Pre-Budget Report 2007

Practical Law UK Legal Update 5-376-6308 (Approx. 26 pages)

Pre-Budget Report 2007

by PLC Tax, PLC Incentives and PLC Pensions

Corporate

Corporation tax for related companies

The government announced that it would be launching a joint HMRC and Treasury review this autumn with the aim of simplifying certain aspects of the tax treatment of related companies. They think that, in this area, simplification will be of most significance to UK companies in relation to: the group aspects of the chargeable gains regime, the associated company rules for the small companies' corporation tax rate, self-assessment administration and transfer pricing.

For more information about the tax treatment of groups of companies, see Practice note, Groups of companies: tax.

For further information, see Tax simplification reviews.

Disguised interest

HMRC has announced that, with effect from 9 October 2007, it is extending the range of circumstances in which company distributions are subject to UK corporation tax as if they were interest.

In general, distributions paid from one UK company to another are not subject to UK corporation tax (section 208, Income and Corporation Taxes Act 1988 (ICTA 1988)). This means that, in certain circumstances, it may be advantageous for a recipient to structure a payment that is, economically, interest (which is taxable) as a distribution (which is not).

To counter this, the "shares as debt" rules (found in sections 91A to 91G of the Finance Act 1996) were enacted in 2005. Under these rules, in certain circumstances, distributions may be treated as interest for UK corporation tax purposes. However, at present, the operation of those rules is restricted to distributions falling within section 209(2)(a) and (b) of ICTA 1988. This means that the rules only apply to straightforward distributions (such as dividends).

In the 2007 Pre-Budget Report, HMRC stated that it was aware of a scheme under which the taxpayer sought to structure distributions in such a way that they were not of the straightforward type falling within the shares as debt legislation. If successful, this approach might enable the distributions to escape UK corporation tax. To counter this, HMRC intends to remove the restriction on the shares as debt rules so that (subject to all other conditions in the rules being met) they apply to all distributions regardless of their type.

HMRC has issued draft legislation and an explanatory note alongside its announcement. This measure is intended to take effect for distributions paid on or after 9 October 2007 and the legislation is intended to be included in the Finance Bill 2008.

For further information, see 2007 Pre-Budget Report - PBRN 09 - Tackling avoidance: corporation tax: disguised interest and HMRC: Distributions from shares treated as loan relationships: draft legislation and explanatory note.

Spreading tax relief for employer pension contributions: indirect contributions now caught

Employers will be prevented from circumventing the rules relating to spreading large contributions to registered pension schemes. Currently, employers must spread the tax relief available on large contributions that meet certain requirements over a period of up to four years. Some employers seek to avoid these requirements by making contributions indirectly to their scheme, either through a new or an associated company. The new provisions will catch these indirect contributions, and will apply to employer contributions made on or after 10 October 2007 under binding obligations entered into on or after 9 October 2007. HMRC has published draft legislation for inclusion in the Finance Bill 2008 (see Finance Bill: Spreading of relief on indirect contributions, PBR draft).

For further information, see 2007 Pre-Budget Report - PBRN13 - Spreading of tax relief for pension contributions.

Stamp duty: exemption from stamp duty for fixed duty and low value transfers

Transfers of shares and securities which attract a fixed stamp duty of £5, and transfers attracting £5 ad valorem stamp duty, will no longer need to be presented to HMRC for stamping, with effect for transfers on or after Budget Day 2008.

Ad valorem stamp duty is charged at 0.5% of the consideration given for the transfer of shares and securities on sale (Part I, Schedule 13, Finance Act 1999), rounded up to the nearest £5 (section 112, Finance Act 1999). Transfers where the consideration is £1,000 or less therefore attract £5 stamp duty and must be presented for stamping to the Stamp Office. (See Practice note, Stamp duty: How much transfer duty is payable?).

Some transfers of shares and securities attract a fixed stamp duty charge of £5 (Part III, Schedule 13, Finance Act 1999), and are therefore required to be stamped. These include:

Replacement or second copies of instruments.
Instruments transferring shares otherwise than on sale (such as transfers between nominees).
Some declarations of trust.

Legislation will be introduced in the Finance Bill 2008 so that instruments currently attracting ad valorem duty of £5, or fixed duty of £5, will no longer attract stamp duty and will not need to be presented to the Stamp Office.

For further information, see 2007 Pre-Budget Report - PBRN 20 - Reduction of Stamp duty administrative burden.

Stamp duty and SDRT intermediary relief

Earlier this year the government announced that it intends to extend the stamp duty and SDRT intermediary relief to shares admitted to trading on Multilateral Trading Facilities. However, the FSA has first to consider the regulatory implications of the proposed changes. The FSA is expected to report the initial findings of its consultative process shortly, and a further update will be given following that report. For background on the changes, see Budget 2007: Stamp taxes reliefs for exchange intermediaries.

For further information, see 2007 Pre-Budget Report - Chapter 5 - Fairness and opportunity for all, paragraph 5.85.

Employment and self-employment

Consultation on simplification

As part of its declared intention to simplify business tax, the government has announced its intention to consult this autumn on the following:

How best to collect tax on benefits in kind and expenses through the payroll, helping up to 500,000 employers by removing the need for a separate end of year process.
Removing the £8,500 a year threshold at which most benefits in kind become taxable, making it simpler for employers when reporting benefits.
How to improve the present separate systems for collecting Class 2 and 4 national insurance contributions (NICs), to make it easier for around 3 million self-employed people to understand and pay their NICs.

For further information, see 2007 Pre-Budget Report - Chapter 4 - Sustainable growth and prosperity, Box 4.6.

Holiday pay NIC avoidance schemes stopped for most employees

Payments to most employees from holiday pay schemes will be subject to National Insurance contributions from 30 October 2007.

Typical holiday pay schemes involve employees receiving their holiday pay from a third-party administered fund to which several employers contribute. The current exemption was introduced in the 1960's to help the construction sector with its high workforce mobility (paragraph 12, part 10, Schedule 3 Social Security (Contributions) Regulations 2001).

Workers in the construction industry will still be able to benefit from holiday pay schemes until 30 October 2012 when the exemption will be completely withdrawn.

For further information, see 2007 Pre-Budget Report - PBRN 06 - Exploitation of National Insurance contributions exemption and The Social Security (Contributions) (Amendment No 9) Regulations 2007.

