While attention will inevitably focus on its effect on the lower paid, today's announcement that the standard rate of VAT will increase to 20% from 4 January 2011 will come as an unpleasant, if not entirely unexpected, surprise for many businesses within the financial services sector. Coupled with the introduction of a levy on banks' balance sheets from 1 January 2011, the Coalition Government has provided the sector with its own version of a "Double Whammy", alleviated in part by a generous increase to the amount of entrepreneurs' relief and a staged reduction in the main rate of corporation tax.
Details of the principal changes affecting the financial services sector are:
VAT and IPT
VAT will be increased to 20%. This increase will apply to all supplies made on or after 4 January 2011 but will not affect any goods or services which are currently exempt from VAT or taxed at the zero or reduced rates. Detailed guidance published today by HMRC includes an explanation of how the rate change applies to supplies of goods or services which span 4 January 2011.
Along with the increased rate, anti-forestalling legislation (now a familiar term) is being introduced to prevent the 17.5% rate being applied to goods or services actually supplied after 4 January 2011. The legislation will apply to any supplies made on or after 22 June 2010 to businesses which cannot fully recover VAT where certain conditions are met.
The guidance produced by HMRC and anti-forestalling measures are similar to those which applied in relation to the increase in VAT from 15% to 17.5% earlier this year, and accordingly should already be familiar.
Corresponding changes will be made to the rate of insurance premium tax, with the standard rate increasing from 5% to 6% and the higher rate from 17.5% to 20% from 4 January 2011.
A bank levy will be introduced from 1 January 2011 on the aggregate liabilities of certain banking institutions and groups whose aggregate liabilities exceed £20 billion.
The levy will apply to the consolidated balance sheets of UK banking groups and building societies, aggregated subsidiary and branch balance sheets of foreign banks and banking groups operating in the UK, and the balance sheets of UK banks in non-banking groups.
It is proposed that the levy will be set at 0.04% in 2011, rising to 0.07% in subsequent years, with a reduced rate set at half the main rate for longer-maturity wholesale funding, and will not be deductible for corporation tax purposes.
The Government will consult on the proposal over the summer and final details will be published later this year.
Corporate Tax Rates
Today's Emergency Budget contained some good news for companies with an announcement that both the main rate and small companies' rate of corporation tax will be reduced from 1 April 2011.
The current main rate of corporation tax of 28% will reduce by 1% in each of the next four financial years, starting on 1 April 2011. The small companies' rate will reduce from 21% to 20% from the same date, instead of rising to 22% as had previously been planned.
The changes to plant and machinery capital allowances announced today, although deferred until 1 April 2012, are less welcome. For new and carried forward expenditure, writing-down allowances will reduce to 18% per annum for the main pool and 8% per annum for the special rate pool (e.g. including "long-life" assets).
Capital Gains Tax
Of particular interest to entrepreneurs and employee shareholders, the rate of CGT will increase from 18% to 28% for higher rate taxpayers with effect from midnight on 22 June. The current rate of 18% will remain for basic rate taxpayers to the extent that their total taxable income and gains, ignoring gains realised so far in this tax year, fall below the threshold for higher rate tax. Any excess gains realised after today will be taxed at 28%.
As regards entrepreneurs' relief, the effective 10% rate remains but the lifetime limit will be increased from £2m to £5m from tomorrow. Those who have already used up the previous £2m limit (or £1m limit before 6 April 2010) will be entitled to claim further relief but only on qualifying gains arising in future.
As a result of today's changes, the maximum value of the relief rises from £160K to £900k. If a company or business sale is on the horizon, it is therefore even more important to take early advice to ensure that the relevant conditions for entrepreneurs' relief are satisfied.
Real Estate Investment Trusts ("REITs")
It was confirmed today that the earlier proposal to allow a UK REIT to use stock dividends as well as cash dividends to satisfy the requirement to distribute 90% of the profits from its property rental business in each accounting period will go ahead. This measure will come into effect after the next Finance Bill receives Royal Assent.
