UK: The 2006 Budget (Part 1 of 2)

Introduction

This was the Chancellor of the Exchequer’s tenth Budget. Back in 1997, when Gordon Brown gave his first Budget speech, the Harry Potter book phenomenon was just beginning and Titanic was the biggest box office movie. Today, in the background notes to the Budget, there was more than a whiff of magical sleight of hand and the impending doom of tax breaks being soaked in cold water. The detailed analysis of the Budget proposals are contained in the following pages. However, some of the key highlights are as follows:

• Significant changes have been announced to the tax treatment of interest in possession and accumulation and maintenance trusts. These will broadly affect many families who have held assets in such trusts and who will now find they are within the same inheritance tax regime that currently applies to discretionary trusts. This will require much restructuring and seems to hit hardest on those planning for the future eg towards paying for children’s education. This ironically contradicts the strong Budget speech theme of trying to enhance the UK’s education offering. Various other changes to the trust rules were also either announced or confirmed.

• Self assessment filing deadlines look set to change from 2008. The deadline will be brought forward from 31 January to 30 September if you want to file a paper copy and until the end of November if you file on-line. The big issue will be whether Her Majesty’s Revenue & Customs (HMRC) information technology systems will be able to cope with the inevitable rush to e-file.

• We now know far more about the much awaited rules for Real Estate Investment Trusts (REITs). For example, the conversion charge has been set at 2% of the value of the company’s investment properties and many will be looking to see if REITs offer a useful new way forward.

• Anti-avoidance continues to dominate the technical papers from HMRC. There are changes to the disclosure rules and numerous measures hitting at marketed employment and financial product schemes which have been revealed to HMRC already.

• With pensions ‘A-Day’ only days away, some more changes were announced to the rules with a little more detail on prohibited assets.

• The Venture Capital Trust (VCT) market now knows that its existing 40% income tax relief rate will not revert to 20% at the end of this tax year but will go to 30%. Other announcements were made to the tax shelter rules which will affect the VCT and Enterprise Investment Scheme markets. 

With a record 64 Budget Notes, running to 156 pages, and numerous consultation papers and other publications, this was a bumper Budget pack. If this turns out to be Gordon Brown’s last Budget he has certainly gone out with one to remember.

Francesca Lagerberg 
National Tax Director at Smith & Williamson
22 March 2006

1. Personal tax

1.1 Personal tax rates

There were no major headline changes to income tax rates. The personal tax allowance for those under 65 rises by £140 to £5,035 in 2006/07. The Capital Gains Tax (CGT) annual exemption for individuals goes up by £300 to £8,800 from 6 April 2006 and the Inheritance Tax (IHT) nil rate band threshold rises to £285,000.

Comment: The Chancellor found himself with enough funds to follow through his initiatives on education etc and therefore did not need to tap into raising funds via the personal tax rates. We now know there will be a small IHT nil rate band increase for each of the next few years so that by 2009/10 it will have risen to £325,000.

1.2 E-services and filing deadlines

On the day of the Budget, Lord Carter of Coles announced his review of e-services. This includes a range of measures to encourage us all to file our tax returns on-line and also a specific measure aimed at changing the self assessment filing deadlines. For those who still want to file paper copies of their 2007/08 tax returns, the filing deadline will be 30 September 2008. This is a significant change from the existing 31 January 2009 deadline. If you e-file your self assessment return, you will have until 30 November 2008 to send in the return. The Government has already stated it supports these changes. Also in the report is the suggestion that the enquiry window should run for 12 months from the date a return is filed.

Comment: The review of e-services contains a lot that is welcome but the more problematical decision to change filing deadlines for self assessment returns will dominate discussion. To succeed this will require a huge re-education process for taxpayers. It will require information providers e.g. banks, to send out relevant tax information on time. But most important of all it will require significant improvements in the HMRC information technology systems to cope with the rush to e-file. HMRC’s systems have consistently not been up to the job in the past and 2008 is but a short 2 years away.

1.3 Capital Gains Tax – Bed and Breakfasting

The rules are to be changed with effect from 22 March 2006 for the matching of share sales with purchases in certain limited circumstances. 

The matching rules match share sales to purchases in the following 30 days in priority over purchases made prior to the date of the sale. The rules were originally brought in to prevent people selling shares one day and re-acquiring them the next (‘bed and breakfasting’) in order to utilise the annual exemption or capital losses.

Following the loss of a tax case by HMRC and possible avoidance schemes being disclosed, the 30 day rule will not apply where the purchaser is non-resident or Treaty non-resident at the date of purchase. In that case, the sale will be matched to earlier purchases.

Comment: This targets specific avoidance and will be unlikely to apply under normal circumstances.

1.4 Alignment of tax and NICs

Smaller employers might be interested to note that there is to be a consultation on aligning tax and NICs to see if this can remove some of the tax obstacles that the current system provides. There will be a consultation in the Pre-Budget Report later this year but there are no hints as to options and proposals in this area yet.

1.5 lternative financing arrangements

For various religious reasons some individuals and companies prefer to invest or borrow under socalled ‘alternative finance arrangements’, which do not involve the receipt or payment of interest. Various changes are being brought in to help enhance the existing rules and in particular to develop them to be Shari’a compliant.