Increase in fuel benefit charge

The multiplier for the fuel benefit charge has been increased from £14,400 to £16,900 from 6 April 2008. The fuel benefit charge applies to employees provided with free fuel for their company car for private use. Income tax and Class 1A NICs are charged on a percentage of the multiplier. The relevant percentage depends on the carbon dioxide emissions of the company car.

For further information, see 2007 Pre-Budget Report - PBRN 23 - Fuel Benefit Charge.

Review finds no general case for the further alignment of income tax and NICs systems

The results of a Treasury review of the case for further aligning the ways in which income tax and NICs are administered and collected have been published.

The review looked at improving the administrative alignment of the two systems, particularly the proposal that NICs should be collected cumulatively on an annual basis (like PAYE income tax). The key findings of the report are that further alignment:

Would result in lower savings for employers than might be expected.
May adversely impact lower-paid individuals.
Would result in high costs for the exchequer.

The government's conclusion as a result of the review is that the benefits of further alignment would be outweighed by the disadvantages.

However, the report does identify some areas in which worthwhile improvements could be made:

Improving and aligning the guidance on tax and NICs.
Collecting tax on benefits in kind through payroll.
Improving the collection of NICs from the self-employed.

The government welcomes comments on the analysis and conclusions of the report.

For more detail, see Income tax and national insurance alignment: an evidence-based assessment.

Environment

Biofuels

The government has announced that it will extend the current fuel duty incentive for biofuels to biobutenol on a pilot basis. For details, see 2007 Pre-Budget Report: environmental announcements.

For further information, see 2007 Pre-Budget Report PBRN27 - Facilitating Use of Biobutanol.

Changes to air passenger duty (APD)

Two changes are proposed to APD:

First, from 1 November 2008, travellers on flights which offer business class seating only (and no other class of travel) will pay the higher (standard) rate of APD. Currently, passengers on these flights are only liable to pay APD at the reduced (lower) rate. The government proposes to amend, in Finance Bill 2008, the definitions of the different classes of travel (by reference to leg room sizes of seats) in order to effect this change.
The current rates of APD are:

Destination	Reduced rate	Standard rate
EU	£10	£20
Outside the EU	£40	£80

Second, a proposal to replace APD from 1 November 2009, so that duty will be levied per plane instead of per passenger. The government will consult on this proposal shortly and expects revenue from the new duty to be around £520 million for tax year 2010/2011.
Although in his Pre-Budget Report speech, Alistair Darling said that the aim was to shift the duty from passengers to airlines, it is difficult to see how this statement will hold true as it is expected that airlines will increase fares accordingly to absorb the cost of the duty.

For further information, see 2007 Pre-Budget Report - PBRN 24 - Air Passenger Duty (APD).

Extension of landfill tax exemption to dredging waste

See 2007 Pre-Budget Report: environmental announcements: landfill tax.

For further information, see 2007 Pre-Budget Report - PBRN26 - Landfill Tax: Exemption for Waste Arising from Dredging and Treated with Additives

For information about other environment related announcements in the 2207 Pre-Budget Report, see PLC Environment, Legal update: 2007 Pre-Budget Report: environmental announcements.

Finance

Financial derivatives: clarification of UK corporation tax treatment

Following the 2007 Pre-Budget Report, HMRC has issued guidance clarifying the UK corporation tax treatment of financial derivatives transactions.

Broadly, derivatives are taxed in accordance with their accounting treatment. See Practice note, Derivatives: tax for a discussion of the UK corporation tax treatment of derivatives generally.

Following discussions with industry, HMRC has issued a guidance note seeking to clarify how certain derivative transactions are taxed in light of perceived uncertainty. The guidance specifies that, for UK corporation tax purposes:

HMRC views synthetic financial transactions (for example, entering into a derivative contract that replicates the risks and rewards of share ownership) as no different to the equivalent "real" transaction (such as actually buying shares).
Buying a share in the hope that its price will rise is conceptually the same as "shorting" a share (that is, agreeing to sell a share at a particular price before buying it, in the hope that its price will fall). Therefore, synthetic long and short positions are conceptually the same as one another and as the equivalent "real" transactions.
Derivatives giving exposure to part of an asset (for example, only interest payments or currency fluctuations on a security or combinations of such elements) are conceptually the same as those giving exposure to the whole of the asset.
Where a series of transactions are bundled, they should not be separated: they should be treated as a whole. Therefore, using:
- two or more derivatives to express a single view (such as using a series of derivatives to express the view that an asset's price will rise but only within a certain band);
- a derivative linked with another financial asset (for example, the writing of a put option the exercise of which would result in the disposal of a share); and
- a sequential series of short derivatives in place of a single long, otherwise identical derivative (to increase liquidity)
should each be treated as a whole, single derivative transaction.

In addition, HMRC states in the guidance that none of the transactions discussed above is of itself indicative of trading. This means that profits from such transactions may be taxed as investment, rather than trading, income depending on the circumstances of the parties and the transactions.

The guidance is to be incorporated into HMRC's Business Income Manual.

This guidance aims to promote consistency in the application of UK tax rules to derivative transactions in their various forms and seeks to do so by looking at their economic substance regardless of their legal form. Although it is possible that this approach may reduce the scope for avoidance (although HMRC does not point to any such avoidance about which it is currently concerned), clarification or simplification of the rules in this area is likely to be a welcome gesture.

For further information, see HMRC: Tax Treatment of Financial Derivatives.

Hedging foreign exchange risks: taxation of exchange gains and losses

HMRC is to make a short-term change to the tax treatment of exchange gains and losses on loans and derivatives that are used to hedge foreign exchange (forex) risk arising from a company's investment in non-sterling trading or business operations. HMRC intends to lay regulations effecting the change before the end of the year. This will be followed in the first quarter of 2008 by a technical note and draft regulations for consultation with a view to introducing more extensive changes in 2009. The aim of this is to produce a single code for forex matching.

A company may hedge (or "match") non-sterling shares or similar investments through the use of, for example, a loan in the same non-sterling currency or an appropriate currency derivative. Under the current UK corporation tax rules for forex, broadly, exchange gains and losses on such loans and derivatives are ignored so that only the net economic position is subject to tax.

