UK: Corporate Tax - UK publishes draft Finance Bill 2011

Last Updated: 14 December 2010
Article by Simon Yates

As part of its commitment to reform the tax policy making process, the new UK government had promised to make draft legislation available for comment much earlier than had previously been the case. For decades UK tax specialists have been used to seeing a Budget in the spring, with a draft Finance Bill coming one or two weeks later and being enacted in July. This year, the publication of the Bill and much of the associated explanatory material has been accelerated by three months. It remains to be seen what tax measures will now be announced in the spring Budget, but on the basis of the new approach we must expect that there will only be isolated anti-avoidance measures.

The key measures contained in the Bill, and in a significant policy document on the future of corporation tax published a few days before, are summarised below.

The introduction of the Bank Levy

The Bank Levy will be charged at a fixed percentage of certain liabilities on bank balance sheets. It will apply to the global consolidated balance sheets of UK banking groups, the UK group, subsidiary and permanent establishment balance sheets of non-UK banking groups, the balance sheets of UK banks and banking sub-groups in non-banking groups, and the balance sheets of standalone UK banks.

It will be noted that this formulation will in many cases impose the charge by reference to the liabilities of non-UK companies. This cuts across the new government's general policy goal of achieving a more territorial tax system. It also raises the possibility of double taxation if, as the UK hopes, other countries introduce similar measures. At present none of the UK's tax treaties address the issue, and whilst the new law includes provision empowering treaty provisions to be made, these would (as always) be subject to negotiation with the relevant other countries.

The levy has two rates: long term equity and liabilities are charged at 0.0375%, whilst short term liabilities are charged at 0.075%. This latter figure is slightly higher than the 0.07% suggested when the measure was first announced in June (at which point it was envisaged that there would be only one rate applicable to all liabilities). It does not apply to the first Ł20 billion of chargeable liabilities, and some liabilities – notably Tier 1 Capital and amounts covered by Government guarantee schemes such as retail deposits – are excluded altogether. The levy will apply to accounting periods ending after 1 January 2011, albeit at a reduced transitional rate of 0.05% until 2012.

Foreign branch exemption

At present the UK tax system operates a credit system for the taxation of overseas branches. A UK resident company is subject to UK tax on all its worldwide profits and gains, with credit being given for overseas tax borne on those profits.

This credit system is to be replaced by an elective exemption system. If a company so elects, it will be able to exclude all profits of its overseas permanent establishments from UK tax. However, on making this election, it will also lose the ability to utilise losses incurred in overseas permanent establishments against UK taxable profits. Any such election will be irrevocable, and must apply to all permanent establishments – picking and choosing is not permitted.

Anti-avoidance rules will prohibit the artificial diversion of profits from the UK to exempt foreign branches.

This measure, which will take effect from an as yet undecided date in 2011, represents a genuinely significant shift of emphasis in the UK tax system. In contrast to the Bank Levy, it is a real step towards a more territorial system, which it is hoped will enhance the UK's competitiveness by no longer seeking to tax profits with little or no connection to the UK.

Controlled Foreign Companies

The draft Finance Bill contains some relatively minor adjustments to the UK's controlled foreign companies regime. More significant in this context was the earlier policy document which indicates that thinking is progressing on the shape of a new set of controlled foreign companies rules. The consultation process relating to these rules began in 2007, and full new legislation is promised for 2012.

As with the foreign branch exemption the aim is to take a more territorial approach to taxation. Profits unconnected with the UK will be outside the scope of the rules. Again, as with the foreign branch exemption (and as required by the European Court of Justice in the Cadbury Schweppes case), there will be a focus on profits which have been artificially diverted from the UK. There will also be special, more lenient, regimes for group finance companies and IP holding companies.

There remains a large amount of work to be done before these proposals can be put into law. Although some of the major guiding principles which will be adopted are becoming clearer, many points of detail remain explicitly undecided. Complex and difficult as the issues are, the consultation process on this issue has taken too long, and it is to be hoped that the government follows through on its apparent commitment to push for a reasonably rapid resolution.

Relief for interest

The UK government is currently conducting a review of all reliefs available under the UK tax system, as part of a wider policy desire to simplify the system and to fund reductions in headline rates by cutting back on often complex reliefs.

There had been some speculation that the UK would introduce new restrictions on its currently very generous rules allowing relief for interest deductions. In particular there had been suggestions that the purpose for which a loan was taken out might become relevant to interest deductibility (many jurisdictions, for instance, deny deductions on loans taken out to acquire equity). However, apparently driven by a combination of the likely complexity of such a result and a recognition that the existing regime is a real competitive asset for the UK, the government has explicitly ruled out any significant changes to the regime for interest deductibility.

This is extremely welcome. The existing regime is generous, and from a certainty perspective the assurance that it will not change materially is valuable. On the downside, this would appear to mean that the much-criticised "worldwide debt cap" will remain unreformed, but set against the benefit of the rest of the interest deductibility regime this is a small price to pay.

A Patent Box regime

As part of a wider reform of the taxation of intellectual property which also interacts with the controlled foreign companies rules, the UK is intending to introduce a "patent box" regime from 2013 under which proceeds from patents will be subject to corporation tax at the reduced rate of 10%.

This measure has been long trailed, and comes in response to many multinationals moving their intellectual property out of the UK to other jurisdictions which offer lower, or in many cases nil, tax on IP related profits. Although the initial response has been positive it remains to be seen whether this will be sufficient to prevent further migrations of IP.

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.

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