UK: Tax Focus - February 2014

ARTIFICIAL USE OF DUAL CONTRACTS BY NON-DOMICILES

By Dave Bareham

Draft legislation has been published in order to counteract the perceived abuse of dual employment contracts used by non-domiciled individuals in order to shelter earnings from UK tax in relation to overseas work. HMRC have often contended that there is in fact only a single employment contract.

Current position

A UK resident, non-domiciled individual may claim the remittance basis of taxation in respect of earnings that relate to employment held entirely outside of the UK.

Many non-domiciled individuals use 'split contract' arrangements; one contract relating to employment wholly within the UK and another for employment wholly outside of the UK. The earnings from the non-UK employment are only subject to UK tax to the extent that they are remitted into the UK.

Draft legislation

The draft legislation seeks to dis-apply the remittance basis where employment is artificially split into a UK employment and one or more foreign employments. These rules will apply for employment income and general earnings arising on or after 6 April 2014 where all of the following conditions are met:

• An individual has both a UK employment and one or more 'relevant' (i.e. foreign) employments.
• The UK employer and the relevant employer are 'associated' with each other.
• The UK employment and the relevant employment are 'related'.
• The foreign tax rate that applies to income in respect of a relevant employment, calculated in accordance with the amount of foreign tax credit relief, which would be allowed against income tax if the income were not taxed on the remittance basis, is less than 75% of the UK's additional rate of tax (currently 45%).

A typical scenario is where a UK resident, non-domiciled employee has employment contracts with both a UK company and a foreign employer within the same group and the two employments are 'related' (for example, they are mutually inclusive or involve working for the same clients or if the employee has a senior position within the organisation).

Action points

Where split contracts genuinely represent different roles being performed and are not split purely on a geographical basis, the remittance basis should still be available for non-domiciled employees. The draft legislation should not prevent newly resident employees from temporarily claiming the remittance basis on overseas workdays (typically for their first three years in the UK).

Employers should consider reviewing split contract arrangements in order to ensure that they genuinely relate to distinct roles and consider restructuring contracts where appropriate.

TIME RUNNING OUT TO CLAIM CAPITAL ALLOWANCES ON PROPERTY

By Mark Webb

In practice, it was often difficult for taxpayers and HMRC to determine the extent to which a previous owner had claimed capital allowance relief on qualifying items in buildings. This was especially the case where expenditure was incurred many years before the capital allowances claim in question was made.

New rules, entitled 'mandatory pooling', will address this difficulty. A transitional period has run from April 2012 and the new rules will apply in full from April 2014.

'Mandatory pooling'

The new rules broadly mean that:

• the vendor and purchaser must agree the value of fixtures and fittings and other qualifying items to be transferred as part of a sale
• qualifying items can be transferred at any value between their cost and £1
• the purchaser is able to enjoy tax relief up to the agreed value of the items transferred
• the vendor and purchaser must make a joint election confirming the agreed value and send it to HMRC within two years of the property sale
• if the vendor and purchaser cannot reach an agreement the value that qualifying items are transferred at can be determined by a first tier tax tribunal.

Crucially, at the time of writing this article, there is no requirement for vendors to take any action ahead of a property sale. This position will change from April 2014. From this date, any items forming part of a property that qualify for capital allowances must have been 'pooled' (identified and disclosed in a tax return) prior to sale, otherwise they cannot be transferred to the purchaser. Non-pooling of qualifying expenditure from April 2014 would mean no future purchaser of the property would be able to claim capital allowances on that expenditure.

Implications of the new rules

As a result of these new rules, capital allowances will become a more important consideration for businesses looking to purchase property. The vendor's compliance with these new rules is also likely to form a more important part of commercial negotiations.

Failure by vendors to comply with these new rules may cause sales values to be reduced, as purchasers will be unable to claim the level of tax reliefs on the property that they might have expected. There could also be significant delays to the completion of future sales while the necessary work identifying and pooling qualifying expenditure is carried out.

The wide application of the new rules means that property owners who would not normally consider capital allowances should be mindful. When buying a property, organisations such as charities or property trading companies should ensure, that the business that they are purchasing the property from has met the requirements. Otherwise, when they come to sell the property, they may not meet the new requirements with capital allowances lost and prices reduced.

HMRC GUIDANCE ON FRS102

By Matt Watts

HMRC recently issued guidance on the current tax implications of FRS101/102, the new accounting standards applicable to UK companies who do not already account under IFRS or FRSSE.

Financial instruments

FRS102 classifies financial instruments as either 'basic' or 'non-basic' as follows:

• Basic financial instruments (such as cash, trade debtors, trade creditors and simple loans) – recognised at transaction price/ amortised cost i.e. no change; and
• Non-basic financial instruments (such derivatives, non-plain vanilla debt, investments in convertible debt) – recognised at fair value, leading to greater volatility in the profit and loss account.