Currently, the relevant rules are found in:

The so-called "disregard regulations" (SI 2004/3256) (see Practice note, Derivatives: tax: The Disregard Regulations).
In relation to loan relationships where international financial reporting standards (IFRS) are not used, section 84A of the Finance Act 1996.
In relation to derivative contracts where IFRS are not used, paragraph 16 of Schedule 26 to the Finance Act 2002. (In relation to the taxation of derivatives generally, see Practice note, Derivatives: tax).

Under Schedule 6 to the Finance (No 2) Act 2005, the last two of these provisions are repealed with effect from a day to be appointed. Under the 2007 Pre-Budget Report, the government has announced that it intends to appoint 1 January 2007 as that day. For periods of account beginning on or after that date, the government intends to introduce new regulations providing for a comprehensive code for "forex matching".

In the meantime, also as part of the 2007 Pre-Budget Report, the government has announced the following measures following discussions with industry:

Companies will be allowed to elect to value "matched" shares at the value of the net foreign currency assets underlying the shareholding, rather than at book value of the shares (as required at present). Amendments to the disregard regulations to allow such "net asset value matching" will be made later this year and will have effect for periods of account beginning on or after 1 January 2007.
The present rules for identifying which loans and derivatives are matched with shares, which rely on the taxpayer’s intentions, will be replaced with a more objective approach. Draft regulations effecting this are to be published for consultation early in 2008. This legislation is also intended to refine the "net asset value matching" approach (see above) and to include a targeted anti-avoidance rule to prevent taxpayers disregarding exchange gains in circumstances where exchange losses would be claimed for tax purposes. These measures are intended to have effect for periods of account beginning on or after 1 January 2009.

The first measure to be effected ("net asset value matching") is to be welcomed as it will increase flexibility for taxpayers and aid the convergence of tax and economic profits in relation to financial and associated instruments. However, although it is to be hoped that a unified code for forex taxation will give greater clarity to this area of the tax legislation, taxpayers will have to wait to assess the impact of those measures (including the ambit of the proposed anti-avoidance measures) until the draft legislation is produced next year.

For further information, see 2007 Pre-Budget Report - PBRN 08 - Tax and accountancy: hedging foreign exchange risks.

Leased plant and machinery: anti-avoidance

HMRC has announced anti-avoidance measures targeted at schemes aimed at obtaining a tax advantage by:

Selling and leasing back plant and machinery in such a way that the sale does not attract tax but the lessor on the leaseback does not suffer from the restrictions imposed on relief on the rental payments.
Exploiting the rules for long funding leases by creating a tax loss where there is no (or little) commercial loss.

For a general discussion of the UK tax considerations relating to equipment leasing, see Practice note, Equipment leasing: tax.

Sale and finance leaseback

Prior to 2004, it was possible to avoid tax by entering into arrangements whereby an entity that was not subject to UK tax would sell an item of plant and machinery to an entity that was within that charge, which entity leased the item back to the seller. Under this arrangement, there was no UK tax on the sale but the seller (as lessee) was entitled to tax deductions for the rental payments. This scheme was countered by legislation enacted in 2004 (sections 228A-228J, Capital Allowances Act 2001), which provides that, in certain circumstances, relief for rental payments on a sale and finance leaseback is restricted (see Practice note, Equipment leasing: tax: Double-benefit leasing).

However, HMRC understands that it is still possible to seek to take advantage of these rules. Examples would be where:

A business enters into a sale and finance leaseback in which the leaseback is to a person connected with the seller but who is not resident in the UK. In such a situation, it could be argued that the seller sells tax-free but the lessee is not affected by the restriction on relief for rental payment deductions.
A business enters into a sale and finance leaseback with the seller/lessee migrating from the UK shortly afterwards. The seller/lessee therefore makes a tax-free sale but, again, is not affected by the restriction on relief for rental payments.

HMRC does not accept that any such schemes would have the desired UK tax effect. However, for the sake of clarity and caution, HMRC is amending these rules so that the relevant provisions no longer apply to sale and finance leaseback transactions. (It should be noted that the provisions will still apply to lease and finance leaseback transactions.) Instead, leases in sale and finance leaseback transactions will be treated as long funding leases (unless the asset is less than four months old when sold and the parties make an election). The general effect of the long funding lease rules is to tax finance leases as if they were loans: see Practice note, Equipment leasing: tax.

The new measures are due to take effect for transactions entered into on or after 9 October 2007. As part of the 2007 Pre-Budget Report, HMRC has issued a technical note and draft legislation (intended to be included in the Finance Bill 2008).

For further information, see 2007 Pre-Budget Report - PBRN 06 - Leased plant and machinery: anti-avoidance and HMRC technical note: Leased Plant and Machinery - Anti-avoidance (9 October 2007).

Long funding leasing

A lessor under a long funding lease is not entitled to claim capital allowances on the cost of the leased asset but, to compensate, it is only taxed on a small proportion of the lease rental income. However, HMRC understands that avoidance schemes have been developed that purport to establish an alternative deduction for the cost of the leased asset, approximately equivalent to that cost, even though there is no commercial loss.

Under the type of scheme considered by HMRC:

A lessor acquires an item of plant or machinery on trading account.
The item is leased out under a long funding lease.
The lessor claims that its taxable rental income is restricted under the long funding lease rules (sections 502B-502D, ICTA1998).
The lessor claims that it is entitled to trading deductions for the cost of the item.

HMRC does not accept that any such schemes would have the desired UK tax effect. However, for the sake of clarity and caution, HMRC is amending the rules so that the restriction on taxable income does not apply where:

A trading deduction is available for the cost of a leased asset.
A taxpayer enters into a long funding lease and one or more other transactions, and (one of) the main purpose(s) of the arrangements is to secure a substantial difference between the accounting and tax profits attributable to those arrangements that is (wholly or partly) attributable to the restriction on taxable income. This is aimed at countering attempts by taxpayers to use the long funding lease rules to create a substantial tax loss where there is no (or little) economic loss.

For further information, see 2007 Pre-Budget Report - PBRN 06 - Leased plant and machinery: anti-avoidance and HMRC technical note: Leased Plant and Machinery - Anti-avoidance (9 October 2007).

Sale of lessors: companies in partnership

HMRC has announced that the anti-avoidance rules relating to the sale of plant and machinery leasing businesses are to be retrospectively amended to avoid an "unintended and unfair tax liability" where a company acquires a business of leasing plant and machinery carried on by a partnership.

