Budget 2016: a spoonful of sugar?

With the media reaction to the most recent Budget, you would be forgiven for thinking that the only tax measure proposed was that in relation to the so-called “sugar tax”. However, George Osborne’s eighth Budget was arguably his most substantive, certainly in recent years, from a tax perspective. This article concentrates on the headline changes likely to be of most relevance to lawyers and their clients.

Capital gains tax rates

One of the biggest crowdpleasers was the reduction in the top rate of capital gains tax from 28% to 20%, and the rate paid by basic rate taxpayers from 18% to 10%. These will apply to all chargeable gains accruing from 6 April 2016, other than those arising on the sale of residential property and carried interest gains. Carried interest is the share of profits realised from a fund’s investments that is paid to executives of a private equity fund.

The 28% and 18% rates are retained for residential property that does not qualify for private residence relief. HMRC stated in a policy paper that this was to “provide an incentive for individuals to invest in companies over property”.

The fact that the reduction will not apply in relation to gains from the sale of residential property, together with the increased rates in LBTT (and SDLT in England) for multiple home owners, underlines how strongly the Government wishes people to move away from investment in second homes and buy-to-let properties.

This significant reduction in CGT rates is likely to result in an increase in individuals, so far as possible, seeking to arrange their tax affairs in order to receive as much as possible in the form of capital gains rather than income. There is also likely to be a notable increase in employers seeking to incentivise employees using tax-favoured share plans, as there was in 2008 following the reduction in the top rate of CGT at that time from 40% to 18%.

Entrepreneurs relief – long-term external investors

Welcome and somewhat unexpected changes were also announced to entrepreneurs’ relief (ER) from capital gains tax, which reduces the rate of CGT to 10%. Previously a relief applying only to business owners, ER is now being extended to long-term investors in unlisted trading companies.

ER was previously only available to individuals who have worked for and owned at least 5% of the ordinary shares in a company for at least a year before their shares are sold. Subject to a lifetime cap of £10 million, ER will be extended to external investors, provided certain conditions are met, including that the shares are newly issued in an unlisted trading company, or an unlisted holding company of a trading group, on or after 17 March 2016 and are held for a continuous period of at least three years from 6 April 2016 before their disposal.

Whilst the overall reduction in the rates of CGT may have lessened the importance of ER for many, at half of the top rate of CGT it remains a valuable relief and the extension to external investors will be welcomed, particularly by smaller companies seeking to attract new capital.

Employee shareholder status – lifetime limit

The Chancellor also announced that new employee shareholder status (ESS) agreements entered into after 16 March will be subject to a new lifetime limit of £100,000 of exempt CGT gains.

ESS agreements enable employees to be given shares in the employer company worth between £2,000 and £50,000 in exchange for giving up certain employment rights. Any profit made when those shares are sold is exempt from CGT.

Since its introduction, it has been recognised that ESS provides very generous tax reliefs and the Government was keen to avoid the reliefs being abused. It was, therefore, anticipated that some form of restriction would eventually be imposed, albeit it has come in earlier than many had predicted.

A lifetime limit of £100,000 ought to ensure that those whom the status was initially introduced to benefit continue to do so, and that ESS can continue to be used as an extremely useful incentive and employee retention tool.

Corporation tax rates and losses

A further reduction in the corporation tax rate to 17% from April 2020 was also announced. The Government states that this will benefit over 1,000,000 companies and ensure that the UK has the lowest rate of corporation tax in the G20.

Currently, carried forward losses can only be used against profits from certain types of income and only in the same company. The Chancellor has announced that from 1 April 2017 loss relief will become “more flexible”, so that losses incurred on or after that date can be used against profits from other group companies or set against other income streams. This is a welcome change and will bring our rules on losses carried forward more in line with other jurisdictions.

However, this is slightly tempered by the announcement that also from 1 April 2017, only 50% of profits can be offset by carried forward losses. This only applies to profits over £5 million, and so it only affects big business. The limit is £5 million per group, not per company (though group members will be able to divide the £5 million between themselves as they see fit).

Oil and gas breaks

There are some specific measures to support the oil and gas sector, at a time when the fall in global oil prices has hit it very hard. The Government will permanently reduce the rate of petroleum revenue tax (PRT) to zero, reduce the supplementary charge from 20% to 10% (both of these changes coming into effect from 1 January 2016), and maintain the ring fence corporation tax at 30%. However, many feel that the Chancellor’s measures did not go far enough to assist the sector, particularly given that these rate reductions will have little or no effect where companies are making losses.

Loans to shareholders

If a company is controlled by its directors, or by five or fewer shareholders, an extra corporation tax charge is levied in respect of any loans the company makes to its shareholders. The rate of tax charged on loans to shareholders is being increased from 25% to 32.5% with effect from 6 April 2016. This measure is to bring the rate in line with the increase in the dividend upper rate to 32.5% (previously announced in the 2015 summer Budget), and ensures that individuals are unable to gain an unfair tax advantage by taking loans from their companies rather than remuneration or dividends. It is worth noting that this tax charge can be reclaimed when the loan is repaid or written off, so it has only a cash flow impact.

Restrictions on interest deduction for companies

Discussions in relation to the OECD’s Action Plan on Base Erosion and Profit Shifting (BEPS) have been ongoing for some time now. While there was not much further detail in relation to how the UK will adopt the OECD’s recommendation on action point 4, on restricting deductibility of interest payments, the “Business Tax Road Map”, published on Budget day, was a useful summary of the Government’s current position.

Broadly, from 1 April 2017 a fixed ratio rule limiting net interest deductions to 30% of a group’s EBITDA will apply subject to certain exemptions, including a de minimis threshold of £2 million net UK interest, which is good for small groups but not much help (by design) for big business, and a public infrastructure exemption. There will be an abolition of the overly complex and much hated worldwide debt cap rules; however, the cap will be killed off only to be instantly resurrected within the new rules in a slightly different form.

The lack of further detail in relation to the proposed public infrastructure exemption is particularly frustrating for the infrastructure, real estate and energy sectors, given that the highly geared nature of projects in these fields means that these new rules could potentially have a major impact on them.

The Business Tax Road Map comments that “further consultation will be conducted on the detailed design of all aspects of the rules in due course”. Given that the Government intends the new rules to come into effect in a year’s time, this does not leave much time to sort out the fine tuning.

Personal taxes – lifetime ISA

A number of developments in the area of personal taxes were also announced, one notable one being the “lifetime ISA”, which has been designed to help the younger generation save either to buy their first property or for retirement.

A consultation is expected in relation to the lifetime ISA; however current proposals state:

• Individuals aged between 18 and 40 will be able to open a lifetime ISA, and for every £4 saved the Government will apply a bonus of £1.
• Individuals will be able to save up to £4,000 per year and therefore receive a bonus of up to £1,000.
• Savings and the bonus can be used to help individuals purchase their first home, worth up to £450,000, or to save for retirement. If the savings are retained until the 60th birthday they can be withdrawn tax free.
• Money can be withdrawn at any time before 60, but individuals will lose the Government bonus and the growth and will be subject to a 5% charge, if the funds are not used towards a deposit on a first home as set out above.