The new measures include:

• two additional financial arrangements that replicate the effect of investments or loans at interest, ensuring that they are taxed no more or less favourably than equivalent arrangements that do give rise to interest;

• provision for low-cost alternative finance arrangements by employers to employees to be taxed in the same way as equivalent loans that give rise to interest; and

• allowing other similar arrangements, which equate in substance to a loan or deposit but do not give rise to the payment or receipt of interest, to be brought into the existing legislation by Treasury Order.

The employee changes will take effect from 22 March 2006 and the remaining provisions will apply to arrangements entered into on or after 6 April 2006 for income tax purposes. The Stamp Duty Land Tax implications are covered in further detail in that section of this report.

1.6 Landlord’s Energy Saving Allowance

Minor enhancements are being made to the scope of the Landlord’s Energy Saving Allowance, which is only available to individual landlords (and others who pay income tax) who let residential property.

The enhancement is to extend the current allowance which allows for a deduction against profits for certain expenditure like loft and cavity wall insulation. From 6 April 2006 it will also include expenditure on draught proofing and insulation for hot water systems.

Comment: This measure is very minor but helpful to individual landlords. However, there is no assistance to corporate landlords looking to introduce energy saving measures.

1.7 Residence and domicile

This year’s statement on the hoary chestnut of residence and domicile reform is: ‘The Government is continuing to review the residence and domicile rules as they affect the taxation of individuals and in taking the review forward will proceed on the basis of the evidence and in keeping with its principles.’

Comment: This is word for word what the Pre-Budget Report 2005 said on this issue but a marked difference from the Budget 2005 which talked of consultation papers and asked for contributions to the debate. It looks like this review is stuck firmly in the ‘too difficult pile’ but that is a welcome result for many who were concerned about changes.

2 Business

2.1 Corporation tax rates

Although the main rate of corporation tax remains at 30%, from 1 April 2006 the nil rate band is abolished. This was announced in the December 2005 Pre-Budget Report. It means that the small companies’ rate of 19% will apply to taxable profits from £0 to £300,000. This removes the Non Corporate Distribution Rate (NCDR). Marginal relief from the small companies’ rate to the main rate on profits between £300,000 and £1.5 million will still be calculated using the fraction 11/400.

Comment: The previously announced abolition of the NCDR means that companies which have profits under £50,000 and make distributions will no longer be struggling with those complex series of rules but they will have to face a 19% tax charge. For a few companies that did not make full distributions this could give rise to a tax increase and rumours of a small de minimis to help them have come to nothing as yet. However, the Budget ‘Red Book’ notes at paragraph 5.84 that it is still concerned about ‘tax motivated incorporation’ and in particular agencies, contractors and employers encouraging taxpayers to use corporate structures to avoid tax. In particular it is targeting ‘disguised employment through managed service company schemes’. This suggests a crack-down in the near future on some composite companies which have not been operating within the spirit of the rules.

2.2 Research and development tax relief

HMRC has made two minor changes to the workings of research and development (R&D) tax relief. The first is in relation to the time limits for making claims. Until now, the repayable tax credit could be claimed within one year of the normal filing date, while claims for an enhanced deduction could be made up to six years from the end of an accounting period to which they relate.

New rules will align the process such that the repayable tax credit and enhanced deduction will need to be claimed within one year of the normal filing date. Transitional rules will apply for accounting periods ending before 31 March 2006 – a claim for the enhanced deduction will need to be made by the earlier of the current time limit and 31 March 2008.

Secondly, qualifying expenditure for R&D tax relief purposes will be extended to include payments made to clinical trial volunteers. In respect of the large company scheme this will relate to payments made from 1 April 2006. With regard to the small and medium sized enterprises (SMEs) scheme and vaccine research relief, this extension is subject to state aid approval from the European Commission.

Comment: Companies that believe they may be engaged in R&D activities should look to the possibility of claiming relief as soon as possible. It will no longer be possible for a company that is out of time in claiming the repayable tax credit to make a belated claim in the form of an enhanced deduction.

In Smith & Williamson’s 2005 Pre-Budget commentary it was reported that HMRC would be creating dedicated R&D units run by specialist staff and that a statement of practice would be issued. No further details were given in the Budget.

2.3 First year capital allowances for small business

HMRC has reintroduced, for one year only, an increased rate of first year capital allowances for small businesses spending on plant and machinery.

Small businesses normally receive a first year allowance of 40%. However, for spending incurred between 1 April 2006 and 31 March 2007, this allowance will increase to 50%. In effect, this accelerates the tax relief available for capital spending such that a small business can claim a larger relief against profits during the accounting period in which an investment is made.

A small business is one which satisfies two of the following criteria – not more than 50 employees, £5.6m turnover and £2.8m balance sheet total.

Comment: Small businesses looking to embark on a programme of capital allowance qualifying expenditure (or simply purchasing a new item of plant and machinery) are advised to defer or bring forward dates of expenditure such that they fall within the year to 31 March 2007.

2.4 Capital allowances for cars

A consultation document entitled ‘Modernising tax relief for business expenditure on cars’ was released with the Budget. This continues the review on the so-called ‘expensive’ car rules that operate for capital allowance purposes.

