One of a series of articles by Adrian Rudd of PricewaterhouseCoopers, Tax Adviser's representative on the Technical Committee, focusing on FA 2000 (published in December 2000 issue of Tax Adviser).
Each year the Technical Committee makes detailed representations about the provisions in the Finance Bill, highlighting technical and practical issues arising. Some of these comments result in amendments being made to the legislation before enactment. This article summarises some of these points, and includes the Inland Revenue’s responses to the points raised by the Institute. Further issues will be highlighted in other articles. References to sections are to the Finance Act.
Sections 62 - 63 and Schedules 14 – 15: Enterprise investment scheme and venture capital trusts
The Institute welcomed the reduction of the holding period from five to three years, but was disappointed that this will only apply to shares issued on or after 6 April 2000. This will introduce further complexity into a very complex relief, particularly for serial investors who will have different rules for holding periods for investments made in different companies at various times. The Institute suggested that the holding period be amended to three years for all investments, irrespective of the date of issue of the shares.
The Revenue replied that the purpose of the EIS and VCT schemes is to attract new money into small higher-risk growing companies. Reducing the period for existing shares will not attract any new investment. Furthermore existing investments were made on the basis of a five-year holding period. The increase in complexity is only marginal and no different for an investor who has a range of different investments maturing on different dates.
The Institute commented that amendments to TA 1988, s.297 relating to the receipt of royalties or licence fees are restricted to situations where the intangible asset has been created by the company carrying on the trade. Given that the purpose of the relief is to stimulate entrepreneurial activity, it appears strange that distributors of products who receive licence fees will still fall outside the definition of a qualifying trade.
The Revenue replied that the relaxation provided by s.297 was intended to encourage the development by the company (or group) of new intangible assets beyond computer software and those arising from research and development. Including companies which have acquired intangible assets created by third parties could channel tax relief to low risk passive investment activities rather to entrepreneurs.
Sections 66 and 67: Taper relief
As a result of the Finance Act, many shareholdings became business assets for the first time on 6 April 2000. This change in status means such a shareholding acquired before 6 April 2000 and sold before 6 April 2010 will bear capital gains tax at a higher rate than if the same shareholding were acquired on 6 April 2000 and sold on or after 6 April 2004.
For example, assume such a shareholding is sold on 6 April 2004. If bought on 6 April 2000, only 25 per cent of the gain will be taxed. If bought before 17 March 1998, 41.67 per cent of the gain will be taxed. The Institute cannot understand the policy reason for taxing assets held for a longer period more harshly than those held for a shorter period. It suggested that taper relief for business assets should be calculated using the greater percentage based on the actual period of ownership or a deemed acquisition date of 6 April 2000.
The Revenue advised that the taper system is designed to reflect not only the length of time that an asset has been held, but also whether it has been a business or a non?business asset. The Revenue sees no unfairness in charging to tax a higher proportion of the gain on an asset that has been partly a business asset and partly a non business asset in the relevant period of ownership than in the case of an asset that was a business asset throughout. The actual asset history should not be disregarded when assessing taper relief.
Meaning of ‘trading company’
The Institute predicted that following the significant relaxation of the definition of qualifying shareholdings for business asset taper relief, the narrowness and imprecision of the definition of ‘trading company’ will cause difficulties for taxpayers. Many investments which might be expected to qualify for taper relief as a business asset will not in fact qualify.
The Revenue promised to issue guidance later in the year on the interpretation of the phrase ‘trading company’. This will deal with the meaning of the word ‘substantial’ when assessing whether a company is substantially trading.
If employees are in doubt as to whether their companies are defined as trading for the purpose of taper relief, they should contact the company. The company should discuss the issue with its inspector if it is in doubt. If there turn out to be real difficulties in practice, then the Revenue will consider whether some more structured process needs to be put in place.
Employees who retire
The Institute pointed out that the extension of the definition of business assets to include shares held by employees of a trading company, or the holding company of a trading group, could prejudice an employee who decides to retain the shares following retirement, since the shares would no longer be qualifying business assets. The purpose of taper relief is to encourage long-term investment in business assets, yet these changes will have the opposite effect for retiring employees. The Institute suggested that taper relief should be based on the greater percentage at the date of cessation of employment or the date of disposal of the shares.
The Revenue advised that the purpose of the special tax relief for employee shareholdings is to obtain productivity benefits by aligning the interests of employees with those of the company. These benefits cannot arise once an employee has retired. So the Government would not be able to justify to other taxpayers a special tax benefit for retired workers.
The Revenue pointed out that in some cases, employees who retire retain business assets status for their company shareholdings, for example if the company is an unlisted trading company or if the ex-employees hold at least five per cent of the voting rights.
If not, then on a disposal of shares within ten years of retirement, the apportionment process will give due credit for the period that the asset had been a business asset.
Section 69 and Schedule 20: Research and development (R&D)
Restriction to small and medium-sized enterprises (SMEs)
The Institute believes that large companies should be entitled to this relief, since R&D is as important in large companies as in SMEs. Indeed, the production of new goods often requires a level of capital and other resources found only in large companies. Further, the use of the Companies Act definition of SMEs means that companies which make losses or small profits could be regarded as large companies for the purpose of the relief. If an exclusion for large companies were required, then the definition used for corporation tax quarterly payments would be more appropriate.
The Revenue advised that R&D tax credits are aimed specifically at the SME sector because these companies are most likely to grow and increase their R&D, but they also face the greatest barriers to risk and funding. Large companies do not face these same barriers and to include them within the scheme would increase the cost considerably without bringing matching benefits.
Restriction to scientific research expenditure
The Institute feels that restricting relief to scientific research expenditure will render the relief largely ineffective. The relief should be extended to expenditure on industrial and commercial R&D – this is essential to improving the competitiveness of business and is as important as pure science. Frequently pure research in the UK has led to profitable commercial developments in other countries. The Institute suggested that any new tax incentive should be focussed on the commercial exploitation of new inventions and discoveries, since this is where the present system is inadequate.
The Revenue replied that R&D tax credits are available for spending on pure and applied research, and experimental development. The definition of R&D for tax purposes is based on, and has the same scope as the definition of R&D used generally. It follows the OECD’s international standard for measuring R&D, which also forms the basis for the accounting standard in SSAP 13. R&D does not include wider commercial and product development. The tax credit focuses on R&D because it is designed encourage innovation by smaller companies and, as noted above, aims to address some of the particular difficulties faced by such businesses accessing finance and bearing the clear risks of R&D.
R&D tax credits are not given on capital spending on R&D because this already benefits from the generous 100 per cent scientific research allowances (now renamed research and development allowances). These greatly accelerate relief for spending on assets that would otherwise qualify for allowances at lower rates (for example IBA or M&P), and provide relief where none would otherwise be due, for example on offices used for R&D.
Revenue expenditure on R&D will normally be written off immediately to profit and loss under SSAP 13. The R&D tax credits scheme reflects this and increases the amount of this deduction. The Revenue believes that this is simple and straightforward. Considerable complexities would be introduced if the tax credit were to be given on deferred expenditure that has not yet been recognised as a deduction in the profit and loss.
The Revenue made two further points. First, it considers that the 20 per cent discount is an appropriate measure for the payable R&D tax credit, in particular bearing in mind the introduction of the 10 per cent starting rate in addition 20 per cent rate of tax for small companies.
Secondly, a company will not be prevented from claiming relief under the Corporate Venturing Scheme merely because it invests in a company that is entitled to R&D tax credits.
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