies will no longer automatically be treated as associated.
The difficulty will be in deciding at what point ‘substantial commercial interdependence’ exists.
The Corporate Tax Road Map
The government’s aim is to create the most competitive corporate tax regime of the major world economies. The Corporate Tax Road Map sets out how the government intends to approach reform of the corporate tax system over the next five years.
The principles it will adopt include:
- lowering corporate tax rates but reduce the reliefs and allowances available
- avoiding unnecessary changes to tax legislation and ensuring that any changes improve the long-term stability of the corporate tax system
- adapting the tax system for the effects of globalisation and technological developments over the last 20 years.
The focus of the Road Map is on large corporates as these increasingly operate across national borders and may choose not to have their headquarters in the UK. That means the UK’s corporate tax system should focus more on profits from the UK activity in determining the tax base rather than attributing the worldwide income of a group to the UK. This is referred to as a territorial basis of taxation.
Some aspects of the UK corporate tax system have changed in recent years to become more territorial. In particular dividend income from the foreign subsidiaries of a UK parent company are now generally exempt from UK corporation tax following a change in the rules in 2009.
The main areas of tax changes in the next five years will be to the:
- Controlled Foreign Company (CFC) regime
- taxation of innovation and intellectual property (IP)
- taxation of foreign branches.
CFC reform
The CFC rules currently may apply where a UK company has a subsidiary which operates in a country with a relatively low rate of corporate tax. In certain circumstances the profits of the subsidiary may be subject to UK corporate tax.
Interim improvements to the existing CFC rules will be introduced in Finance Bill 2011 and more fundamental proposed changes have been announced for consultation with interested parties. The legislative outcomes of the proposals will be included in Finance Bill 2012.
The main interim improvement will be to exempt a CFC which carries on a range of 'foreign to foreign' activities involving transactions wholly or partly with other group companies. The exemption will be designed to produce a proportionate outcome in contrast to the 'all or nothing' approach generally taken by the existing CFC exemptions.
The more fundamental proposed changes will concentrate on the artificial diversion of profits from the UK in two areas – group finance arrangements and intellectual property.
Comment
The current CFC rules are seen by the government and business to go further than they need to protect the UK tax base. The changes are targeted at large multinational companies.
Taxation of innovation and IP
The government is consulting on a preferential regime for profits arising from patents, known as a Patent Box. The intention is to introduce rules in Finance Bill 2012.
The government intends to introduce a 10% corporation tax rate for profits arising from patents to apply from 1 April 2013. All patents first commercialised after 29 November 2010 will qualify for inclusion in the Patent Box. Detailed qualification and transitional rules will be discussed during the consultation period.
The government wishes to continue the current Research and Development Tax Credits schemes but it will review the extent to which the relief is appropriately targeted at those costs most closely linked to genuinely innovative activity.
Comment
The low tax rate Patent Box is focusing on scientific and high-tech IP because of their particularly strong link to Research and Development and technical innovation activities. Patents are identifiable and legally protected, and so can be easily traded or licensed between companies. Multinational groups therefore have a choice over where they locate work generating scientific and high-tech IP, and over where ownership of patents is located.
It is hoped that the Patent Box will encourage companies to locate the high-value jobs and activity associated with the development, manufacture and exploitation of patents in the UK.
Taxation of foreign branches
A foreign branch exists when a UK company carries on part of its trade in another country without establishing a separate trading subsidiary.
The government is consulting on an exemption from corporation tax for the profits of foreign branches of UK companies. The intention is to introduce new rules in Finance Bill 2011.
The exemption will only apply if companies irrevocably elect to opt into the exemption regime. The election will apply to all present and future branches of the company.
Otherwise the existing rules will apply.
Large and medium sized companies will be able to opt-in for branches in all countries, including those with which the UK has no tax treaty. However small companies will not be able to opt-in branches located in non-treaty countries because of the risk of the loss of tax through diversion of personal income.
Comment
Currently, UK companies are subject to corporation tax on the profits of their foreign branches, with credit given for foreign tax paid on the same profits. In cases where the foreign tax paid is less than the UK tax, the company must pay a ‘top up’ of UK tax.
If the branch makes losses then these can be offset against UK income. In contrast, the exemption regime will not give relief for losses. So for a company considering setting up an establishment outside the UK, remaining outside the exemption may be beneficial if early stage losses are contemplated. There will however be a transitional rule when a company opts into the branch exemption regime. Under this rule a company's branch profits will become exempt only after the tax losses of those branches in the immediately preceding six years have been matched by profits.
Corporate capital gains simplification
Following extensive consultation on simplification of the capital gains rules for groups of companies, legislation will be introduced to modernise the ‘degrouping charge’ rules.
Under current law, if a company leaves a group holding an asset acquired from a fellow group member within the previous six years, any gain or loss that had been deferred on that asset acquisition is reinstated as a chargeable gain or loss (a degrouping charge) separate to any gain or loss incurred on the disposal of the shares in the company.
It is proposed that where a company leaves a group as a result of a disposal of its shares, any degrouping charge will be treated as additional consideration for the disposal. This ensures that shareholder reliefs, such as the substantial shareholdings exemption, will also apply to the degrouping charge.
Other changes to corporate capital gains proposed are to:
- remove some existing restrictions on the use of capital losses within a group of companies after acquisition of a business
- replace a complex set of anti-avoidance rules on ‘value shifting’ with a clearer purpose-based rule.
Anti-avoidance
The government remains committed to tackling avoidance of tax and has announced a variety of policies to take forward including:
- a study into whether a General Anti-Avoidance Rule could be framed to meet the objectives of deterring and countering tax avoidance in a fair way
- legislation to address avoidance schemes under which, in accordance with generally accepted accounting practice, amounts that are taxable under the rules on loan relationships and derivative contracts are not fully recognised in a company’s accounts
- legislation to counter avoidance involving changes in the functional currency of an investment company.
Introduction »
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