These rules relate to expenditure on cars costing more than £12,000 which are dealt with in a separate ‘pool’ when calculating capital allowances. The Government is keen to link this in some way with environmental issues e.g. carbon dioxide emissions.

Comment: The Government is consulting on three options:

1. Abolish the current restrictions and treat all cars in the same way as any other plant and machinery in the ‘general pool’;

2. Introduce a new car pool for all cars with a writing down allowance of less than 25%;

3. As Option 2 above but includes a range of first year allowances for cars depending on carbon dioxide emissions.

Option 3 is the Government’s preferred choice and is likely to be the outcome once consultation is complete.

2.5 Taxation of leased plant and machinery

The 2005 Pre-Budget Report released detailed provisions for changing the tax treatment of leased plant and machinery including draft legislation.

These proposals seek to remove tax as a consideration in choosing between lease finance and loan finance by taxing leases which function as financing transactions in a similar way to loans. Following the publication of this legislation, amendments have been made to the original proposals, and confirm the start date as applying to ‘long funding leases’ finalised on or after 1 April 2006.

The regime applies to leases of plant and machinery and similar transactions properly accounted for as leases under Generally Accepted Accounting Principles (GAAP).

GAAP recognises two types of lease: finance leases and operating leases, but within this recognition there are arrangements that range from short term operating leases to pure financing transactions. The reform introduces a definition to identify leases that function primarily as financing transactions – ‘funding leases’. Shorter leases will be excluded, so the provisions will only apply to ‘long funding leases’.

The advantage of capital allowances under shorter leases in most cases is minimal and would not effect the decision to lease an asset as opposed to finance it, and the new regime will therefore not apply to:

• leases of 5 years or less; and

• leases of between 5 and 7 years where, on an annual basis, the lease rentals do not vary by more than 5% (after excluding variations linked to changes in interest rates and exceptional payments made at or before inception) and the residual value implied by the lease terms is no more than 5% of the fair value of the asset at the start of the lease.

Hire purchase transactions with lessees will be brought into these rules if the lease should be accounted for as a finance lease under GAAP. Hire purchase transactions with overseas lessees will be treated in the same way as for UK lessees.

The taxation of long funding leases will be dependent on their correct accounting treatment. Where a lease is a long funding lease:

• Finance lessors will be taxed on the finance income recognised in the accounts, not gross rental receipts;

• Finance lessees in computing profits can deduct the finance cost elements of rental payments as shown in their accounts;

• Capital allowances will be available to lessees, not lessors.

And

• Operating lessors and lessees will be taxed in a similar way to finance lessors and lessees.

• Capital allowances will be available to lessees, not lessors.

To prevent double claims a lessee cannot claim where a lessor or any superior lessor is entitled to claim capital allowances. In such circumstances the lease will be treated as a non-funding lease.

Detailed transitional rules will be published in the final legislation, and an election will be introduced to enable lessors to be within the new legislation, providing the value of leased assets does not exceed £10m. The election will allow the lessor to be taxed on accounts profits provided the accounts reflect the statutory basis.

Comment: This is a reaction to recent tax cases where arrangements have essentially been financing transactions, and lessors have benefited from capital allowances, while the ‘real’ trade has been conducted by the lessee. The idea of the new legislation is to benefit lessees. However, the benefit of this for smaller entities is minimal because in most cases they will lack the profit sufficient to benefit from the relief.

2.6 Restrictions on the creation and use of corporate capital losses

As announced in the Pre-Budget Report with effect from 5 December 2005, Targeted Anti-Avoidance Rules (‘TAARs’) are introduced to prevent the avoidance of tax through the creation and use of capital losses by companies. Draft legislation and guidance notes were issued for consultation and revised versions of both have now been reissued. Some comments have been taken on board.

The new legislation is targeted specifically at three particular areas of avoidance:

• the contrived creation of capital losses;

• the buying of capital gains and losses;

• conversion of income to capital and using capital losses to create a deduction against income.

Conversely there is reassurance that the legislation will not apply where there is a genuine commercial transaction that gives rise to a real commercial loss as a result of a genuine commercial disposal.

a) Contrived creation of capital losses

Schemes or planning which create capital losses without the company/groups concerned actually suffering a commercial loss, in other words ‘contrived’ capital losses, will be disallowed by the new legislation, which will take effect to disallow losses that arise on or after 5 December 2005 where the arrangements have the obtaining of a tax advantage as one of their main purposes. Where a company can show that tax avoidance was not an objective of the arrangements, then these are unlikely to be caught by the legislation.

b) Loss and gain buying

This provision seeks to put a stop to schemes which have been created to deliberately avoid the existing capital gain and loss buying rules on a change of company ownership.

• Loss buying – the existing legislation will remain applicable in most cases, but where tax avoidance is a main purpose the new rules will override the current rules. Where the new rules apply, capital losses accruing on assets belonging to the company prior to the change of ownership will not be available to offset against gains in the new group. The new rules apply to tax advantages arising on or after 5 December 2005.

• Gain buying – New rules are targeted at denying the use of an intermediary’s capital losses to shelter gains. These new rules apply to tax advantages arising on or after 5 December 2005 and will apply where obtaining a tax advantage is a main, or one of the main purposes of the arrangements.

c) Conversion of income to capital and using capital losses to create a deduction against income

HMRC is concerned about the significant amount of unused capital losses available to companies being involved in future avoidance. To prevent this they are introducing two widely targeted antiavoidance measures to tackle two types of scheme that secure tax deductions in this area:

• ‘conversion of income to capital arrangements’ in which the converted income is then sheltered by existing capital losses;

• creating a capital gain which is covered by existing capital losses, and as a consequence of the arrangements, an income deduction is created.

