Executive summary

In his Budget speech of 29 October 2018, the United Kingdom (UK) Chancellor introduced his Budget as a budget for Britain’s future. He made it clear that the range of measures he was announcing were intended to put the Government on a path to a full spending review next year which would set out the Government’s priorities for public spending. The Chancellor did recognize that Brexit negotiations with the European Union (EU) were at a pivotal moment. A successful deal between the UK and the EU would deliver a boost through both the end of uncertainty and a boost from the release of the Government’s fiscal headroom that is being held in reserve. However, the Chancellor also made it clear that if economic circumstances were to change in the event of ”no deal” being reached, then he would consider fiscal interventions and this might involve the upgrading of the Spring Statement to a full Budget.

The Chancellor stated that the UK has turned an important corner and that ”austerity is coming to an end.” He put forward a range of measures to ensure the sustainability and fairness of the UK tax system in the future and boost investment in the UK. Those measures include the proposed 2% UK Digital Services Tax from April 2020 and the new rules on offshore receipts in respect of intangible property (previously the extension to the royalty withholding tax rules). There are also proposed changes to the intangible fixed asset regime and a new Structures and Building Allowance, which has immediate effect.

Detailed discussion

Business taxes

Digital Services Tax: UK measure announced

Building on position papers released in the Autumn Budget 2017 and Spring Statement 2018, the Government has announced it will introduce a Digital Services Tax (DST) aimed at reforming the corporate tax system to capture value generated by certain digital business models from their UK user-base.

The UK measure is intended to be narrowly targeted at social media platforms, search engines and online marketplaces as these business models are considered to derive significant value from participation of their users. Revenues generated that are linked to UK users will be subject to the DST at 2%. For example, this will include revenues generated from targeting advertisements at UK users or facilitating transactions between UK users. The DST will be an allowable expense against UK corporation tax.

The measure is not intended to apply to e-retailers, financial and payments services, the provision of online content, sales of software/hardware or television/broadcasting services.

Businesses with global revenues from in-scope activities below £500m will be excluded and the first £25m of UK revenues is also not taxable. A safe harbor mechanism for loss-making and very low profit margin businesses will be the subject of the upcoming consultation.

The Government reiterated its commitment to developing an international solution. The UK measure will be formally reviewed in 2025 and dis-applied if a global solution is in place by then.

A consultation will be released in coming weeks to explore key design issues, which should be reviewed carefully by businesses potentially affected by the DST (or a longer term global measure). The DST will be legislated for in Finance Bill 2019-20, and apply from April 2020.

To date, the unilateral measure has been relatively narrowly targeted towards social media platforms, search engines and market places but may expand in scope over time as international discussions continue or as unilateral action is taken by more territories. The detailed provisions will need careful consideration to assess the impact on particular businesses and determine what action should be taken.

Offshore receipts in respect of intangible property (previously extension of royalty withholding tax): draft legislation released

The Government has published draft legislation to apply a UK income tax charge to amounts received by a foreign resident entity in respect of intangible property to the extent that those amounts are referable to the sale of goods or services in the UK. The measure will apply to the proportion of the foreign resident entity’s income that is derived from UK sales made directly by the foreign resident entity correlated parties and, in some circumstances, unrelated parties and will be effective from 6 April 2019. The measure will only apply to entities that are resident in jurisdictions with whom the UK does not have a full tax treaty.

The draft legislation follows a consultation document that was published on 1 December 2017 to extend the royalty withholding tax rules. A response to the consultation has also been published. The draft legislation makes significant changes to the proposals set out in the consultation document including:

• Directly taxing the offshore entities that realize intangible property income in non-full tax treaty jurisdictions, rather than levying a withholding tax, and making related parties jointly and severally liable for the tax.
• Broadening the income in scope of the measure to include embedded royalties and income from the indirect exploitation of intangible property in the UK market through unrelated parties.
• Introducing a de minimis UK sales threshold of £10m, an exemption where tax paid in the territory of residence of the foreign entity is at least 50% of the UK income tax charge that would otherwise arise, and an exemption for entities that have not acquired their intangible property from related parties where substantially all of the relevant activity has at all times been undertaken in the territory of residence of the foreign entity.

Anti-avoidance rules that protect against arrangements designed to avoid the charge, where one of the main purposes is to obtain a tax advantage, apply from 29 October 2018.