Schedule 10 to the Finance Act 2006 was introduced to counter avoidance involving the sale of companies leasing plant and machinery (see Legal update, The 2006 Budget: main points: Sale of lessors). Generally, Schedule 10:

Brings into charge an amount of income that is taxed on the seller's group, with the buyer's group obtaining relief in an equal amount.
Provides that, where the business is carried on by a company in partnership (with one or more other companies or persons) and the company's partnership interest is reduced:
- the outgoing partner brings into account an amount of interest for tax purposes; and
- the incoming partner (including a partner whose share is increased) receives relief in an equal amount.

On a sale of a leasing business by one partnership to another, the charge on the sellers should be equal to the relief obtained by the buyers. However, on a sale by a partnership to a single company, the current rules operate in such a way that the members of the partnership suffer a tax charge but the single company does not obtain relief.

Under the measure announced in the 2007 Pre-Budget Report, this situation will be remedied so that, where a partnership sells a leasing business to a single company, relief will be available to the buyer in an amount equal to the income recognised by the sellers. The amendment is intended to have effect (retrospectively) on and after 5 December 2005.

Alongside this announcement, HMRC has today issued a technical note on the change, together with draft legislation. The legislation, inserting new paragraphs 23(4A) and 32(3A) into Schedule 10 to the Finance Act 2006, is intended to be included in the Finance Bill 2008.

The announcement is a welcome development, which should remove unintended but detrimental effects under the current rules. For this reason, the retrospective effect of the proposed amendment is to be applauded.

For further information, see 2007 Pre-Budget Report - PBRN 05 - Sale of lessors: companies in partnership and HMRC technical note: Sale of Lessors - Companies in Partnership (October 2007).

Miscellaneous

Consultation on tax appeals

HMRC has published a consultation document entitled "Tax appeals against decisions made by HMRC" that looks at the administrative machinery that supports appeal rights against HMRC decisions. Responses are requested by 31 December 2007.

The consultation aims to take advantage of the opportunity presented by reform of the tribunal system under the Tribunals, Courts and Enforcement Act 2007 to streamline and improve the "complex patchwork of legacy legislation and practice" in relation to appeals that HMRC has inherited. It also builds on the review concerning HMRC's powers (for background on the powers review, see Legal update, Consultation on the powers for the new revenue department).

The consultation does not cover rights of appeal or the new tribunal system itself (the Ministry of Justice will be consulting on the latter separately later in the year). What it does cover is the internal handling of appeals from the point at which the taxpayer first disagrees with a decision to the point at which it is either resolved or becomes the responsibility of the Tribunals Service.

The most interesting and significant proposal for consideration is the introduction of an impartial internal review of decisions relating to all taxes, building on arrangements already provided for in relation to VAT in the VAT Guide, Notice 700, at paragraph 28.3. The consultation document raises various questions as to how this might work in practice.

The consultation document also addresses administrative matters relating to tax appeals, including proposals relating to alignment of time limits, and transitional arrangements relating to the transfer of powers to the new tribunal.

For further information, see Tax appeals against decisions made by HMRC.

Disclosure regime: options to improve scheme reference number system

The government will consult on improving the operation of the scheme reference numbers system used in the tax avoidance disclosure regime. These rules require promoters, and in some cases, users of certain tax planning arrangements to give notification to HMRC. Upon receiving a notification, HMRC may issue the notifier with a reference number which must generally be included in the tax return of any person obtaining a tax benefit from the arrangements.

For more information on the tax disclosure regimes, see Practice note, Direct tax disclosure regime, Practice note, National insurance contributions disclosure regime and Practice note, SDLT disclosure regime.

For further information, see 2007 Pre-Budget Report - Chapter 5 - Fairness and opportunity for all, paragraph 5.94.

Progress report on implementation of Review of Links with Large Business

HMRC has published a progress report on the implementation of its 2006 Review of Links with Large Business (for background, see HMRC proposes introduction of system for advance rulings and other changes, for the previous progress report, see Budget 2007: Progress report on implementation of Review of Links with Large Business).

The update covers:

Advance rulings. A new Advance Agreements Unit is to be launched for significant inward investors to the UK. In addition, responses to the consultation on clearances and advance agreements have been published. For background to the consultation, see Legal update, HMRC proposes to extend tax clearances. Overall business welcomed the proposals in the consultation and a pilot scheme will be running from January 2008, with a view to delivering new arrangements around Budget 2008.
Improved guidance. The programme of planned improvements and updates to guidance has been updated to summer 2008.
International panel. A new panel of international expertise on tax administration is proposed, to help HMRC develop a shared understanding of the contribution of the UK tax system to the overall attractiveness of the UK as a place to do business.
Relationship managers. This service, which currently applies only to the largest businesses dealt with by HMRC's Large Business Service, is to be extended to a proportion of large business "customers" within HMRC's Local Compliance business unit.
Transfer pricing. Responses to the consultation on HMRC's approach to transfer pricing enquiries have been published.
Training. A five year tax professionalism programme is being put in place to raise the level of expertise among HMRC's tax professionals.

For further information, see Making a difference: clarity and certainty.

Review of anti-avoidance legislation

The government announced that it would be launching a joint HMRC and Treasury review this autumn with the aim of simplifying certain aspects of anti-avoidance legislation.

This review will explore the relative effectiveness of targeted anti-avoidance rules and more generic approaches. It will also look at where anti-avoidance provisions should sit in the tax code (for example, whether or not all anti-avoidance provisions should be contained in primary legislation and whether they should be integrated with other tax rules or contained in a separate part of the tax code).

For further information, see Tax simplification reviews.

Oil taxation

Consultation on oil taxation

In September 2007, the latest round of discussions on the North Sea fiscal regime with the oil and gas industry ended (see Practice note, Oil taxation: The history of oil taxation in the UK). In the 2007 Pre-Budget Report, the government stated that it is currently considering the conclusions from those discussions and will publish a consultation document examining the options for further action in due course.

For further information, see 2007 Pre-Budget Report paragraph 5.86.

Pensions

Inheriting tax-relieved pension savings: anti-avoidance measures

Additional anti-avoidance provisions will be introduced to stop members of registered pension schemes passing on through inheritance planning pension savings that have received tax relief. Since enacting its pensions tax simplification measures in 2004, the government has refined the legislation on several occasions with this goal in mind. HMRC believes that some scheme members have attempted to circumvent the current restrictions by assigning or reallocating rights to pension assets on their death.