The new rules will apply where the obtaining of a tax advantage was the main or one of the main purposes of the arrangements and HMRC will have to issue a notice to counteract the avoidance. Again, the purpose of the legislation is to capture tax avoidance schemes and not commercial transactions, such as sale and leaseback arrangements which are specifically excluded from the new anti-avoidance rules. Informal clearance procedures will be available in respect of these arrangements, which will apply to chargeable gains accruing on any disposal made on or after 5 December 2005.

Comment: The substance of the proposals in the Pre-Budget Report have now been largely enacted with the result that the more aggressive capital loss schemes which were the more obvious targets have been largely nullified. There are also guidance notes which give clear examples of how HMRC intend to interpret the legislation. Great care will need to be taken, particularly with group transactions because even those ideas which some may have considered routine planning, are now apparently caught according to HMRC guidance.

Transactions or arrangements which are implemented for bona fide commercial reasons giving rise to a real commercial loss as a result of a genuine commercial disposal should not be affected by these provisions.

2.7 Group Relief

The decision of the European Court of Justice (ECJ) in the case of Marks & Spencer v Halsey ruled that the group relief rules were not fully compatible with European law. As a result, proposals are being introduced to extend the rules for the relief of losses within a group. The rules apply to foreign subsidiaries resident in the European Economic Area (EEA) or a foreign subsidiary that has incurred the relevant loss in a permanent establishment in the EEA.

The foreign losses will be relievable in the UK after all possibilities of relief have been exhausted and future relief is not available in the country that the losses were sustained or in any other country.

Such losses will have to be recomputed under UK tax principles. Further, relief will not be available for losses other than the unrelieved foreign tax loss. The compliance obligation will fall on the UK based claimant companies that will have to prove that the loss is unrelievable and that it has been correctly computed.

As expected, anti-avoidance provisions are being introduced with effect from 20 February 2006 to deny loss relief where there are arrangements which either result in losses becoming unrelieved or give rise to unrelieved losses which would not have arisen but for the extension of the above relief. 

Subject to the anti-avoidance rules, the new rules will be effective from 1 April 2006.

Comment: Short of the abolition of group relief, which would have been very unpopular with UK taxpayers, HMRC had no option but to amend the UK legislation as a result of the ECJ ruling. It is estimated that the cost to the Exchequer of the proposals is approximately £50 million per annum. The practical difficulties of making the appropriate claims and the time limits have been shifted to the UK claimant company but further clarification is awaited.

2.8 Controlled Foreign Companies

It is proposed that the Controlled Foreign Companies (CFC) rules should be tightened further in respect of companies that become non-resident in the UK as a result of the tie-breaker article in double taxation treaties before

1 April 2002. The amendment will mean that such companies will become subject to the CFC provisions and eliminate their use for anti-avoidance purposes.

Comment: No Budget is complete without some measure to eliminate anti-avoidance that is not already within the CFC rules! The proposed change is to correct the anomaly that arose for companies that became non-resident before 1 April 2002.

2.9 Securitisation and International Accounting Standards

The temporary regime to allow securitisation companies to remain within UK GAAP from 1 January 2005 rather than convert to International Accounting Standards has been extended for another year until 31 December 2007. Companies that were within the regime on 22 March 2006 can elect to remain within it for another year.

2.10 Home computers for private use

The tax relief provided for Home Computer Initiative Schemes is to be removed from 6 April 2006. Although the HMRC press release is unclear, its helpline has confirmed that there are no transitional provisions.

Up to 5 April 2006 an employer has been able to lend a computer to an employee for entirely private use at home and there has been no taxable benefit provided the computer concerned cost no more than £2,500 or, if it has been leased, the rental was no more than £500 a year. From 6 April such computer equipment will be chargeable to tax as a benefit in kind measured at 20% of the market value of the computer when first provided as a benefit or the lease rental charge if higher.

Comment: This will come as something of a blow to employers who have introduced Home Computer Initiative Schemes, particularly if salary sacrifice arrangements have been used in conjunction. Typically such schemes bind the employee in for up to three years during which time they effectively pay for the computer which has until now been an exempt benefit. The employer will pay Class 1A NIC on the benefit that will replace the Class 1 NIC on the salary sacrificed, thus reducing the expected saving.

2.11 Mobile phones – more than one for an employee

A mobile phone provided by an employer to an employee for business and private purposes has been an exempt benefit in kind since April 1999. The exemption could also extend to more than one such telephone provided to the employee for himself and members of his family or household. From 6 April 2006 employer provided mobile phones in excess of one per employee will be treated as a taxable benefit in kind (between 1990/91 and 1998/99 a scale benefit of £200 per phone used privately was applied).

