UK: Tax Focus - A Summary Of Current Tax Issues For Companies, June 2007

Changes to clearance processes for financial transactions

In this year’s Budget it was announced that HM Revenue & Customs (HMRC) could speed up its procedures for allowing relief from UK tax for loan interest paid to non-residents, and to extend the circumstances in which UK residents can enter into thin capitalisation agreements. These changes will allow companies to receive confirmation of their application for clearance to pay interest gross much sooner than before.

HMRC has published a detailed announcement about the changes, which apply to certified treaty applications received by HMRC after 21 March 2007. HMRC will continue to correspond with non-residents where an application is deficient in some way. Certified applications received by HMRC on or before 21 March 2007 will continue to be dealt with as before.

Under the new rules, HMRC will no longer automatically consider whether the loan arrangements forming part of a treaty application will adhere to the arm’s length principle. This will now be considered as part of the normal risk assessment procedures followed by HMRC when dealing with payers’ self-assessment tax returns. Any thin capitalisation enquiries will therefore be dealt with as part of enquiries into that return.

In addition, HMRC has extended the scope for thin capitalisation agreements. Currently, a UK borrower can only enter into a thin capitalisation agreement if the overseas lender makes a treaty application. In some cases, such as with discounted bonds, no interest arises and thus there can be no withholding tax (and, therefore, no treaty application). This would ordinarily prevent a thin capitalisation agreement being made. HMRC has also extended the range of situations on which thin capitalisation agreements can be made. These agreements will be Advanced Pricing Agreements, subject to a new statement of practice which has been issued in draft.

Changes were introduced in the Budget that will affect the deferred tax calculations of companies reporting under UK GAAP or IFRS. These changes are as follows.

1. Corporation tax will be reduced from 30% to 28% as of 1 April 2008.

2. Industrial, hotel and agricultural building allowances:

- to be withdrawn over the next four years (3% from April 2008, 2% from April 2009, 1% from April 2010 and 0% from April 2011)

- balancing adjustments to be withdrawn in respect of balancing events occurring on or after 21 March 2007, other than in certain limited circumstances.

When these rules are applied, deferred tax assets and liabilities will be reduced due to the change in corporate tax rates. In addition, the change in the rules for industrial building allowances will impact on deferred tax calculations. For example, under UK GAAP, deferred tax assets or liabilities will be reversed and, going forward, accounting and tax differences will be treated as permanent differences.

The Court of Appeal has rejected the taxpayer’s appeal in a recent case regarding the place of supply of services under a global contract between PricewaterhouseCoopers and Zurich Insurance. The issue in dispute was whether the place of supply was where the services were performed, cost borne and benefit derived (HMRC’s argument as Zurich has a branch in the UK), or where the contract was agreed and services paid for (Zurich argued the place of supply was in Switzerland at its head office). The Court of Appeal decided that the former was the correct approach and the UK branch was receiving services subject to UK VAT.

Global contracts which are agreed by the head office, but relate to specific branches, should be reviewed to ensure the VAT charged on the services received and the respective input tax recovery are appropriately managed. This is of particular importance to partially exempt businesses.
[Zurich Insurance Company v Revenue and Customs Commissioners [2007] EWCA Civ 218]

Employers should be aware of the importance of taking advantage of the generous corporate tax deductions available for share awards and share options (approved and unapproved) courtesy of the Finance Act 2003.

In brief, where an employee enjoys an award of shares in his/her employer company or the parent company of the group, a corporate tax deduction is available for the employer. This deduction is equal to the amount on which the employee is taxed on the award and applies for the year in which the employee is taxed.

However, shares only qualify for relief if they are in a quoted (or subsidiary thereof) or standalone company. The sting in the tail is that shares that do not qualify for relief are automatically treated as ‘readily convertible’ and their receipt is liable to the operation of Pay As You Earn (PAYE) and National Insurance Contributions (NIC). This is regardless of whether or not there is any market for them. Normally, shares without any ready market do not suffer PAYE and NIC.

Further, we are concerned that some tax inspectors may be taking the view that if a company does not claim Schedule 23 relief, it must be because it cannot, and therefore the inspectors seek to recover PAYE and NIC. This is not strictly correct as in order for a company to avoid this pitfall, it only has to be entitled to claim Schedule 23 relief rather than actually claim it. We advise companies to claim the relief in all circumstances where it is due in order to avoid a needless argument.

The Chancellor announced a number of measures in this year’s Budget which will affect the Enterprise Investment Scheme (EIS) and Venture Capital Trusts (VCTs).

The amendments include changes to the rules on EIS Approved Funds, relevant intangible assets, the definition of 90% subsidiaries and VCT realisations. However, the most significant revisions relate to restrictions on investee companies.

Investee companies (or groups as appropriate) will be restricted in terms of the number of employees they can retain and the amount of funds they can raise. This is the first time that constraints of this type have been introduced, continuing the recent trend of reducing the number of companies that can take advantage of venture capital schemes. This is a matter of concern to many small and medium-sized companies, which have traditionally relied on raising funds under the EIS and through VCTs to satisfy their capital requirements.

The new rules will require that investee companies have no more than 50 full-time employees at the date of the relevant share issue, and raise no more than £2m from venture capital schemes in any 12-month period.

Venture capital schemes, for this purpose, comprise the EIS, VCT funds and the Corporate Venturing Scheme (CVS). These amendments apply to funds raised by VCTs after 5 April 2007, and to the EIS and CVS from the date the Finance Bill receives Royal Assent (expected in July). The Treasury has stated that these two changes are required following the publication of new EU State Aid provisions in relation to risk capital.

On 17 April 2007, HMRC announced the offshore disclosure facility. This will enable UK taxpayers who have underpaid tax on interest arising on offshore bank accounts to make full disclosure and incur a maximum penalty of 10% of the unpaid tax. Anyone subsequently found to have underpaid tax will face significantly higher penalties, which are unlikely to be less than 30% of the tax due.

In order to utilise this facility, taxpayers need to:

• notify HMRC of their intention to make a disclosure by 22 June 2007

• make full disclosure and payment of all unpaid tax, interest and penalties by 26 November 2007.

Notification can be made online, by telephone or post. Disclosure must be made on the form provided by HMRC, which requires:

• details of the offshore bank account, including the source of the funds

• a list of assets held offshore at 5 April 2006, including the source of the funds
• the calculation of tax due, interest and penalties

• a formal offer in settlement.

Taxpayers must disclose all undeclared tax liabilities, not just those relating to offshore accounts. HMRC will make a final decision on whether to accept the disclosure by 30 April 2008.

This facility is currently only available for taxpayers with an offshore account, but a parallel system will apply for taxpayers who make a full disclosure of other underpayments of tax. This extends to all taxes including inheritance tax, corporation tax and PAYE. Therefore, if you have not held an offshore account and make full disclosure under this facility’s terms, you can expect the same treatment.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.