Article by Colin Davis, CIOT Technical Officer for corporate and international tax matters, summarising developments on large business taxation.
Published in October 2001 issue of Tax Adviser.
During the past four years, a number of important changes have been introduced or announced which affect the taxation of large companies. The consultative document issued by the Treasury on 19 July draws them together in an attempt to present a coherent strategy for the reform of large business taxation.
This paper reviews the changes already implemented and summarises the current state of consultations regarding proposed changes. Comments from members on consultations in progress are welcome.
Changes already implemented
First came withdrawal of tax credit repayments to pension funds (regarded as a retrograde step by most commentators, the effects of which are currently compounded by a fall in the stock market and interest rates, and an increase in the longevity of scheme members). Although not consulted on beforehand, it was justified by the Government as restoring a level playing field between distributed and retained profits. For the same reason, and after consultation, advance corporation tax (ACT) itself was then abolished –a step which was more widely welcomed.
This change was coupled with the introduction of Quarterly Instalment Payments of corporation tax for large companies (QIPs), based on estimates of current liability. It remains to be seen how well companies are coping with the problem of estimating corporation tax liabilities in advance. Life is made marginally less difficult for groups by the introduction of group payment arrangements under which the tax liability can be estimated, and QIPs paid, for the group as a whole. The QIPs are subsequently allocated to specific companies when the tax computations are prepared. The CIOT has pressed for a preceding year basis for QIPs, but this has been resisted. The Revenue are conducting a review of QIPs in the light of final tax computations for the accounting periods concerned, and have promised to discuss the outcome with the representative bodies.
Last year saw important changes in the system of double tax relief for dividends received from overseas subsidiary and associated companies. There was no prior consultation on these changes (except for a consultative document the previous year which reviewed the principles of double tax relief by credit and exemption methods, but gave little hint of the direction of any intended change). The original proposals removed the possibility of ‘mixing’ credits for foreign taxes exceeding the UK rate with lower credits on dividends from low-taxed profits. Late amendments were made to last year’s Finance Bill and further amendments have had to be made in this year’s Finance Act. These have restored some of the benefits of the former ‘mixing’ regime by allowing some ‘onshore pooling’of tax credits, but under rules which are not benign to the offshore structures of group ownership of subsidiaries that the previous regime had encouraged. Some problems remain, and it remains to be seen how the system, which is now extremely complex will bed down.
Although the possibility of moving to an exemption system for foreign dividends is discussed briefly in the latest document on substantial shareholdings (see below), such a move risks either allowing some low taxed profits to escape further tax on repatriation to the UK (which could be an unacceptable cost to the revenue) or removing the remaining ability to shelter such tax by ‘mixing’ or ‘pooling’ (unwelcome to corporate taxpayers). It could possibly also be accompanied by restrictions on the deduction for interest payable within the shareholder’s group, which would be most unwelcome. Therefore, it is widely expected that the existing system will continue, although there will be pressures to address some of its problems and complexities.
The rules relating to group relief and intra-group transfers of assets have been widened to bring them into line with recent decisions of the European Court of Justice. The government also chose to extend these benefits to groups with parent companies outside the European Union. This is a welcome change.
The requirement to deduct tax at source from payments of annual interest etc. has been removed in relation to intra-UK payments. The CIOT has welcomed this change, but has also called for a general abolition of withholding tax on such payments.
Future changes which have been announced
Intellectual property and other intangible assets
The law relating to the taxation of intellectual property is to be reformed. The present law is a combination of fragmented legislation and case law. It lacks coherence and clarity. The proposed reform, broadly speaking, will tax all profits and relieve all losses, of both a capital and revenue nature, as if they were all revenue items, and by reference to the accounting treatment – similar to the tax treatment of loan relationships introduced in 1996. It has been the subject of detailed consultations, and much progress has been made in the development of the new rules.
A major problem has been the absence of a clear dividing line between intellectual property such as patents and copyrights, and other intangible assets such as goodwill. A decision has been taken to include all intangibles within the reform. This then raised the question of rollover relief for gains on disposals of goodwill. The Revenue have responded with a generous proposal for a reinvestment relief to be retained notwithstanding the inclusion of goodwill in the ‘deemed revenue’ regime.
Another major issue is the acceptance of the accounting treatment of intangible assets for tax purposes. The proposal is to accept the application of FRS 10 for tax purposes, subject to adjustments for bundled assets, items not reflected in the profit and loss account, intra-group transfers and consolidation adjustments.