2.12 VDU users – eye tests or glasses

HMRC has informally let it be known that no tax charge will arise where an employer assists an employee who is obliged to use Visual Display Units (VDU) equipment with the cost of an eye test or prescription glasses if they are required for that purpose. HMRC then realised that it had failed to provide for vouchers, issued by employers to their employees to pay for necessary eye tests and/or glasses, to be automatically exempt from the special charge to tax on vouchers. It had also failed to include specific exemption for employer provided eye tests and glasses. These oversights will be rectified from 6 April 2006.

2.13 Company car and fuel benefit tax

The company car fuel multiplier has been fixed at £14,400 for 2006/07. This is the amount to which the percentage given by a car’s emissions rating is applied to arrive at the taxable benefit for private fuel. It has remained unchanged since it was originally introduced for 2003/04. 

Announcements have also been made concerning the carbon dioxide (CO2) emissions table for company cars for 2008/09. For cars with emissions of 120 grams per kilometre (g/km) or less the appropriate percentage will be 10%. For those with emissions between 121 g/km and 139g/km there will be no change and the old minimum percentage of 15% will continue to apply. Cars with emissions in the range 140g/km to 144g/km will have an increase of 1% to 16% in their appropriate percentage with corresponding increases applying across the table range so that the maximum of 35% will apply to cars with emissions in excess of 234g/km.

Comment: These changes are in line with the Government’s wider focus on driving down CO2 emissions. There is an attempt also to tax the more gas guzzling vehicles off the road.

2.14 Reform of Film Tax Relief

The Budget includes a final Regulatory Impact Assessment (RIA) which is a ten page document updating the information included in the Pre-Budget Report (PBR) and introducing the new relief. The relief is only available to ‘film production companies’ i.e. not individuals or partnerships and relates to the production of qualifying UK films. Such films will be determined by a new test administered by the Department of Culture, Media and Sport (DCMS) and will typically be films where at least 25% of film budget is spent in the UK. The relief will apply to films intended for theatrical release, that are culturally British as certified by the DCMS and where principal photography commences after 1 April 2006. Where principal photography commences before 1 April 2006, the existing tax relief under s42, Finance (No2) Act 1992 (‘large budget tax relief’) and s48, Finance (No 2) Act 1997 (‘low budget tax relief’) will continue to apply.

Comment: As announced in the 2004 Budget, the Government has put an end to film sale and leaseback partnerships which have been the subject of aggressive tax planning over past years and thus resulted in numerous press releases and anti avoidance provisions being introduced. However, this does not necessarily put an end to film partnerships as there are still likely to be opportunities for individuals to invest in the film industry as schemes relying on Generally Accepted Accounting Principles (GAAP) are not affected by the new rules.

2.15 Financial products: anti-avoidance

A raft of measures have been introduced to close down tax schemes which fall under the financial products heading of the disclosure of tax avoidance scheme rules. These measures block the following schemes:

• avoidance of tax on interest on cash using stock lending arrangements on non-commercial terms;

• arrangements involving purchase and sale of rights to distributions on shares used by financial traders to create tax losses;

• avoidance of tax through use of instruments which are economically loans but which are claimed not to be loan relationships because they cannot be settled in cash (so called ‘mandatory convertibles’) but by the issue of shares;

• exploitation of the group continuity rules for loan relationships and derivative contracts to take advantage of different accounting methods used by group companies, or to avoid tax on discount arising on transfers;

• exploitation of accounting rules which result in profits on loan relationships being de-recognised, and thus falling out of tax;

• avoidance of tax in respect of loan relationships under arrangements where the investor receives less than a full commercial lending return (which would be taxable), but another connected party receives the value of that return in a non-taxable form; and

• arrangements to hedge currency exposures resulting in tax relief where there is a loss on the hedge but no tax charge where there is a profit. Most of these changes take effect from Budget Day.

Comment: As the anti-tax avoidance unit gears up in HMRC, it is picking off known and marketed schemes. These changes all appear to be targeted measures aimed at closing down disclosed tax schemes.

2.16 Sale of Lessors

a) Leasing companies

As part of the wider reform of leasing taxation, measures were proposed in the Pre-Budget Report to change the taxation of leasing companies when they are sold with effect from 5 December 2005. 

In the early years of a leasing arrangement, the capital allowances available to the lessor will outweigh the taxable income arising from the leasing arrangement. Later in the life of the lease, this will change as the capital allowances pool reduces and the company will pay tax on the income.

The Government is aware of arrangements where leasing companies have sold leasing subsidiaries for a capital profit to groups with existing tax losses that can use them against the future taxable profits in the leasing subsidiary. The purchaser can buy an income stream at an advantageous price because of its tax losses, and the seller will not pay capital gains tax on the sale of the subsidiary because of the substantial shareholding exemption.

These arrangements will be prevented by the introduction of legislation that will:

• impose a tax charge on the lessor company on the day of sale equal to the tax benefit obtained to date from the allowances. This charge will be borne by the original owner regardless of what arrangements are put in place;

• grant relief equal to the tax charge to the lessor company on the day after the sale which will only be available to the new owner. The aim is to ensure that a tax driven sale to a loss making group is unattractive as the purchase will only increase the losses of the purchaser. By contrast, a commercial sale to a profitable leasing group will be neutral as the charge and relief will cancel each other out.

Anti-avoidance legislation will be introduced to prevent access to the relief in the lessor company where the sale has arisen through a non-commercial transaction. This will operate where the main purpose, or one of the main purposes of the arrangements, is to obtain access to the relief. The relief will be restricted to use against income from leases in place at the time.

