Nasty medicine

Business and employment taxes

The most important changes to business taxes derive from the changes in rates already mentioned – in income tax and corporation tax, together with the changes (in both directions) in NICs. These change the balance in the choice of trading medium. While the comparison between corporation and income tax rates points clearly towards the use of a company, the need to extract profits into individual hands and the increase in national insurance in particular muddies the waters. The change in the rate of VAT (see below) is also of great significance to the majority of businesses.

Apart from these rate changes, there were significant changes in capital allowances. This is another part of the taxation spectrum which has been in a fairly constant state of flux over recent years; and some degree of stability might be particularly welcome. The changes announced in the emergency Budget will not take effect until April 2012.

The standard writing-down allowance for plant and machinery is to be reduced from 20% to the arithmetically unfriendly 18%. The special rate pool rate (for certain long life and other assets including many cars) is to be reduced from 10% to 8%.

The maximum amount of the annual investment allowance – effectively a first year allowance at 100% – is to be reduced from £100,000 to £25,000. This very significant reduction in an allowance that has already had a volatile history since its introduction in 2008 will encourage those intending major investments in plant and machinery to do so before the reduction comes into force – which again may involve some deliberate economic stimulus.

First year allowances at 100% are to be made available for expenditure on new zero-emission goods vehicles.

The conditions attaching to the enhanced tax relief for expenditure on research and development are to be relaxed: any associated intellectual property need not be owned by the claiming company.

Companies wishing to offer their employees share options under the Enterprise Management Incentive Scheme will now be required to have a “permanent establishment”, as opposed to being required to operate “wholly or mainly”, in the UK. The change, which will allow more companies, including overseas ones, to grant EMI options to their employees, was brought about to ensure compliance with EU guidelines and takes effect in respect of EMI options granted on or after 27 July 2010, the date of Royal Assent.

Consortium loss relief is to be restricted to the appropriate share of the loss for each participant, and changes are to be made in the companies which can qualify (both in relation to their location and the basis of ownership/control of the company from which losses may be claimed). Avoidance involving the loan relationships rules and derivative contracts has been tackled (F(No2)A 2010, s 8 and sched 5; see also FA 2010, ss 43, 45, 62 and sched 19).

The rules minimising benefits in kind charges in relation to zero and low emission vehicles are further extended to encourage green transport (FA 2010, ss 58 and 59).

It is perhaps surprising, given the pressure on parliamentary time before the election, that space was found in FA 2010 to exempt players in the Champions League final 2011 from charges that would otherwise arise on a proportion of their worldwide income (FA 2010, s 63 and sched 20).

On the other hand, it is unsurprising that the perceived villains of the recession were the subject of some special attention. A bank levy is to be introduced from 1 January 2011, on the balance sheet value of banks and building societies (with certain exclusions), in conjunction with similar measures to be introduced in (at least) France and Germany. This follows and is in addition to the bank payroll tax introduced in the first 2010 Budget (FA 2010, s 22 and sched 1).

Value added tax

In the end, VAT was left to do the heavy lifting in the tax increases required to attack the fiscal deficit. Having provided some fiscal stimulus by the reduction to 15% which expired on 1 January 2010, the return to 17.5% is now limited to just over a year. Many of the issues relevant to restoration of the 17.5% rate apply also to the pending increase.

The standard rate of VAT will increase from 17.5% to 20%, with effect from 4 January 2011 (F(No2)A 2010, s 3). The date will at least allow businesses to recover from any New Year hangover. The timing gives ample time for preparation; and planning may be particularly relevant for those who cannot recover all their VAT expenditure. Indeed, there must be some hope of stimulating something of a pre-increase surge of expenditure, even beyond the normal festive season effect.

However, as with the return to 17.5%, anti-forestalling measures were introduced (s 3 and sched 2) to prevent businesses artificially advancing tax points to benefit from the current rate. These take the form of a supplementary 2.5% charge on certain supplies of goods or services on which VAT at 17.5% has been declared. The relevant supplies arise where the recipient cannot recover all of the VAT on the supply and in addition one or more or a number of other conditions are met. These are that the supplier and customer are connected parties; the value of the supply exceeds £100,000 (this can include related supplies); the supplier funds a prepayment for the goods or services supplied; or a VAT invoice is issued in advance where payment is not due in full within six months. Further rules are introduced to prevent the use of options to secure the lower rate.