Gains on substantial shareholdings
Similarly, there has been detailed consultation on the proposed relief for gains on the disposal of substantial shareholdings. This is intended to improve the competitiveness of the UK as a parent company location and to remove tax disincentives to groups in rationalising their strategic holdings. Considerable progress has been made and this is reflected in the details contained in the latest document. In particular, in response to representations made by various organisations, the preference now seems to be for an exemption rather than a deferral, although a final decision on this had not been taken at the time of writing.
A major issue has been the definition of substantial shareholding. It is intended that the relief should apply in relation to structural shareholdings rather than portfolio shareholdings. The original leaning towards a 30 per cent shareholding has been modified to a 20 per cent holding (on a TA 1988, Sch. 18 basis). The Treasury is apparently concerned that this might be too restrictive, but recognises that there needs to be a rule which can be operated in a self assessment environment without too much judgement being involved. Consultation continues on this and other matters.
Another major topic of discussion has been the definition of trading company and trading group. The Revenue believe that technical consideration prompt reference to an activities test, such as applies for taper relief purposes, but the merits of a purpose test have been widely canvassed.
There will be further discussions on the operation of the de-grouping provisions of TCGA 1992, s. 179 in the context of the proposed new relief.
Relief for expenditure on R&D
The Revenue have had a very good response to the ‘Increasing Innovation’ consultative document which proposes a 150 per cent deduction for qualifying expenditure on research and development (R&D). The preferred incremental scheme has, however, come in for criticism for being very complex. Most if not all representative bodies, including the CIOT, have lobbied for a volume based scheme, like the scheme for small and medium sized enterprises (SMEs) introduced by FA 2000, Sch. 20. The problem for the government is that it has only a limited amount of money available for the scheme, and wants to target the relief as effectively as possible to increase the amount of R&D undertaken. However, to achieve this it needs to influence decisions of large companies. Influencing decisions means getting reliable information to directors at the time the decisions have to be made, but precise targeting means complex definitions and caveats, which make it difficult for directors to determine in advance whether the relief will be available.
Two problems arise whichever scheme is chosen and further consideration is likely to be given to each. The first is how to deal with sub-contracted R&D work. The preference appears to be for the contractor rather than the sub-contractor to get the new relief. Allied to this is a proposed requirement that the R&D expenditure should be incurred for the purposes of a trade carried on in the UK.
The second problem is what requirements there should be regarding the ownership of any intellectual property (IP) arising from the R&D work. It had been proposed that any IP should belong to the company incurring the qualifying expenditure. However, in some groups all IP is held by one company, often in the jurisdiction of the parent company. This appears to imply a transfer of rights by the company incurring the R&D expenditure to the IP company. The transfer pricing rules will apply to such a transfer.
Corporate debt, financial instruments and forex
A consultative document issued by the Revenue on 26 July proposes to deal with a number of limitations in these three tax regimes, including assimilating the forex legislation into the financial instruments and loan relationships legislation, with a consequent repeal of the existing foreign exchange (forex) legislation and regulations. This follows consultation on a Technical Note issued on 7 November 2000. Anti-avoidance legislation is also to be enacted.
This is a complex area of tax law. The CIOT has welcomed certain aspects of the proposals, such as the intention to address some of the problems that arise with connected party debt. It has, however, urged the government to allow proper time for consultation over the detail, otherwise there is a danger that many of the problems with the original legislation caused by its complexity and unfamiliarity both to taxpayers and Inspectors, will be repeated again. This danger arises even for areas of change that are welcome in themselves, but some aspects of the proposals will also remove opportunities that were given to the taxpayer in the original forex regime.
Employee share awards and share options
The Government is considering whether a corporation tax deduction can be given for employee share awards and options. No details were available at the time of writing.
At present, the issue of shares does not usually result in any change to profit and loss account. No expenditure is incurred by the company, so there is nothing to deduct for tax purposes. If the proposed changes in accounting standards are implemented, then as from some future date, amounts will more typically be charged in the profit and loss account. One of the ideas likely to be consulted about is whether the tax treatment should more closely follow the accounts treatment.
There is an anomaly under the present system in that (in the absence of specific planning) shares acquired by employees, otherwise than under an approved scheme, give rise to a charge to income tax under Sch. E without any corresponding deduction for the employer company.
Comments from members
These should be sent to Colin Davis at the CIOT.
020 7235 9381
October 2001 by