Since the proposals were published in the Pre-Budget Report, the Government appears to have received representations from interested parties and will introduce changes to narrow the scope of the rules, with retrospective effect from 5 December 2005, to:

• align the definition of a plant or machinery lease to that proposed in leasing reform;

• remove transactions that could be triggered by group reorganisations from the scope of the rules where all companies involved remain within a 75% group;

• allow companies to surrender losses as group relief over a period of at least 12 months after the change in ownership.

Other technical changes to ensure the rules work as intended will be introduced with effect from 22 March 2006, and legislation will be published before the end of March.

b) Leasing partnerships

As similar benefits can be obtained through leasing partnerships and manipulation of partnership profit shares, the legislation will trigger the same charge and relief if a partner sells or reduces its interest in a partnership.

Furthermore, restrictions will be introduced covering the availability of losses to partners in leasing partnerships to ensure that the same effects as are currently available cannot be obtained by companies operating through partnership arrangements.

Comment: This measure confirms the Government’s intention to tackle the tax abuses it believes arise in the leasing industry, and ensure that only commercial arrangements are put in place in the future. The Government believes that many transactions in the leasing industry are tax driven and appears determined to stamp these out. However, it does appear to have listened to representations from industry to bring in changes to make the proposals operate in a more practical way.

2.17 Employment Related Securities

Legislation will be introduced retrospectively to counter avoidance schemes using securities options. 

As a result of a change in the law in 2003, it became possible to award extremely valuable options of indefinite length without employees paying tax on receipt of them.

Not surprisingly, planners have taken advantage of this change and this has been seen as sidestepping the relevant rules. With effect from 2 December 2004, where securities options have been granted as part of a tax avoidance scheme, the option will now be treated not as a right to acquire securities but as a security itself. The option can be converted into securities by exercise so will be treated as a convertible security. As a result, it will in effect be taxable on its full value at receipt.

Although the rules will be backdated to catch relevant options granted since 2 December 2004, the collection of PAYE and NIC on those options will be delayed until Royal Assent to the Finance Bill 2006.

Comment: In practice, options are generally awarded to remunerate employees rather than to avoid tax so it will only be exceptional cases which are caught by this new treatment. However, any legislation which has retrospective effect is likely to be highly controversial.

3 VAT and other indirect taxes

3.1 VAT registration limits

The annual turnover limit beyond which compulsory VAT registration is required has been increased from £60,000 to £61,000. The turnover limit which determines whether a business may apply for deregistration will be increased from £58,000 to £59,000. The registration and deregistration limits for acquisitions from other EU Member States will be increased from £60,000 to £61,000. These changes are effective from 1 April 2006.

Comment: These changes are in line with the usual increments of £1,000 or £2,000 per annum over the last decade.

3.2 Fuel scale charges

The following table highlights the changes to the fuel scale charges and output tax in each accounting period. These changes take effect for the first prescribed accounting period beginning on or after 1 May 2006.

3.3 Annual Accounting Scheme

The turnover below which businesses are eligible to join the scheme will increase from £660,000 to £1,350,000 and the turnover above which businesses must leave the scheme will increase from £825,000 to £1,600,000. The lower turnover limit of £150,000, above which a business cannot join the scheme until it has been registered for a year, will be removed.

These changes are effective from 1 April 2006.

Comment: HMRC is keen to promote schemes which they believe facilitate small business. However, the uptake of the Annual Accounting Scheme (which allows businesses to spread payments more evenly over the year) has been slow, and HMRC has substantially increased the entry limit in order to increase its use. HMRC is also seeking approval from the European Commission to increase the turnover limit for entry to the Cash Accounting Scheme from £660,000 to £1,350,000, which would be welcomed by many eligible businesses.

3.4 Missing Trader Intra-Community (MTIC) fraud

The Government has announced further steps to tackle MTIC fraud, also known as ‘carousel’ fraud. The measures are designed to assist HMRC in identifying and tracking goods which are most susceptible to fraud, such as mobile phones and computer chips. In addition, legislation is to be introduced to enable a further anti-fraud measure to be implemented, once the European Commission gives its agreement.

A summary of the measures is as follows:

• Existing HMRC powers to enter premises and inspect goods will be explicitly clarified to allow HMRC officers to mark goods, e.g. by date-stamping the outer packaging, and to record details of the goods by any means, including electronic scanning of barcodes. 

• HMRC will be empowered to issue directions to individual businesses to require them to keep specified records relating to goods they have traded, e.g. International Mobile Equipment Identity (IMEI) numbers for mobile phones. This will be supported by a penalty for failure to comply, although there will be a right of appeal, both against the issue of a direction and the imposition of a penalty for non-compliance.

• The person liable to account for VAT on the sale of certain goods will be changed from the vendor to the purchaser. The categories of goods affected will be specified in secondary legislation. There will also be a consequential change to allow adjustment of the VAT on sale where full payment has not been received within 6 months.

The first two measures above will have effect from Royal Assent. The latter measure will only come into effect once the proposal has been agreed with other European Union Member States.