Various normal commercial situations are excluded from the anti-forestalling rules, including rent where the period involved is less than a year. HMRC issued a Guidance Note, “VAT – Change of the Standard Rate to 20 Per Cent: Anti-Forestalling Legislation” (22 June 2010), which is useful in situations where any doubts as to the correct treatment may arise. Solicitors will of course wish to bear the increase in mind, particularly when invoicing clients who are not able to recover all VAT charged to them (such as in relation to all private business, financial services or education clients). It is recognised that solicitors may provide continuous supplies of services or (more likely) single supplies over a period of time. In such cases, the work done can be apportioned over the different rates of VAT applicable at different times.

Perhaps somewhat surprisingly, given the fiscal imperative, there were no changes proposed to zero rating, such as on food, children’s clothing, new residential property and books; to the reduced 5% rate for domestic fuel and power and a range of other targeted goods; nor to exemptions, which apply to wide range of goods and services, such as much land, financial services and education.

Changes were also made to the flat rates which certain businesses can choose to apply rather than adopt standard VAT accounting.

The VAT position is to be amended where such items as land, boats and aircraft are used for private purposes. The changes will not appear before the third possible Finance Bill of 2010. Essentially, they will bring an end to what is known as “Lennartz” accounting, under which VAT is recoverable in full on assets acquired for both business and private use, and the private use is then charged to VAT subsequently as it occurs. In future, it will only be possible to recover VAT on the initial supply to the extent that it is to be used for business. Changes to the capital goods scheme will also be introduced, to take account of changes in private use in years subsequent to the initial supply. This is likely to be an important change wherever business assets are put to some private use.

The standard rate of insurance premium tax is increased from 5% to 6%. The higher rate is being increased from 17.5% to 20% (in line with the increase in VAT, in relation to which the higher rate is an anti-avoidance measure): F(No2)A 2010, s 4.

Taxes on land

The March 2010 Budget brought an increase in the stamp duty land tax nil rate band for residential property to £250,000 for first time buyers, for purchases on or after 25 March 2010. This SDLT holiday is intended to last for two years to 24 March 2012, but there is ample scope for this to be changed again.

The details are in FA 2010, s 6, which inserts new ss 57AA and 73CA into FA 2003. The conditions which may cause some difficulty are that all the purchasers (if more than one) must be first time buyers (which involves never having acquired a major interest in land, in the UK or otherwise). They must also intend (presumably at the time of purchase) to occupy the property purchased as their only or main residence. This last condition seems quite loose; and the scheme may be rather difficult to police effectively. Solicitors should take particular care not to be involved in its abuse, as they could have a significant degree of personal responsibility if assisting in completing an incorrect SDLT tax return.

As a quid pro quo for this new relief, the rate of SDLT on residential properties over £1m is to be increased to 5% for purchases on or after 6 April 2011 (FA 2010, s 7). However, there is no sign that this increase is to be time limited, unlike the first time buyers’ relief.

To counter partnership avoidance schemes, the anti-avoidance rules in s 75A will be applied to SDLT on partnerships (FA 2010, s 55).

The special rules applicable to furnished holiday lettings have been subject to extensive proposed changes, reversals of these proposals and detailed discussion. This continues.

The starting point here was an extension of the special reliefs for furnished holiday lettings, for the year 2009-10, to all property within the European Economic Area. This was to meet the UK’s obligations under European law, but its announcement was accompanied by intimation that simpler consistency would be achieved by complete abolition of the special regime with effect from 2010-11.

After consultation, this intention was formally changed from the date of the emergency Budget. (A useful “Questions and Answers” document on Furnished Holiday Lettings was published by HMRC on 22 June.) The rules continue in their current form for 2010-11; and yet another consultation has been launched, with responses welcomed by 22 October 2010. This includes a range of proposals, which will preserve the basic form of the relief, but with the following changes:

• to increase the minimum period over which a qualifying property is available to let to the public during a year from 140 to 210 days;
• to increase the minimum period over which a qualifying property is actually let to the public during a year from 70 days to 105 days; and
• to restrict the use of loss relief from furnished holiday lettings so it can only be set against certain income from the same business.

Given the relatively short length of the Scottish tourist season, these proposals may cause some difficulties – but for those who run such accommodation, they represent a substantial improvement on complete abolition of the special regime.

Measures will be introduced to allow real estate investment trusts to issue stock dividends in lieu of cash, without falling foul of the rules on their required level of distribution.