The government will extend the existing anti-avoidance rules by imposing an unauthorised payments charge and IHT charge if a "connected person" becomes entitled to an increase in their own pension rights that is attributable to the death. These new provisions will not apply to schemes with more than 20 members. HMRC has published draft legislation to implement the change in the Finance Bill 2008 (see Finance Bill: Inheritance etc of tax-relieved pension savings, PBR draft).

For further information, see 2007 Pre-Budget Report - PBRN 15 - Inheriting tax-relieved pension savings.

Pensions tax simplification: technical improvements

The lifetime allowance test will be amended in three minor respects relating to pension increases. Currently, a member's pension entitlement must be tested against the lifetime allowance if the member becomes entitled to an annual pension increase exceeding a specified level (so-called "benefit crystallisation event 3"). HMRC's proposed changes are as follows:

The exemptions from the benefit crystallisation event 3 test will be widened.
Increases in pensions in payment will be exempt from a lifetime allowance test, provided they do not exceed a "normal" rate of increase.
Schemes must use the figure for the increase in the retail prices index that is published two months before the increase occurs.

For the most part, these changes will be backdated to 6 April 2006 when pensions tax simplification came into effect. HMRC has published draft legislation to implement these measures in the Finance Bill 2008 (see Finance Bill: Registered pension schemes: benefit crystallisation event 3, PBR draft).

Several further technical changes will be made to the pensions tax legislation:

The calculation of protected lump sum rights (that is, existing rights on 5 April 2006 to lump sums exceeding 25% of a member's pension rights) will be simplified. In particular, scheme administrators will not have to calculate whether "relevant benefit accrual" has taken place if further contributions are made.
The definition of investment-regulated pension schemes will be amended so that it does not include large occupational schemes or other schemes whose members cannot realistically influence decisions to invest in "taxable property".
Protection from IHT will be given to funds derived from UK tax-relieved pension savings held in overseas pension schemes.

For further information, see 2007 Pre-Budget Report - PBRN 14 - Pensions: technical improvements.

For further background information about pensions tax simplification, see Practice note, Pensions tax simplification: overview.

Personal tax and investment

Capital gains tax reform

All disposals made by individuals, trustees and personal representatives on or after 6 April 2008 will be subject to a single rate of capital gains tax (CGT) of 18%. Taper relief will also be abolished for disposals on or after that date.

Individuals, trustees and personal representatives who make gains on the disposal of chargeable assets (including shares and property) are subject to CGT at the savings rates of income tax (10%, 20% and 40%). Tax is on net chargeable gains after deduction of allowable losses, taper relief and any other available reliefs.

The availability of taper relief currently reduces the amount of the gain chargeable to CGT. The availability of relief depends on the length of time an asset has been held and whether the asset is classified as a business asset or a non-business asset for taper relief purposes. Gains on the disposal of business assets (which include all shares in unlisted trading companies) are currently taxed at an effective rate of 10%, provided the asset has been held for at least two years. For more detailed information about taper relief, see Share purchases: tax: Taper relief.

For disposals on or after 6 April 2008 taper relief will no longer be available (even if assets were held before this date). The new single rate of CGT (subject to allowable losses and any available relief) will also apply to held over gains coming into charge on or after 6 April 2008.

A number of other measures will also be introduced in the Finance Act 2008, also applying to disposals made on or after 6 April 2008. They are:

The withdrawal of the indexation allowance for individuals on assets held at 6 April 1998. Indexation allowance provides relief from tax on the effect on gains of inflation. For disposals on or after 6 April 2008 indexation allowance will no longer be available in computing the gain arising. Since indexation relief only applies to disposals of assets held at 6 April 1998, this change will only affect assets that were held at that date.
Abolition of the 'kink test'. The abolition of the kink test will mean all assets held on 31 March 1982 will be deemed to have had a cost equivalent to their market value on that date.
The withdrawal of halving relief. Currently, halving relief may be available where a chargeable gain effectively includes a deferred gain that relates to a period before 31 March 1982.
Changes to the share identification rules. The changes to the CGT rules will allow for the simplification of the current rules for the identification for CGT purposes of shares and securities, and of other assets which cannot be distinguished from one another.

The annual exemption for individuals and trustees will remain. The amount for 2007-08 is £9,200 for individuals and £4,600 for some trustees.

Other CGT reliefs will continue to apply. These include:

Private residence relief.
Business asset roll over relief.
Business asset gift hold over relief.

For further comment on the impact of the CGT changes on share incentives, see PLC Share Schemes and Incentives, Legal update: Pre-Budget Report 2007: Main points for share schemes and incentives. The government has also expressed the hope that these changes to CGT will ensure greater fairness in the taxation of those working in the private equity industry, see Private equity.

For further information, see 2007 Pre-Budget Report - PBRN 17 - Capital gains tax reform.

Changes to taxation of non-domiciled individuals

Non-domiciled individuals who have been resident in the UK for seven years will only be able to use the remittance basis of taxation if they pay an additional tax charge of £30,000 a year, with effect from 6 April 2008.

Currently, UK residents who are not domiciled (or not ordinarily resident) in the UK can be taxed on a remittance basis. This means that they are only taxed here on income and capital gains arising overseas when that income or gain is remitted into the UK. They are taxed on all UK source income and gains on disposals of UK assets as they arise.

For more information about the concepts of residence and domicile, see Practice note, Taxation of employees: Residence and domicile.

Legislation will be introduced in the Finance Bill 2008 which will mean that a non-domiciled individual who has been resident in the UK for seven years must pay an additional tax charge of £30,000 a year in order to continue to be taxed on a remittance basis.

If an individual decides not to use the remittance basis (and not pay the additional £30,000 tax charge) they will be taxed in the UK on all their worldwide income and gains whether or not they are remitted to the UK.

The new rules will come into force on 6 April 2008. For an individual resident in the UK before that time, the seven year period starts from the start of their period of residence and not from the date that the new rules come into effect. So, for example, an individual not domiciled within the UK who has been resident in the UK for five years in April 2008 will only be able to claim the remittance basis of taxation for two more years before they have to pay either the £30,000 annual tax charge or pay tax on worldwide income and gains.