Comment: The essential feature of carousel fraud is that one of the traders in the supply chain goes missing with the VAT that he has charged and collected from his customer. The proposed introduction of what is, in effect, a reverse charge on supplies of specified goods, such as mobile phones and computer chips, should reduce the risk of fraud substantially. However, the measure requires a derogation from EU VAT Law and, accordingly, cannot be introduced until approval has been received from the European Commission. The Government asked for this derogation in January 2006 and is seeking to persuade other Member States to introduce similar measures.

3.5 Buildings and land – rewrite of existing tax law

The Chancellor announced in his Pre-Budget Report last December that the legislation relating to the option to tax provisions was to be rewritten into a language that is clearer and easier to understand, removing redundant material and using more modern language. The opportunity is also being taken to introduce appeal rights and make minor changes to improve administration. 

A consultation document was issued on 5 December 2005 and the redrafted legislation will now come into effect by Treasury Order shortly after Royal Assent to the Finance Bill 2006.

Comment: This particular area of VAT is generally accepted as being one of the most complex pieces of legislation on the statute books as it contains a considerable amount of anti-avoidance detail which has evolved over the years in response to VAT planning arrangements. As a result it is now extremely difficult to apply and open to interpretation, and therefore any simplification and rewrite is to be welcomed. However, the industry will be watching carefully to make sure that HMRC do not take the opportunity of the rewrite to set out the law in a way in which it would prefer it to be interpreted rather than in the way it was intended by the legislators, in order to nullify the effect of case law decisions which have not always gone in its favour.

3.6 Partial exemption special methods

HMRC has announced an informal consultation on two proposed changes that it believes will strengthen and simplify the partial exemption regime. Subject to the outcome of the consultation, changes will be made to the Regulations, probably taking effect from April 2007. 

The first proposal would require taxpayers who apply for a special method under Regulation 102 to make a formal declaration to the effect that, to the best of their knowledge and belief, the method requested is fair and reasonable. If it subsequently transpires that this was not the case, HMRC will be entitled to recoup any VAT that has been incorrectly claimed. HMRC suggest that this measure will help it to approve special methods more quickly.

Comment: HMRC has become increasingly wary of approving any special method and many businesses have suffered unacceptable levels of delay and uncertainty whilst waiting for HMRC to respond. Any change that improves this situation is to be welcomed – but it is by no means clear how the proposed ‘fair and reasonable’ declaration will speed up the process. Needless to say, the Commissioners’ view of what constitutes a fair and reasonable recovery of input tax - especially with the benefit of hindsight – is likely to be different to the views of the taxpayer and this could lead to more, rather than less, uncertainty.

The second proposal would give HMRC the power to approve a special method that deals with the recovery of input tax that is attributable to supplies made outside the UK (such as financial or insurance transactions with customers outside the EU). HMRC takes the view that the recovery of input tax on transactions outside the UK is subject to a separate regime under Regulation 103 and thus that its powers to approve or direct a special method under Regulation 102 does not cover such transactions.

Comment: Many existing special methods already cater perfectly adequately for both UK and overseas supplies and the proposed change may have little or no practical effect on most partly exempt businesses. The so-called ‘separate regime’ for input tax on overseas supplies was an accidental outcome of UK case law (in particular the decision of the House of Lords in Liverpool Institute of Performing Arts [2001] STC 891) and at odds with the primary European legislation; the change should therefore be welcomed.

3.7 Closing a loophole: change in the treatment of goods sold by fi nance companies

Under existing law, cars and other goods returned to a finance company during the life of an HP agreement – whether at the instigation of the customer or as the result of repossession – can then be re-sold without VAT (i.e. treated as not a supply). At the same time, the finance company has the right to adjust the amount of VAT declared on the original sale, to reflect the reduced consideration following the early termination of the agreement. The result, in some circumstances, was that a significant part of the value that the finance company received for the sale of the goods could slip through the VAT net. The Regulations will now be amended to close this loophole with effect from 13 April 2006.

Budget Note 47 and VAT Information Sheet 05/06 explain these changes in more detail.

Comment: HMRC took the view that this reduction in the VAT paid on such goods was not the intention of the legislation, but failed to convince the High Court of this (see the decision in General Motors Acceptance Corporation UK Limited CH/2003, summarised in VAT Information Sheet 05/04). The Value Added Tax (Cars) Order 1992 and the Value Added Tax (Special Provisions) Order 1992 are now to be amended to ensure that where the VAT declared on the original selling price falls to be adjusted the finance company cannot also treat the re-sale of the goods as free of VAT.

3.8 Taxation of phone cards

HMRC has announced two apparently minor changes to the law affecting the treatment of face value phone cards under the heading ‘Protecting the Revenue’. The first affects credit vouchers that are issued by one person and redeemed by another; these vouchers are not generally liable to VAT, the expectation being that they will be redeemed against a supply of services on which VAT will be due. The new measure will introduce enabling legislation that will permit HMRC to specify circumstances in which such vouchers will be subject to VAT.

The second part of this measure apparently clarifies an area of the legislation (concerning ‘the place of supply of a right to services’) that is currently considered to be ambiguous.

Comment: The wording of this announcement suggests that these changes are intended to close a loophole or prevent avoidance, which might explain the lack of detail. This note should perhaps be read as a statement of intent

3.9 Reduced VAT rate for contraceptives

Contraceptive products, including ‘morning after’ contraception, will qualify for the reduced rate of VAT of 5%. The reduced rates are expected to apply from 1 July 2006. 