The legislation will take effect from 6 April 2019, but anti-avoidance provisions will apply from 29 October 2018. Given the limited time before the rules enter force, businesses that hold intangible property in non-full tax treaty jurisdictions should be looking at the provisions in detail and considering the impact in order to assess what actions might need to be taken in advance of the new rules coming into effect.

Changes to intangible fixed assets regime

As announced at Budget 2018, and following a consultation document published in February 2018, the Government has confirmed that it intends to make changes to the corporate intangible fixed assets regime. In particular, the Government has confirmed that it intends to:

• Partially reinstate relief for goodwill in the acquisition of businesses with eligible intellectual property from April 2019. Detailed proposals will be included in the Government’s response to the consultation to be published on 7 November 2018. While provisions for this policy will not be included at the time of the introduction of Finance Bill 2018-19, after a brief consultation to ensure the policy design delivers the intended outcome, the Government will seek to legislate for the change in Finance Bill 2018-19 through Government amendment.
• Make changes to the regime’s de-grouping charge rules so that a charge will not arise where de-grouping is the result of a share disposal that qualifies for the Substantial Shareholding Exemption, so that the rules more closely align with the equivalent rules for chargeable gains. The Government intends to legislate for this change in Finance Bill 2018-19, but has confirmed that the changes will have effect in relation to de-groupings occurring on or after 7 November 2018.

While detailed proposals remain to be published, the proposed changes could have a significant impact on groups and improve the international competitiveness of the UK as a location to hold and exploit intellectual property. There will be a brief consultation period on the proposed changes and once the detailed proposals have been published, potentially affected groups should carefully assess the impact of the changes and consider what action to take. Nothing was said about removing the pre/post 2002 asset distinction or revisiting the 4% fixed rate amortization election, despite these being considered in the February consultation.

Capital allowances

Various amendments have been made to the capital allowances regime:

• Structures and Buildings Allowance (SBA): Tax relief is introduced for new Nonresidential buildings and structures (excluding land) at an annual rate of 2% on a straight-line basis. The new incentive is broader than the previous Industrial Building Allowances regime abolished from April 2011 and applies to contracts for construction works entered into on or after 29 October 2018. Relief will be limited to the original cost of construction or renovation, relieved across a fixed 50-year period regardless of ownership changes, and can be claimed from the time the building is brought into use.
• Special rate pool: In conjunction with the introduction of the SBA, the writing down allowance rate for integral features and long life assets will be reduced with effect from April 2019 from 8% to 6% per annum on a reducing balance basis.
• Annual investment allowance (AIA): This 100% first year allowance has been temporarily increased, from £200k to £1m for expenditure incurred between 1 January 2019 and 31 December 2020.
• Meaning of ”plant”: There is clarification that expenditure incurred on the alteration of land may only qualify for plant and machinery allowances where the assets being installed are plant or machinery (not buildings or structures) as a result of recent case law
• Enhanced capital allowances (ECAs): From 31 March 2020 (for companies) and 5 April 2020 (for unincorporated businesses) the scheme which currently provides a 100% first year deduction for certain energy-saving or environmentally beneficial plant and machinery (including the associated First Year Tax Credit) is to be abolished.
• Electric charge-points: As previously announced, the 100% first-year allowance for such expenditure will be extended for a further four years until 31 March 2023 for corporation tax and 5 April 2023 for income tax.

After relatively minor changes to the capital allowances regime in recent years, the reforms announced this year are extensive and represent the most significant amendments to the capital allowances regime since 2008.

The Government has been swift to act on the Office for Tax Simplification’s recommendations following the consultation on capital allowances earlier this year, and the Government’s aim of improving the UK’s international competitiveness and encouraging investment is likely to be welcomed by UK businesses and investors at a time of increased uncertainty.

A fivefold increase in the AIA from £200k to £1m, together with the introduction of tax relief for new Nonresidential buildings and structures, should help stimulate investment in the UK and will have a positive impact on all tax-paying businesses who invest in capital assets used for commercial activities. Businesses may wish to consider accelerating their future capital investment programs in order to benefit from these measures.