Tax impact

Tax treatment will follow the accounting treatment, and therefore for 'non-basic' financial instruments the requirement to recognise at fair value will result in greater movement in the financial statements (either in P&L or statement of other comprehensive income). As these adjustments will generally be taxed, then companies should expect greater volatility in their tax computations.

HMRC sets out specific tax rules for the following types of financial instrument.

• Intercompany loans – treat as a 'basic' financial instrument, ie amortised cost basis.
• Debt-equity swaps – any amount of profit recognised in P&L or reserves is taxable. However, there are exempt gains arising where a debt is released in consideration of shares (s322 CTA 2009 – see CFM 33200 onwards for more detail)
• Hedging relationships – possible to disregard the accounting treatment on election (SI 2004 / 3256). See CFM 13270 for further details.

Investment Properties

Investment properties should be initially recognised at cost, and then subsequently at fair value, with movements recorded in the P&L.

Tax impact

The movements in fair value on properties let to third parties are not taxable unless the property is actually sold. However there is a requirement to reflect deferred tax on this movement (although this is not detailed in HMRC's guidance).

Intangibles including goodwill

Under FRS101/102 the useful economic life of an asset must be finite and cannot exceed 5 years where a reliable estimate cannot be made. Previously under UK GAAP the rebuttable presumption was a maximum life of 20 years, although an indefinite life could apply.

Tax impact

This could result in a material impact to the amortisation of intangible assets for both accounting and tax. Where tax relief is claimed on amortisation, then the rate of relief may increase under FRS102. However if the election to amortise the asset at 4% per annum for tax has been made, then this will not be impacted by the change in accounting treatment.

Leases

FRS 101 / 102 does not have the presumption that if the present value of minimum lease payments is greater than 90% of the fair value of the asset then this would be classified as a finance lease. This could impact the tax treatment of some leases previously seen as finance leases.

Another tax change is the change arising from the spreading of lease incentives (FRS102 requires the incentive be spread over the term of the lease unless there is a more appropriate method, while previous UK GAAP requires the spreading of an incentive over the period to the first rent review). This may create differences in the period over which lease incentives are recognised for tax purposes.

The assessment of finance leases for lessors changes under FRS102 from the 'net cash investment' method (under SSAP 21) to the 'net investment' method. This could create some differences in the timing of income recognition and therefore tax assessment.

This is only a brief summary of some of the issues highlighted in the recent HMRC guidance, as FRS101/102 could have a wide ranging impact for those companies affected. Please speak to your usual S&W contact to discuss the potential impact for you.

THE OECD BASE EROSION AND PROFIT SHIFTING ACTION PLAN

By Rajesh Sharma

There has been considerable publicity in recent months on the alleged tax avoidance perpetrated by multinationals that has resulted in the Organisation of Economic Cooperation and Development (OECD) publishing its action plan on base erosion and profit shifting (BEPS).

The action plan, consisting of 15 proposals to counter the perceived tax avoidance, has been endorsed by the G20 countries as well as China and India (who are not members of the OECD) and seeks to provide countries with domestic and international instruments that better align rights to tax with economic activity within the next two years. The principal objective is to counter tax rules that lead to the avoidance of tax by aggressive planning of the supply chain or the concept of double non taxation.

Some of the principal areas that are being considered are as follows.

• The taxation of the digital economy - the bulk of the profits are attributable to the intangible assets and the ability to deliver digital products and services without the need for a substantial physical presence where the customers are situated. The approach taken for indirect taxes has been mooted as a potential alternative for the taxation of the profits.
• The establishment of coherent corporate income taxation at an international level - ensuring transparency, so that tax loopholes are effectively eliminated, thus preventing the erosion of the tax base in the countries of operation. This will require a massive effort on the part of the OECD to overcome the interaction of one country's interests, tax and legal systems, with another country's, taking account of economic unions, for example the EU and North American Free Trade Agreement (NAFTA).
• Prevention of the abuse of tax treaties - by developing model treaties that result in the elimination of double non taxation. This will require an update of the definition of permanent establishments and the universal inclusion of the limitation of benefits articles in tax treaties.
• A proposal to introduce a multilateral instrument to expedite amendments to bilateral treaties that could be adopted by other OECD member states. A particular problem with this proposal is the potential shift of the sovereignty of the participating countries to institutions such as the OECD.

The successful implementation of the recommendations of the action plan will be dependent on the attitude of the member countries toward making changes to their domestic legislation in a reasonably short period of time. This will require political manoeuvring as well as curbing the use of unilateral action by any country. For example the French proposal for taxing the digital economy using the 'byte tax' may be regarded as unjust by the highly innovative companies that seek to develop their commercial business rather than simply to avoid taxes.

We have taken great care to ensure the accuracy of this newsletter. However, the newsletter is written in general terms and you are strongly recommended to seek specific advice before taking any action based on the information it contains. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. © Smith & Williamson Holdings Limited 2014. NTD174 code exp: 30/6/2014