The Budget and the crystal ball

Given the upcoming general election, the Budget predictably did not contain any real surprises, but there were still a number of important announcements for practitioners and clients in the Chancellor’s Budget delivered on 18 March 2015.

Some, but not all, of the measures announced were included in the Finance Bill 2015, which was much shorter than usual, and was approved by Parliament before it dissolved on 30 March 2015. The remaining measures announced have still to be adopted into legislation, and the result of the general election will influence whether these measures are adopted as announced. An emergency Budget in June is likely.

“Making taxes easier” – for whom?

Almost certainly the biggest surprise was the announcement by George Osborne of the intention to abolish self-assessment returns for individuals and small businesses. This was confirmed as a centrepiece of the Budget speech – and in the Budget Overview document under the heading “Making taxes easier”.

The outline proposal is to create a system of “digital tax accounts”, whereby taxpayers can return their taxable income and gains in real time – and pay more “flexibly”. Of course it rather raises the question whether the overriding intention is to “make taxes easier” for taxpayers, or for HMRC? “Both,” would be the Chancellor’s likely answer.

The main concern here is that a new regime of tax reporting makes it much easier for future governments to increase powers (particularly in relation to information gathering), without appropriate or commensurate safeguards. Likewise, it creates a template for a gradual move to equivalent treatment for self-employed people to those on PAYE, i.e. a monthly payment on account of tax.

This has the potential to remove the cashflow advantage which is such a significant benefit for small business.

A “roadmap” setting out the proposals, and a consultation on a new payment process (leading to legislation), are promised for the next Parliament. It is almost inconceivable that a Labour-led Government would not wish to press ahead with this proposal, so we can await developments with great interest.

“Facilitating” tax evasion

Another big announcement is the proposal for new criminal offences relating to tax evasion and penalties, specifically aimed at those who “facilitate” or promote it (principally the banks, in the wake of the Swiss banking saga that dominated the news in February). The Chief Secretary to the Treasury, Danny Alexander, made this announcement, originally a Liberal Democrat proposal, on 19 March. The Conservatives seem to have endorsed it – and once again, it would be very odd if Labour did not press ahead with its introduction, or possibly something even stronger, so we can expect a consultation and in due course (probably in the 2015 Autumn Statement) draft legislation.

Diverted profits tax: sting in the tail

The Chancellor confirmed that the new diverted profits tax (DPT) would come into force on 1 April 2015, as
originally planned. However, some changes will be made to the legislation, initially published in draft in December 2014. DPT is a new 25% tax aimed at large multinationals who artificially shift their profits offshore, and is often referred to in the media as the “Google tax”. It will apply where a foreign company “exploits the permanent establishment rules”, or where a UK company or a foreign company with a UK-taxable presence creates a tax advantage by using transactions or entities that “lack economic substance”.

The revised draft legislation narrows the requirement for companies to notify that they are affected by the regime. The requirement will only now apply where there is significant risk that a charge to DPT will arise and where HMRC does not know about the arrangements. The emphasis will be changed so that notification will not be required if it is reasonable for the company to assume that a charge to diverted profits tax will not arise. There will be no duty to notify for any accounting period if it is reasonable for the company to conclude that it has supplied sufficient information to enable HMRC to decide whether to give a preliminary notice for that period, and that HMRC has examined that information (whether as part of an enquiry into a return or otherwise); or HMRC has confirmed that there is no duty to notify because the company or a connected company has supplied such information and HMRC has examined it.

In a nasty sting in the tail, HMRC states that, as a 25% rate of tax would not be a significant deterrent for oil and gas companies, which pay corporation tax at higher rates, DPT will be set at 55% for such companies.

Entrepreneurs’ relief: the end of “Manco”

There was an unwelcome surprise for private equity investors when the Chancellor announced measures to restrict entrepreneurs’ relief, which applied from the date of the Budget, offering little or no time for unsuspecting investors to sell shares and benefit from relief.

The measures announced are aimed at restricting the availability of entrepreneurs’ relief to those with at least a 5% stake directly in a company carrying on a trade. This puts an end to the widely adopted “Manco” structure, previously used by those with holdings less than 5% who structured their holdings through a management vehicle to get them over the threshold.

There were further restrictions to prevent entrepreneurs’ relief being available to individuals and members of partnerships selling personal assets used in a business but not, at the same time, disposing of a significant holding of shares in the company, or a significant share in the assets of the partnership, carrying on the business.

Disguised investment management fees

Legislation was passed in the Finance Act 2015 to ensure that certain fees and other payments, which individuals receive as remuneration for investment management services, are subject to income tax.

Originally announced as part of the Autumn Statement in December 2014, the rules, broadly, will affect fees paid to individuals who have provided investment management services directly or indirectly to an investment scheme involving at least one partnership, where at least some of the fee is not subject to UK income tax. The rules specifically exclude carried interest and coinvestment returns received by the investment manager.

The rules were introduced to combat tax planning involving a general partner’s priority profit share (PPS), whereby the PPS is routed to the fund managers in a non-taxable form or as a capital gain, rather than as a management fee, which is taxable as income.

The original draft of the legislation contained very narrow definitions of both carried interest and coinvestment, requiring a minimum preferred return of 6% and a coinvestment return at a rate “reasonably comparable” to a commercial interest rate. Consequently, there was significant concern across industry that the rules would catch genuine carried interest and coinvestment arrangements that did not fit within these definitions, and tax them as earned income.

In response to representations made to HMRC, the definitions of both carried interest and coinvestment have been widened significantly. The definition of carried interest no longer requires a minimum preferred return of 6%, while the definition of coinvestment now focuses on an arm’s length return that is “reasonably comparable to the return to external investors”. It now seems that genuine carried interest and coinvestment arrangements should not be caught.

Venture capital schemes changes

Provisions in the Finance Act 2015 exclude companies that benefit “substantially” from any subsidy for the generation of renewable energy from qualifying for relief under the venture capital schemes, subject to an exception for qualifying community energy organisations. The measure was originally announced in the 2014 Autumn Statement, and takes effect for shares issued on or after 6 April 2015 for enterprise investment scheme (EIS) and seed enterprise investment scheme (SEIS) purposes, and for holdings issued on or after 6 April 2015 for venture capital trust (VCT) purposes.

A number of further changes were announced, which are subject to state aid approval and are, in summary:

• a requirement will be introduced that all investments are made for the purpose of business growth and development;
• all EIS investors must be independent from the company at the time of the first share issue (excluding founder shares);
• new qualifying criteria will be introduced to limit relief to companies whose first commercial sale took place within the previous 12 years, unless the company has received a previous investment under SEIS/EIS/VCT;
• the total investment a company may receive will be capped at £20 million for “knowledge intensive” companies and £15 million for other qualifying companies; and
• a separate employee limit for knowledge intensive companies will be introduced at 499 employees.

It was intended that the changes would apply from 6 April 2015, but they have not yet been made law, because state aid approval is required. EU law currently allows state aid to be provided to companies within seven years of a first commercial sale, and up to a maximum total investment limit of €15 million. If state aid approval is not obtained for the more generous limits, tax relief in excess of the EU limits could be clawed back, so companies and investors should bear this in mind.