However, the abolition of the 100% first year allowance (and credits) for energy-saving and environmentally beneficial plant is disappointing, given the First Year Tax Credit was extended in Finance Act 2018. In addition, the reduction in the annual rate of relief for special rate pool expenditure from 8% to 6% will have a negative cash flow impact on existing capital allowances claims.

Diverted Profits Tax: amendments

A number of amendments to the Diverted Profits Tax (DPT) legislation have been announced. The legislation will close a perceived tax planning opportunity (whereby corporation tax return amendments are made after the DPT review period) and makes clear that diverted profits that are subject to DPT will not also be subject to corporation tax. The DPT review period (where HM Revenue & Customs (HMRC) and taxpayers work together) is also extended to 15 months and taxpayers will be able to amend their corporation tax return during the first 12 months of the review period.

The clarification that both DPT and corporation tax cannot both apply to profits is positive development, as is the extension of time limits for taxpayers to make appropriate adjustments to the tax return. The DPT legislation is complex and the potential for a double charge under the existing provisions was an area in which EY had asked for statutory confirmation.

The change to extend the maximum review period from 12 to 15 months reflects our experience that given the scale and complexity of DPT enquiries, more time may be needed to reach an agreement, including in cases where both parties are working collaboratively.

New regime for taxation of hybrid capital instruments

The Government announced on Budget Day that it will legislate to introduce a new elective regime relating to the taxation of ”hybrid capital instruments.” In introducing these rules, the Government seeks to provide certainty regarding the tax treatment of hybrid capital instruments that are, in essence, genuine debt instruments. These rules would apply to any UK resident company which issues hybrid capital instruments, regardless of sector, and the existing regulations which apply to certain capital instruments issued by banks or insurance companies will be repealed.

It is expected that new provisions will define a hybrid capital instrument as being a loan relationship on which the debtor is allowed to defer or cancel interest payments, and which has no significant equity features. The provisions are expected to provide that coupons on the instruments are potentially deductible under the loan relationship rules, even if recognized in equity rather than profit and loss. A number of other measures are expected, including a specific exemption from all stamp duties for instruments falling within the rules. The election for the rules to apply will be ineffective where there are arrangements, the main purpose, or one of the main purposes, of which is to obtain a tax deduction for any person.

The Government also intends to include provisions to eliminate mismatches in tax treatment which can arise where a company issues external debt, and then lends the funds raised to fellow group companies

Corporate capital loss restriction

The Government will legislate in Finance Bill 2019-20 to restrict companies’ use of carried-forward capital losses to 50% of capital gains from 1 April 2020. The measure will include a single allowance that allows companies unrestricted use of up to £5m capital or income losses each year. Draft legislation is due to be published in summer 2019 and a consultation was published on 29 October which closes on 25 January 2019. The consultation aims to consider the method to be used to implement this restriction, specific exemptions from the restriction and to identify any unintended consequences.

An anti-forestalling measure to support this change will have effect from 29 October 2018.

Capital gains: Collective Investment Vehicles and Real Estate Investment Trusts

The Government has confirmed that a special regime will apply to the taxation of gains on direct and indirect disposal of UK property by nonresident Collective Investment Vehicles (CIVs). These changes follow on from reforms announced in the Autumn 2017 Budget to the taxation of capital gains realized by non-UK residents on disposals of UK property and UK property rich entities with effect from 6 April 2019.

Draft legislation on the tax treatment of CIVs will be set out in Finance Bill 2018-19 on 7 November.

The UK Government has also announced that for UK Real Estate Investment Trusts (REITs) which are themselves UK property rich, the existing exemption from corporation tax under the REIT regime will be extended to gains on disposals of UK property rich entities.

Nonresident landlords brought within corporation tax charge from April 2020

The Government has released draft legislation to facilitate the entry of Nonresident landlords into the UK corporation tax regime from 6 April 2020. Corporation tax will be payable on the profits of a UK property rental business of a Nonresident company from that date, and the draft legislation confirms this will extend to loan relationships and derivatives entered into for the purposes of the Nonresident’s UK property business. A number of other consequential amendments are included to cover the transition.

Plastics levy

To reduce the problem of excessive and environmentally harmful plastic packaging, and incentivize manufacturers to use recycled plastic, the Government intends to introduce a tax on the production and import of plastic packaging from April 2022. Subject to consultation, this tax will apply to plastic packaging which does not contain at least 30% recycled plastic.