Rules will also be introduced in the Finance Bill 2008 so that:

Days of arrival and departure are counted in determining if an individual is resident in the UK in any year. When deciding if an individual is resident in the UK for tax purposes, HMRC does not, generally, currently count the days they arrive in or depart from the UK. On and after 6 April 2008, days of arrival and departure will be counted as days of presence in the UK for residence test purposes. For the current rules, see Practice note, Tax issues on the relocation of employees: Residence.
Individuals taxed on a remittance basis will not be entitled to personal allowances unless their unremitted foreign income is less than £1,000 a year.
Some anomalies in the remittance basis are removed. These anomalies mean that individuals using the remittance basis of taxation can arrange their affairs to avoid paying UK tax on foreign income and gains effectively brought into the UK

The government hopes that these changes, together with changes to the rules on capital gains tax (see Capital gains tax reform) will ensure that the tax treatment of individuals in the private equity industry operates more fairly (Paragraph 4.59 of the Pre-Budget Report). See also Private equity.

For further information, see 2007 Pre-Budget Report - PBRN 18 - Residence & domicile review.

The remittance basis of taxation does not currently apply to investment income arising in the Republic of Ireland or to earnings from employment with an employer resident in the Republic of Ireland. These restrictions on the availability of the remittance basis will cease from 6 April 2008.

For further information, see 2007 Pre-Budget Report - PBRN 19 - Remittance basis: Irish investment income and employment income.

Clarification of the investment manager exemption

New measures will amend the investment manager exemption (IME) to clarify and simplify the scope of the transactions to which the IME applies.

The IME enables non-resident investors to appoint UK-based investment managers without the risk of exposing themselves to UK taxation provided certain conditions are met. Investors may be funds or individuals. For more detailed information on the IME, see Legal update, Investment manager exemption: HMRC updated statement of practice and Practice note, Investment funds: tax: Offshore company.

The Finance Bill 2008 will amend the existing legislation so that:

The list of transactions to which the IME applies will, with some exceptions, be brought more into line with activities regulated by the Financial Services Authority.
The tax outcome is proportionate where one of the conditions for the IME is not met. This will be achieved by removing a rule which can currently have the effect that the whole of a non-resident’s UK profits are brought into the UK tax net if the investment manager acts in the capacity of a permanent establishment.

The new measures will have effect on and after the date that Finance Bill 2008 receives Royal Assent . The changes are positive and will be welcome, particularly the removal of the risk under the current rules that a minor non-qualifying transaction can cause the whole exemption to be forfeit.

For further information, see 2007 Pre-Budget Report - PBRN 07 - Investment manager exemption.

Consultation on legislation to counter income shifting: HMRC's response to Arctic Systems

In the 2007 Pre-Budget Report, the government confirmed that they will soon begin a consultation on draft legislation to counter income shifting. The intention to legislate had already been announced following the House of Lords judgment against HMRC in the Arctic Systems case - see Legal update, Arctic Systems: new legislation announced following HMRC's defeat in the House of Lords.

The new legislation will take effect from 2008-2009 and will aim to counter arrangements which divert income from one individual to another who is subject to a lower tax rate, to obtain a tax advantage (income shifting). Diverted income in the form of company dividends or partnership profits will be targeted, but employment income, savings interest and income of any other type will not be. In determining whether the provisions against income shifting should apply, the legislation may take account of factors such as the following:

The work done by the individuals;
The investments made by them; and
The risks to which they are subject,

in the business.

For further information, see 2007 Pre-budget Report - PN02 - Protecting tax revenues: Income shifting.

Consultation on reforming the offshore funds regime

The Treasury has published for consultation a discussion paper on proposals to modernise the offshore funds regime, following informal discussions with industry. Comments are requested by 9 January 2008.

The current definition of an offshore fund is based on the regulatory definition of a collective investment scheme in the Financial Services and Markets Act 2000. The offshore funds legislation (contained in Chapter V of Part XVII of ICTA 1988) was introduced as an anti-avoidance measure with effect from 1 January 1984 to prevent income being rolled up in an offshore fund and effectively converted into chargeable gains, which were taxed much more favourably at the time (HMRC still views converting income into gains as advantageous).

The legislation achieves this aim by treating any gains arising on the disposal of a material interest in an offshore fund as income chargeable under Schedule D, Case VI for corporation tax purposes (or as miscellaneous income under Part 5 of the Income Tax (Trading and Other Income) Act 2005) unless the offshore fund is a "distributing fund" (that is, one that distributes at least 85% of its UK-equivalent profits) (for more background on offshore funds generally, see Practice note, Investment funds: tax: Offshore funds).

The main proposals in the discussion paper are:

A new tax definition of an offshore fund as, briefly, a non-UK vehicle in which investors pool their money to collectively invest in various types of assets which are not managed by the investors themselves.
A facility to elect to be a "Reporting Fund". This is broadly similar to a distributing fund under the current regime, but, among other things, the requirement to actually distribute income will be replaced with a requirement to report to UK investors their share of the fund's income. Funds that do not elect to be Reporting Funds will be "Non-Reporting Funds" and investments in such funds will be treated in broadly the same way as investments in non-distributing funds are treated under the current regime.
Removal of investment restrictions to enable Reporting Funds to invest, without limit, in other Reporting Funds, Non-Reporting Funds and other assets, building on the various changes made in relation to the current regime for distributing funds in the 2007 Budget (see Budget 2007: Changes to the Offshore Funds Regime). Administration will also be simplified and Reporting Funds will need to consider their direct holdings only.
Aligning the tax treatment of UK investors in offshore Reporting Funds with investors in UK authorised funds, so far as possible. Broadly, this means that investors will be taxed on the reported income of Reporting Funds, irrespective of how much income is physically distributed, with amounts not received being treated as re-investments to avoid double taxation.

For further information, see Offshore Funds: a discussion paper.

Denial of tax relief for interest relating to a later tax year

From 9th October 2007, further restrictions apply to the amount of tax relief for interest payments paid by individuals for certain qualifying loans, such as loans to invest in partnerships under section 383 of Income Tax Act 2007. This tax relief has previously been restricted to a reasonable commercial amount of interest for the relevant period (section 384, Income Tax Act 2007).

HMRC is aware of an avoidance scheme in which individuals paid all interest on the qualifying loan in advance. The scheme intended to accelerate the tax relief by claiming it in the tax year in which the interest was paid, regardless of the period to which the loan related. The loan was repaid, but the amount of the loan repayment was substantially reduced as the loan was not then interest bearing.

