Anti-avoidance and tweaking around the edges were the main themes in the Budget 2006. The most headline grabbing announcement, the introduction of REITs from 1 January 2007, has been on the cards for over two years so did not come as a surprise, though welcome modifications to the proposals have been made.
Real Estate Investment Trusts (REITs)
First proposed as long ago as Budget 2004 and much consulted upon since, the statutory regime for UK REITs will finally be enacted in Finance Act 2006 and will go live on 1 January 2007 when companies and groups will be able to elect to join the regime.
Many countries already have a form of REIT property investment. The UK REIT offers tax exemption on income and gains from investment property subject to qualifying conditions including as regards the type of business carried on, the use of a UK resident vehicle and the listing of its shares on a recognised stock exchange. No single investor may (broadly speaking) receive beneficially more than 10% of distributions or control more than 10% of share capital or voting rights of a REIT.
The Budget Press Release announces some welcome positive changes in the conditions previously proposed and other features which had cast doubt on the viability of the UK REITS within the UK property industry.
- The conversion charge for property companies deciding to become REITs has been set at 2%, which may be spread over 4 years, to be collected at the same time as corporation tax. This is likely to be viewed as an acceptable charge for accessing REIT benefits.
- 90% of net profits must be distributed rather than the 95% initially proposed in the draft legislation.
- The requirement to maintain interest cover in the ratio of 2.5:1 has been halved to 1.25:1.
- The loss of a REIT's advantageous tax status if any shareholder acquires a stake in excess of 10% has been relaxed.
Venture Capital Schemes
There was mixed news for Venture Capital Trusts ("VCT"s) in the Budget 2006.
The temporary rate of 40% income tax relief for VCT investors was due to revert to 20% for investments made on or after 6 April 2006 but this has been reviewed and, from 6 April 2006, investors in VCTs will in fact be entitled to 30% income tax relief.
However, this is coupled with an increase in the holding period for VCT shares from three years to five years for post 6 April 2006 VCT share issues. Also, any cash held by a VCT after 6 April 2007 will be treated as an investment for the purpose in applying certain qualifying tests. (A VCT must have 70% by value of its investments represented by shares or securities in qualifying holdings to gain and retain approval, and no more than 15% of its total investments can be a single holding in any company).
There were some positive changes for Enterprise Investment Scheme ("EIS") investors. The current investment limit on which an individual can obtain a 20% reduction in their income tax liabilities is increased from £200,000 to £400,000 for shares issued on or after 6 April 2006. The maximum number of eligible shares that an EIS investor can treat as having been issued in the previous year, is 50% of their eligible shares, subject to a maximum value of £50,000 from 6 April 2006 (previously £25,000).
There are also changes to the rules specifying required asset values of VCT, EIS and corporate venturing schemes before and after investments are made.
Anti-avoidance employment-related securities
Following yesterday's budget, HMRC has announced legislation designed to ensure that any gains made by employees under avoidance schemes using share options will be subject to income tax and national insurance contributions in full.
In terms of the draft provisions, a right to acquire securities (including an option to acquire shares) which is received under arrangements the main purpose (or one of the main purposes) of which is the avoidance of tax or national insurance contributions will no longer be taxed under the provisions relating to the taxation of options. Instead, the provisions relating to the taxation of securities will apply. As a result, these options may be taxed on grant and again when they are exercised.
These provisions will have effect in respect of options granted on or after 2 December 2004 or earlier if something is done on or after that date to bring them into the ambit of the new legislation.
Corporate Capital Losses
As announced in the Pre-Budget Report new anti-avoidance rules will be enacted in this year's Finance Act to deter the contrived creation of corporate capital losses, prevent buying of capital losses and gains, and stop the conversion of income streams into capital gains, and the creation of a capital gain matched by an income deduction, where the gains are then wholly or partly franked by capital losses.
Changes to the disclosure regime
Tax professionals and their clients are required by legislation to disclose certain income tax, corporation tax and capital gains tax schemes and arrangements that concern either employment arrangements or certain finance products. Stamp duty land tax schemes were also added last year.
For schemes that are made available or implemented on or after 1 July 2006, new regulations will be introduced that will apply the disclosure rules to the whole of income tax, corporation tax and capital gains tax. Further, if a scheme falls within one of a number of prescribed hallmarks, it will also be disclosable and the time limits for notification of in-house schemes will be reduced.
Anti-avoidance and financial products
The disclosure regime mentioned above has led to a number of schemes being blocked by HMRC already (for example the capital loss schemes mentioned above). Further avoidance schemes have been brought to the attention of HMRC and the Finance Bill 2006 will introduce legislation designed at blocking these.
Although few details are currently available, we do know that the schemes that are to be targeted will include intra-group arrangements to avoid tax on income arising on the group or create a tax loss, the use of stock lending arrangements on non-commercial terms, the creation of losses from the sale and purchase of rights to distributions on shares, and arrangements using loans that are not loan relationships because they cannot be settled in cash.
Taxation of leased plant and machinery
On or after 1 April 2006, leases of plant and machinery under leases of five years or more will be subject to new rules that align the tax treatment of leased plant and machinery with that of plant and machinery acquired under other forms of finance.
Where leases function in a similar way to a loan, the new regime will:
- prevent lessors claiming capital allowances on the cost of the leased asset and tax them only on the proportion of the rental income that reflects the financing charges; and
- allow lessors to claim capital allowances on much the same amount as they would have been able to had they bought the asset, and receive a deduction for that part of the rentals on which capital allowances are not available.
Transitional provisions were published on 5 December 2005 and apply to leasing agreements in place prior to 21 July 2005 where the asset is under construction before 1 April 2006. Such leases are taxed under the current law.
Changes to first year allowances, the hire purchase rules, and the finance costs for oil extraction activities, will also feature in the draft legislation that should be published before the end of March 2006.
Extension to group relief
Following the well publicised Marks & Spencer plc case before the ECJ, changes have been introduced for UK groups with foreign subsidiaries so that group relief complies with European Community law.
The new relief applies only where a UK parent company has a foreign subsidiary (including an indirectly held subsidiary) which has incurred a foreign tax loss that is unrelievable in the home state (or elsewhere) following the exhaustion of all possibilities of relief, and where that subsidiary is either resident in the European Economic Area ("EEA"), or has incurred the relevant losses in a permanent establishment in the EEA. It will be subject to anti-avoidance provisions denying relief where there are arrangements with a main purpose of obtaining UK tax relief.
Stamp duty reconstruction reliefs
Stamp duty reconstruction and acquisition relief (sections 75 to 77 Finance Act 1986) will be extended to cover the acquiring companies situated worldwide, rather than being limited to UK companies (and companies in the EEA since July 2005), provided the other conditions (for example that there is no change in overall ownership of the company or its business). This has potential advantages for multi-national companies acquiring either the whole or part of a business or the share capital of another company.
Furthermore, there will also be a slight relaxation of the requirement under both sections 75 and 77 that the relief will not be denied because the proportion of shares in the new structure held by each shareholder has to change slightly for practical reasons.
Increase in rate of first-year capital allowances for small businesses
The rate of first-year capital allowances for small business spending on plant and machinery has been increased from 40% to 50% for expenditure incurred on or after 1 April 2006 for a one year period.
VAT – increase in turnover thresholds
The annual taxable turnover threshold for determining whether a person must be registered for VAT is increased from £60,000 to £61,000 in line with similar increases in the European Union Member States. Similarly the deregistration threshold has risen from £58,000 to £59,000.