Authorised Investment Funds ("AIFs")
Anti-avoidance provisions will counter the use of AIFs to generate UK tax credits for investors subject to corporation tax. This measure takes effect from today and will apply to the extent that a distribution from the AIF is in respect of income on which it has not suffered UK tax.
From 6 April 2011, the ISA investment limits will be increased in line with the Retail Prices Index ("RPI"). If the RPI is negative the limits will remain unchanged. The current limit is £10,200.
The corporation tax exemption for "dividend" income was extended from 1 July 2009 to cover most UK and foreign dividends but not those of a capital nature. New legislation will be introduced such that the exemption can apply to capital distributions. This legislation will also clarify that distributions out of reserves created by reducing capital are distributions for certain corporation tax purposes (as opposed to repayments of capital). These measures will be backdated to apply to distributions made on or after 1 July 2009, subject to an option for the recipient company to opt out of their retrospective effect.
Companies' profits and losses from loan relationships and derivative contracts are normally taxed and relieved in line with their accounts. That relies on those accounts being prepared under generally accepted accounting principles ("GAAP"). In certain cases, GAAP allows or requires loans, derivatives and their associated cash flows to be 'derecognised'. Subject to certain overrides in the tax legislation, the effect of accounting derecognition would be for profits to fall out of account for corporation tax purposes. To counter tax avoidance schemes disclosed to HMRC, these tax overrides are to be extended such that relevant amounts will be fully recognised for tax purposes where the accounting derecognition applies because of the acquisition or variation of a capital interest in a company, partnership or trust, or because of an event in a subsequent accounting period.
These changes will have effect for credits and debits arising on or after today.
Two changes affecting claims for consortium relief were announced today.
In certain cases, a consortium member ("the link company") is able to surrender its allocation of the consortium's unused losses to another member of its group. Currently, that link company must be UK tax resident. This will be changed such that a company established in the European Economic Area ("EEA") can be a link company.
The amount of losses that a consortium member can claim from the consortium company is presently determined by reference to the lowest of its percentage holding of ordinary share capital, percentage entitlement to profits and percentage entitlement to assets on a winding up. Further tests based on percentage of voting rights and extent of control will also be introduced.
These changes to consortium relief will be included in a Finance Bill to be introduced as soon as possible after Parliament's summer recess.
Life Insurance Companies
Three changes in relation to the tax rules for life insurance companies were announced today.
The first change relates to transfers of a life insurance business from the long term life insurance fund of one company to an overseas non-EEA company. While such a transfer is generally tax neutral, under the current rules non-EEA companies do not meet the definition of an "insurance company", causing a tax charge to arise. The Government has undertaken to discuss with industry proposals to modify these rules to ensure that transfers are relieved from tax in appropriate circumstances.
The second change is an interim measure (pending the full implementation of Solvency II) to prevent tax mismatches where a UK life assurance business is transferred from a UK-regulated entity, currently taxed on the basis of its FSA returns, to an EEA-regulated entity taxed on an accounts basis. The amendment will allow the EEA-regulated entity to be taxed on the basis of its return to the relevant overseas regulator, providing it is equivalent to a FSA return.
The third change is an anti-avoidance measure which builds on provisions introduced in Finance Act 2010 to counter avoidance relating to the apportionment of investment returns among the classes of business of a non-participating fund. It was noted not long after the introduction of that legislation that a tax liability could be avoided by means of a business transfer to another life company. Legislation will be introduced to prevent this avoidance.
The Government announced it is proposing to replace the high income excess relief charge that was due to come into force on 6 April 2011 with a reduction in the annual allowance, possibly to somewhere in the region of £30,000 to £45,000.
Geared Growth and Employment Related Securities
Plans for a consultation on geared growth and employment related shares and securities announced in March have been confirmed. This is generally viewed as a reference to private equity structures but could include growth share plans, where executives acquire shares at a low value as they have no right to share in the current value of the company but do share in future growth. That growth in value is currently subject to the CGT regime rather than income tax.
If you think you may be affected by any of the above, or if you have any other questions, please contact:
Head of Tax
0141 303 2497
020 7002 8538
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This briefing is written as a general guide only. It is not intended to contain definitive legal advice which should be sought as appropriate in relation to any particular matter.