Following an unprecedented response to the call for evidence earlier this year, the report identified a number of single use plastic items where urgent action would be taken to ban or restrict their use. The taxation of single use plastic items will, however, remain under review.

Other business tax developments

Other measures announced in the Budget include:

• ?Permanent Establishment (PE) - Anti fragmentation rule: The Government plans to legislate in Finance Bill 2018-19 to give full effect to changes made to its tax treaties as a result of the OECD¹ BEPS² project. The proposed change will remove access to the current PE exemptions in UK law where the business activities have been fragmented within the UK, unless the overall activity carried on may be seen as preparatory or auxiliary.
• A market value rule for stamp duty and stamp duty reserve tax (SDRT) on certain transfers: This rule is to be introduced for transfers of listed securities to a connected company (or nominee). Where these provisions apply, the transfer will generally be chargeable on the higher of the consideration given and the market value of the listed securities. For stamp duty, these measures will apply in respect of transfer instruments executed on or after 29 October 2018. For SDRT, these measures will apply: (a) where the agreement to transfer securities is conditional and the condition is satisfied on or after 29 October 2018; and (b) in any other case, the agreement is made on or after that date. In addition, the Government will also consult on aligning the consideration rules for stamp duty and SDRT and introducing a general market value rule for transfers between connected persons.
• Preventing abuse of research and development (R&D) tax relief for loss making small and medium enterprises (SMEs): The Chancellor has announced a consultation on the reintroduction of a Pay As You Earn (PAYE) Cap on R&D relief for loss making SMEs for accounting periods commencing on or after 1 April 2020, limiting the payable tax credit to three times the total of a company’s PAYE and national insurance contributions (NIC) liabilities. The new rule will limit the payable R&D tax credit for loss-making SMEs to the lesser of 14.5% of the surrenderable loss, or three times the company’s total PAYE and NIC liabilities for the period.

Developments still to come in the Finance Bill

The following measures are expected to be taken forward in next week’s Finance Bill 2018-19, though we anticipate a number of changes to the draft clauses originally published on 6 July 2018:

• Tax adjustments for lease accounting changes: As previously announced, in Autumn Budget 2017, the Government intends to legislate, in Finance Bill 2018-19, with the intention of ensuring that the tax legislation, including the long funding lease and corporate interest restriction rules, continue to operate as intended following the introduction of the new accounting standard for leases, IFRS 16.
• Corporate interest restriction rules: Legislation is expected to correct and clarify particular areas of these rules (treatment of capitalized interest, REITs, unpaid employee remuneration and public infrastructure companies).
• Minor changes to the reform of loss relief rules: The changes include corrections to the rules where potential claims for loss relief might exceed the limits of what was intended.
• Controlled Foreign Companies (CFC) rules: There are two proposed amendments to the UK CFC rules to ensure that the provisions of the EU Anti-tax Avoidance Directive (ATAD) are transposed into UK tax law. Both will be effective from 1 January 2019.
• Anti-hybrid legislation: There are also two proposed amendments to anti-hybrid legislation needed to comply with ATAD, both of which will be effective from 1 January 2020.
• Oil activities and petroleum revenue tax (PRT): Legislation will be published to provide a mechanism by which a company may transfer a portion of its historic profits and the associated tax paid on those profits to another company, on the sale of an oil license. The legislation will also enable participators in oil fields to obtain PRT relief for decommissioning expenditure in certain situations. Both measures are intended to remove tax barriers to North Sea investment.

What is next?

The Finance Bill 2018-19 is due to be published on 7 November (while the Commons is in recess) with the expectation that clauses in the Bill chosen for debate before the Committee of the whole House will be debated soon after the House returns on 12 November.

The Finance Bill is due to be enacted by March 2019, before the end of the current tax year.

Endnotes

1. Organisation for Economic Co-operation and Development.

2. Base Erosion and Profit Shifting.

For additional information with respect to this Alert, please contact the following:

Ernst & Young LLP (United Kingdom), London

• Claire Hooper | chooper@uk.ey.com
• Chris Sanger | csanger@uk.ey.com

Ernst & Young LLP, UK Tax Desk, New York

• Graham Shaw | graham.shaw@ey.com
• Matthew Williams | matthew.williams1@ey.com

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