The amendments to section 384 mean that relief will only available from 9th October 2007 in respect of interest which relates to the tax year in which it is paid (or part tax year if the loan is made part way through the year). It will not be possible to claim relief for interest paid in advance if an excessive amount of interest has been paid from the start of the loan to the end of the particular period. It will not be possible to carry forward any interest which cannot be relieved in a particular tax year for relief under section 383 in future tax years.

For further information, see 2007 Pre-Budget Report - PBRN 03 - Tackling Avoidance: individuals paying interest in advance: restriction of loss relief and Draft legislation: restrictions on interest relief.

Inheritance tax: nil-rate band to be transferable

With immediate effect, the inheritance tax (IHT) nil-rate band allowance will become transferable between spouses and civil partners. If a person dies with any unused nil-rate band allowance, the unused part may be claimed by their surviving spouse or civil partner. In other words, for those who do not use any of their nil-rate band because their entire estate passes to their surviving spouse or partner, the IHT nil-rate band available to the spouse or partner on their subsequent death is effectively doubled. In the 2007/08 tax year, the nil-rate band is £300,000.

Transferable nil-rate band allowances will be available to survivors of marriage or civil partnership who die after 9 October 2007, regardless of the date on which the first spouse or partner died. HMRC has published draft legislation to implement the change in the Finance Bill 2008, together with illustrative guidance (see Finance Bill: Inheritance tax: transfer of unused nil-rate band etc, PBR draft).

Corresponding changes will be made in relation to alternatively secured pensions (ASPs). Broadly, an IHT charge arises on residual ASP funds when a dependent's pension ceases on their death. But in future, any unused nil-rate band allowance that was available on the original member's death will be passed to the estate of the dependant.

These changes appear highly political, and a direct response to proposals put forward by the Opposition last week.

For further information, see 2007 Pre-Budget Report - PBRN 16 - Inheritance tax (IHT) nil-rate band.

SDRT and unit trusts

The government will be consulting on options to make the rules relating to stamp duty reserve tax (SDRT) and unit trusts simpler to administer and easier for investors to understand. However, no further details were published on the proposals.

Section 122 and Schedule 19 to Finance Act 1999 introduced an SDRT regime in respect of surrenders or transfer of units in unit trusts and open ended investment companies (OEICs) taking place on or after 6 February 2000, by way of substitution for stamp duty.

The regime generally imposes an SDRT charge at 0.5% on the value of surrenders of units to the managers or trustees, which is potentially reduced by two ratios as follows:

If more units are surrendered than issued during the two week period, which consists of the week the surrender occurs and the following week, then the liability is reduced by multiplying it by the ratio I:S (where I and S are the number of units issued and surrendered in the two-week period).
If a fund has investments in exempt assets, the liability is further reduced by multiplying it by the ratio N:(N+E) (where N and E are the average market values of the non-exempt and exempt assets of the fund over the two week period).

For background on SDRT generally, see Practice note, Stamp Duty Reserve Tax.

For further information, see 2007 Pre-Budget Report - Chapter 4 - Sustainable growth and prosperity, Box 4.6.

Private equity

The 2007 Pre-Budget Report contained the following announcements of particular relevance to tax as it relates to the private equity industry:

Shareholder debt. The rules that apply to shareholder debt in leveraged private equity transactions will not be changed following the review announced in March 2007. Paragraph 4.58 of the main Pre-Budget Report says that the government is satisfied that the 2005 changes to the transfer pricing rules have sufficiently extended the scope of the transfer pricing rules to cover all private equity transactions (for background on those changes, see Legal update, Corporation tax: transfer pricing). However, the government will continue to monitor the operation of the transfer pricing rules in relation to shareholder debt in leveraged transactions. The government has already ruled out making wider changes to the interest relief rules (in the joint Treasury and HMRC discussion paper entitled "Taxation of the foreign profits of companies" it published on 21 June 2007; see Article, Corporate tax reform: in with the new, PLC magazine, July 2007).
Taper relief and domicile and residence rules. The reform of capital gains tax to a single rate of 18% from 6 April 2008 and the review of the residence and domicile rules apply generally. However, interest in these areas has been fuelled by controversy about their application to individuals involved in the private equity industry (for further information, see Capital gains tax reform).
Employment related securities. Paragraph 4.59 of the main Pre-Budget Report says that the government "remains interested" in wider aspects of the ways in which those involved in the private equity industry are rewarded, including the application of the legislation on employment related securities. However, the controversial memorandum of understanding between HMRC and the British Venture Capital Association under which HMRC accept that the amount paid by managers for their "carried interest" will equal the actual or unrestricted market value if certain requirements are met has survived (for background on the memorandum, see Practice note, HMRC/BVCA memoranda: management interests in private equity and venture capital).

More generally, the Chancellor welcomed the Walker review and looked forward to improved transparency in the private equity industry. For background on the Walker review and other recent developments in this area, see Article, Private equity: out of the shadows, under the spotlight, PLC magazine August 2007.

For further comment on the impact of the 2007 PBR on share incentives, see PLC Share Schemes and Incentives, Legal update: Pre-Budget Report 2007: Main points for share schemes and incentives.

For further information, see 2007 Pre-Budget Report - Chapter 4 - Sustainable growth and prosperity; 2007 Pre-Budget Report - PBRN17 - Capital gains tax reform and 2007 Pre-Budget Report - PBRN18 - Residence and domicile review.

Property

Abolition of fire safety capital allowances

Capital allowances for expenditure on fire safety alterations required by Fire Authority notices is to be abolished from April 2008.

No capital allowances will be available where that expenditure is incurred on or after 1 April 2008 for companies, and on or after 6 April 2008 for businesses subject to income tax.

Capital expenditure on fire safety equipment such as fire alarms and sprinkler systems which has not been required by a Fire Authority notice is not affected. Such expenditure will continue to benefit from capital allowances currently at the rate of 25% per year on a reducing balance basis. The rate of allowances is set to reduce to 10% (for integral fixtures) and 20% (for plant and machinery) from 2008/2009. For further information on the government's current consultation on capital allowances, see Legal update, Corporation Tax: Capital allowances.

For further information, see 2007 Pre-Budget Report - PBRN 04 - Abolition of fire safety capital allowances.