Contraceptives which currently qualify for zero-rating (e.g. on prescription) or exemption (e.g. when fitted or implanted by a health professional) are not affected by this provision. 

Comment: The Government believes that retailers and vending machine operators will pass on the reduction in full within their prices; however, there is no certainty that this will necessarily happen.

3.10 Auctioneers’ commission

From Royal Assent to the Finance Bill 2006, commission charged by auctioneers in respect of works of art, antiques, collector’s items and second hand goods at public auction will be subject to VAT at the standard-rate, whether the goods are within temporary importation arrangements or not. Before this change, commission was only charged within the value of the imported goods at an effective reduced rate of 5%, and only then if the goods were finally imported into the EU.

Comment: This measure, brought in as a result of an European Court of Justice decision which results in VAT being charged on the buyer’s premium, increases the cost of acquiring affected goods at auction.

3.11 Stamp Duty Land Tax threshold

The Stamp Duty Land Tax (SDLT) threshold for residential property transactions is to be increased from £120,000 to £125,000 with an ‘effective date’ of 23 March 2006. In most cases the ‘effective date’ will be the date of completion, not exchange, but in some scenarios will be the date when the contract is ‘substantially performed’. The 1% SDLT band will be for transactions between £125,001 to £250,000 with all other rate bands remaining the same.

3.12 Withdrawal of Unit Trust ‘Seeding Relief ’

HMRC has withdrawn ‘Seeding Relief’ which gives relief from SDLT when property is transferred into a newly formed unit trust in consideration of the issue of units. There will now be a stamp duty land tax charge on such transfers. 

This measure has effect for all transfers into unit trusts on or after 22 March 2006 described as the ‘relevant time’ in the legislation (there are transitional provisions relevant for contracts entered into before 2pm on 22 March 2006).

The HMRC press release notes that generally the chargeable consideration for a transfer of property will be the market value of the property and SDLT will be due on this amount. Even where transactions are entered into before 22 March 2006 certain transactions are treated as ‘excluded transactions’ and may not benefit from the relief, such as where:

• the unit trust scheme was not established at the relevant time, or contained no assets, or almost no assets, at the time;

• at or after the relevant time the contract is varied in a way that ‘significantly affects’ the transaction (e.g. substitutes a new purchaser). Therefore the details on any transaction will need to be reviewed carefully to ensure the relief is available.

Comment: This measure is not unexpected and many commentators were surprised when it was not included in the Pre-Budget Report. The introduction of this measure is designed to stop the lucrative industry that has grown up in offshore property jurisdictions of transferring properties to offshore unit trusts, and disposing of the units thereby avoiding substantial stamp duty land tax costs.

3.13 Simplification and clarification of the law

A number of measures have been included under this heading to deal with areas where the SDLT legislation has proven to be complex or unclear. From 12 April 2006, regulations will provide that the following transactions will be taken out of the scope of SDLT:

• gift of property where donee or beneficiary agrees or is required to pay capital gains tax or inheritance tax on the gift;

• the payment of landlord’s reasonable costs on grant of a lease (the Budget Day press release also says this is to apply on a variation or termination of a lease but HMRC has advised that this is not the case and apologised that the press release is misleading!);

• a covenant by an agricultural tenant to assign entitlement to the Single Farm Payment to the landlord on termination of the tenancy. Other measures that take effect from Royal Assent include:

• the removal of SDLT charges where there is a transfer of an interest in a partnership, if the partnership property includes land. This applies only to partnerships whose main activity is the carrying on of a trade (other than a trade of dealing in or developing land) or a profession;

• removal of the potential double charge in relation to transfers into a partnership and out of a partnership where there is actual consideration as well as the deemed consideration produced by the legislation;

• clarification that the charge on ‘successive linked leases’ does not apply where an agreement for a lease is followed by the grant of a lease;

• the simplification of various rules in relation to leases;

• clarification that transfers between sub-funds of a settlement are not subject to SDLT.

Comment: The changes for partnerships whose main activity is the carrying on of a trade or profession are particularly welcome and an area where we have, through the Association of Partnership Practitioners and other bodies, been actively lobbying for a practical solution. The rules introduced with the start of SDLT were devised to counteract avoidance schemes but caught many other areas where a charge was either illogical or inappropriate.

3.15 Stamp duty reconstruction relief

The Chancellor has announced measures to amend the rules under which certain company reconstructions and acquisitions may qualify for stamp duty relief. From Royal Assent to the Finance Bill 2006 the requirement that the acquiring company must be registered in the UK will be removed. There will also be a relaxation concerning the proportion of shares held by any shareholder so that relief may be given providing that ‘as nearly as is practical’ there is no overall change in the ownership of the reconstructed business.

3.16 Extension of Alternative Finance Reliefs

Current reliefs allow individuals to purchase land and buildings using alternative financing arrangements which are structured to preclude the payment of interest, such as Shari’a compliant products. These reliefs ensure that the SDLT due is no more than would be due under more conventional loan finance arrangements. These reliefs are to be extended from Royal Assent to the Finance Bill so that all persons such as companies, clubs and trusts can take advantage of this form of financing.

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