Tax administration, penalties and avoidance

A further legislative measure is to be introduced to the rather complex rules which now apply to the interaction between trusters who set up trusts in which they retain an interest and those trusts themselves. Such trusters may receive repayments of tax in relation to such income. They are to be required to repay it to the trust involved, and such repayment will be disregarded for inheritance tax purposes (as one would expect for any payment made under legal obligation – see Inheritance Tax Act 1994, s 10).

The administrative requirements which apply when individuals are required to deduct income tax from interest or other payments are to be modernised and made clearer, with power given to HMRC to make regulations in this area.

The penalty regime throughout the tax system has been subject to extensive recent change and consolidation. Now, a new penalties regime is to be introduced for the late payment of tax and filing of returns in respect of a number of indirect taxes, including VAT, insurance premium tax, aggregates levy, climate change levy, landfill tax and various other duties. This is described as a continuation of the reform that was introduced for direct taxes in FA 2009.

The new regime introduces an escalating scale of penalties based on the number of failures occurring in a set period. As a result, very occasional failures will result in relatively minor penalty, while frequent or prolonged lapses will receive more stringent measures. This is intended to reflect the fact that the submission of returns and payment of tax for these taxes is more frequent than for the taxes dealt with under FA 2009, which may give rise only to annual or occasional liabilities.

The new penalties will be introduced at a date to be announced, to allow time for HMRC computer systems to be updated to process the penalties. This gives businesses an opportunity to review their tax payment practices.

A number of announcements were made in the emergency Budget in relation to tax avoidance, as is now almost compulsory in every Budget. Along with comment on some rather exotic schemes, it was confirmed that consideration is being given to a general anti-avoidance rule. Further consideration is being given to SDLT avoidance for high value properties. Avoidance of employee tax, national insurance and the pension rules by the use of trusts, including employer financed retirement benefit schemes, is intended to be tackled in legislation taking effect from April 2011.

The first 2010 Budget and FA 2010 had introduced anti-avoidance legislation on sideways relief, for certain losses (s 24 and sched 3); property loss relief (s 25); capital allowance buying (s 26 and sched 4); leased assets and leasing companies, which have already been the subject of copious anti-avoidance legislation (ss 27, 29 and sched 5); transactions in securities (s 38 and sched 12); unauthorised unit trusts (s 40 and sched 13); index-linked gilt-edged securities (s 41 and sched 14); approved share incentive plans (s 42); release of debts between connected companies (s 44 and sched 15); risk transfer schemes (s 46 and sched 16).

Changes were also made to extend the disclosure of tax avoidance schemes rules to include arrangements to avoid the 50% income tax rate and certain NIC schemes, as well as to increase the duties on promoters and the penalties for failing to comply with the disclosure rules (s 56 and sched 17).

Simpler means fairer?

As with so much in the new politics, one cannot help but feel that tax policy and the detailed rules that emerge are a work in progress. There is to be yet another attempt at simplification, with the Office of Tax Simplification being launched on 20 July 2010. With what appears in this context to be breathtaking speed, its first project involves a review of all reliefs, allowances and exemptions within the taxes and duties administered by HMRC and identification of those reliefs that should be repealed or simplified. An interim report is requested by late autumn 2010 and a final report with recommendations is to go to the Chancellor in advance of Budget 2011. Given the Government’s need for cash, it is not hard to see the attraction of a simplification project which involves the abolition of reliefs!

Perhaps more promisingly, the second project is aimed at areas of the tax system that cause the most day-to-day complexity and uncertainty for small businesses. This is to include alternatives to the “IR 35” rules for personal service companies and “disguised” employment income. While simplification may be desirable in its own right, there must be some worry that removing complexity could also remove both targeted and general reliefs of great value to the economy. The simplest system of all might involve 100% rates of tax on income and capital (with of course limited returns by other methods to long-suffering citizens). In terms of income tax at least, we might be said to be halfway there with the introduction of the new 50% rate. I think many would agree that this type of simplification has gone far enough.

Whether or not coalition Government becomes the norm for Westminster, and whether or not the coalitions or minority Governments of Holyrood gain more control over Scotland’s tax affairs, it seems certain that changes over the next few years will continue to come thick and fast. No one (not even tax geeks) will complain if the end result is a simpler system – but the road to that Nirvana still looks more like a maze than a motorway.

• Alan R Barr, Brodies LLP/The University of Edinburgh