Land remediation relief and landfill tax

In the 2007 Budget, the government launched a consultation on the extension of land remediation relief and the landfill tax relief for waste from contaminated land (see Legal update, Budget 2007: Land remediation and Legal update, Budget 2007: Landfill tax and the contaminated waste regime).

In the 2007 Pre-Budget Report, the government stated that responses to the consultation had supported the reforms and that it will consider further reforms in these areas to bring more brown-field land back into effective use. The government intends to publish responses to the consultation shortly and to make further announcements in the 2008 Budget.

For further information, see 2007 Pre-Budget Report.

Reduced rate of VAT to encourage occupancy of empty homes

From 1 January 2008, the reduced 5% rate of VAT on renovation and alteration works to empty residential property will be extended to include properties that have been empty for between two and three years.

Currently, the 5% VAT rate only applies housing that has been unoccupied for at least three years.

The standard rate of VAT (currently 17.5%) will apply to any renovation and alteration works not qualifying for the reduced 5% rate, that is, works carried out on houses that have been empty for less than two years.

The measure will be introduced (presumably before the end of 2007) in statutory instrument form and is one of several measures mentioned by Alistair Darling in his Pre-Budget Report speech which are designed to assist the government's attempts to address the chronic lack of housing in the UK. The other measures include planning reforms (see 2007 Pre-Budget Report - implications for Property.

For further information, see 2007 Pre-Budget Report - PBRN 25 - VAT and housing.

REITs

The government has recently reviewed the viability of residential UK real estate investment trusts (REITs) and the REITs listing requirements but has concluded that there is not at present a compelling case for change. However, the REITs regime will continue to be kept under review.

For further information, see 2007 Pre-Budget Report - Chapter 6 - Stronger communities and a better quality of life, paragraph 6.18.

SDLT: certain land transactions not notifiable

With effect from the date of the 2008 Budget, all land transactions (residential and non-residential) where the chargeable consideration (including linked transactions) is under £40,000 will not require a land transaction return.

Most land transactions are required to be returned, even where no SDLT is due. Currently, there are specified exemptions from the obligation to submit an SDLT1 form of return including transactions where there is no chargeable consideration and certain probate transactions. For further information on SDLT, see Practice note, Stamp duty land tax.

New exemptions from returns to be introduced in the Finance Bill 2008, effective from the date of the 2008 Budget, will cover:

All land acquisitions (excluding leases) where the chargeable consideration (including that of linked transactions) is less than £40,000.
Leases of seven years or more where the non-rent consideration is less than £40,000 and the annual rent is under £1,000.

This measure will assist the government by reducing the administrative burden of processing land transaction returns, but only in the limited circumstances where the chargeable consideration is very low. To the extent that land acquisitions qualify for the exemption, property buyers will benefit from not having to complete and submit returns.

For further information, see 2007 Pre-Budget Report - PBRN 21 - SDLT: change in notification thresholds for land transactions.

SDLT: change to anti-avoidance legislation affecting partnerships

This change will apply retrospectively to transactions occurring on or after 19 July 2007 involving certain transfers of partnership interests within property investment partnerships. It will correct anti-avoidance legislation introduced in Finance Act 2007 which went too far.

The measure is being introduced by the government following lobbying by the property industry. The Finance Act 2007 anti-avoidance provisions were aimed at tackling avoidance schemes that exploited SDLT-free partnership property transfers. However, those provisions inadvertently taxed the following transactions even though no consideration was provided:

An existing partner transferring all or part of their partnership interest to a new or existing partner.
A person becoming a partner or increasing their existing share in the partnership and one or more existing partner(s) reducing their partnership share (or retiring from the partnership).

The correction will no doubt be welcomed by the property industry.

However, there will be instances (for transactions between 19 July 2007 and the date of the Pre-Budget Report (that is, 9 October 2007)) where SDLT has already been charged under the Finance Act 2007 provisions and paid over to HMRC. As a result of these measures, taxpayers will be due a refund of tax and, presumably, a repayment supplement. No announcement has been made about the procedure for obtaining refunds and any repayment supplement, but it is hoped that such provisions will feature in the Finance Bill 2008 or that new regulations will be introduced.

Furthermore, because the new measures are stated not to take effect until Budget Day 2008, it seems that the 2007 provisions will continue to operate between 9 October 2007 and Budget Day 2008 so that, technically, tax and returns will still be triggered by transactions falling in that period. Once the changes have been introduced, taxpayers will, presumably, be due a refund of this SDLT, together with, presumably, a repayment supplement. This result seems quite absurd and it remains to be seen whether the government can and will introduce some sensible concessions which effectively give immediate effect to the new measures so as to avoid this situation arising.

For further details, see 2007 Pre-Budget Report - PBRN 22 Stamp Duty Land Tax (SDLT): Change to Anti-Avoidance Legislation Affecting Partnerships.

SDLT: consultations in connection with high value residential property

The government will consult on:

Whether to extend the disclosure regime to stamp duty land tax avoidance for high value residential properties. The disclosure regime operates to identify and then stop certain marketed tax avoidance schemes.
Whether it is practical to address the use of special purpose vehicles to reduce stamp duty land tax avoidance on high value residential properties.

For more information on the SDLT disclosure regime, see Practice note, SDLT disclosure regime.

For further information, see 2007 Pre-Budget Report - Chapter 5 - Fairness and opportunity for all, paragraph 5.97 and 5.98.

The planning gain supplement has been scrapped

The government has announced that it will not be proceeding with legislation for a planning gain supplement. Instead, it will be introducing a new statutory planning charge in the forthcoming Planning Reform Bill in order to fund infrastructure. The Housing Minister, Yvette Cooper has issued a statement on the Bill, see Planning reform - Corporate - Communities and Local Government.

For further details, see 2007 Pre-Budget Report - implications for Property.

VAT

VAT simplification

The government announced that it would be launching a joint HMRC and Treasury review this autumn with the aim of simplifying certain aspects of VAT. They consider that there may be scope for simplification in relation to: procedures relating to the option to tax, partial exemption and the capital goods scheme, the frequency of returns and VAT retail schemes. Unsurprisingly, there may also be complexities that require simplification at EU level.

For more information about VAT, see Practice note, Value added tax and Practice note, VAT and property transactions.

For further information, see Tax simplification reviews.

Pre-Budget Report 2007 | Practical Law