Philip Hammond, the UK’s new Chancellor of the Exchequer, made his first Autumn Statement precisely five months to the day after the Brexit vote on June 23, 2016. Set against the backdrop of forecasted (albeit uncertain) growth figures for the UK economy, the Chancellor sought to prioritize high value investment in housing and infrastructure, increasing productivity and building an economy that works for all.
Significant changes to the UK’s tax system were kept to a minimum, and although there are a few points of note, it will be the changes announced previously that will garner the most attention when the Finance Bill 2017 is released on December 5, 2016. This approach appears to be deliberate as the Chancellor announced that it will also be the last Autumn Statement as the Government intends to return to a system of making major updates to UK taxation only once a year. After spring 2017 the annual Budget will be moved forward to the Autumn so that major tax changes will happen only once per annum and be announced well in advance of the tax year.
Please find below a summary of the key tax proposals as they impact the asset management and the wider financial services industry.
Offshore Funds and Capital Gains Tax
The favorable tax treatment afforded to UK investors in offshore funds with reporting fund status will be marginally eroded from next year. Whilst the capital gains tax (CGT) treatment will be maintained, excess reportable income could increase in some circumstances as the Government legislates to restrict the deduction of performance fees against income. More of the income generated within a reporting fund will be taxed annually at the higher income tax rates. In short investors will be paying more tax and paying it sooner. However, investment managers who invest in fee-free share classes will not be impacted. This measure will apply to reporting periods beginning after April 1, 2017.
On a positive note, no changes to the main rate of CGT were announced. This will remain at 20% (28% on residential property and carried interest) for higher rate tax payers; as it has been since April 6, 2016. Fund managers are reminded to apply to HMRC for reporting fund status before December 31, 2016 for new funds and share classes wishing to enter the regime. Reporting fund status is increasingly relevant given the differential between CGT (20%) and income tax rates (45%) notwithstanding the imminent changes to the non-domicile regime noted below.
The Government remains committed to removing the UK’s concept of permanent non-domiciled status from April 6, 2017. Individuals will become deemed domiciled for tax purposes if they have been UK resident for 15 of the past 20 years. As previously announced, non-domiciled individuals who have a non-UK resident trust set up before they become deemed-domiciled in the UK will not be taxed on income and gains arising outside the UK and retained in the trust. However, UK residential property held through an offshore structure will be subject to inheritance tax. The Chancellor reiterated the intention to ease the rules regarding business investment relief to make capital investment more attractive to non-domiciled individuals. The final detail on the non-domicile changes is expected on December 5, 2016.
Income Tax and NICs
The personal allowance and higher rate threshold will rise to £11,500 and £45,000 respectively in 2017/18, reaching £12,500 and £50,000 by 2020/2021. As a result of recommendations by the Office of Tax Simplification, NIC thresholds for employees and employers will be aligned from April 6, 2017. There will be no additional cost to employees, but this will mean a small increase in employers.
Additionally, the Government has made significant changes to the salary sacrifice regime; which will take effect from April 6, 2017, removing the tax advantages on benefits such as gym memberships, work phones or private medical insurance provided through payroll. However, the perk will remain for ultra-low emissions cars, cycle to work schemes, pensions or childcare.
Pensions and Savings
There was no further tinkering in relation to the contributions into the UK pension regime, leaving savers and advisors to continue to get their heads around the tapering and the new thresholds introduced from April 6, 2016. However, the Government has announced a clamp down on the recycling of pensions savings by the over 55’s accessing pension freedoms and will reduce the money purchase annual allowance for those still in work from £10,000 per year to £4,000.
More significantly, the Government is looking closely at foreign pension schemes and aligning these to the UK domestic pension regime by bringing foreign pensions and lump sums fully into tax for UK residents. They also intend to extend taxing rights over recently emigrated UK resident’s foreign lump sum payments from funds that have had UK tax relief, from 5 to ten years. In addition, they will update the eligibility criteria for foreign schemes to qualify as overseas pension schemes for tax purposes.
There was also confirmation that the annual ISA limit will increase from £15,240 to £20,000 from April 6 2017 as previously announced.
The Government remains committed to reducing the corporation tax rate to 19% from April 1, 2017 and 17% by 2020/2021. However, the Chancellor did note that higher levels of incorporation is driving down income tax and NIC receipts so the Government intends to have a consultation on what action can be taken with hints of taxing income on a ‘look-through’ basis. This is particularly ominous noting the impact of the disguised investment management fee legislation that came into effect from April 2015. The legislation can potentially look through corporate structures to tax individual UK based investment managers on income as it arises, despite a corporate structure sitting between them and the income. Recent draft guidance from HMRC confirmed that the legislation has a much wider reach than first envisaged and individual investment managers should review the impact before submitting their 2015/16 personal tax returns.
The Government confirmed its intention to implement the reforms to the use of interest expense as part of the BEPS initiative from April 1, 2017. Interest deductions for tax purposes will be restricted to 30% of EBITDA where the deduction sought is in excess of £2 million and where the group’s net interest to earnings ratio in the UK exceeds that of the worldwide group. These measures will significantly impact the private equity industry operating in highly leveraged industries.
As previously announced two new rules will be introduced from April 1, 2017 in relation to the deductibility of interest expense for corporation tax purposes. Firstly, from 1 April 2017 losses can be carried forward and group relieved in future and not just in co-terminus periods. Secondly, the amount of profit that can be offset against losses carried forward will be reduced to 50% of the available profit if profits exceed £5 million. This is unlikely to impact small or medium sized companies.
It was announced that the Finance Bill 2017 will include minor changes to the hybrid and other mismatches legislation, ensuring that it works as it was intended to do so. These changes will take effect from January 1, 2017.
In 2017 the Government will consult on whether non-resident companies that have taxable income from the UK should be subject to corporation tax in an attempt to provide a more uniform tax regime. Draft proposals will also be released with detail on the Government’s plan to enable investors that are exempt, like pension funds, to get a tax credit for any tax paid by authorized investment funds in relation to dividend distributions made to corporate investors.
Partnership Taxation Changes
Following an announcement earlier in the summer, legislation will be introduced to clarify and improve certain aspects of partnership taxation. The legislation will seek to ensure that profit allocations to partners are calculated fairly for tax purposes, with the Government proposing to legislate for the basis of allocation for tax adjusted profit to be the same as the allocation of the accounting profit/loss between the partners. HMRC also want transparency on the underlying partners when multiple partnership structures are used and the ability to look through to the ultimate partner when levying tax. This proposal will present a significant administrative challenge for private equity managers who use tiered partnership structures. We await further detail on the practical application of this transparency requirement.
Disguised Remuneration Rules
The Government announced changes to the disguised remuneration rules for employment relationships in Budget 2016 to charge income tax on loans still outstanding by April 6, 2019. In his speech the Chancellor confirmed their commitment to extending the scope of these rules to self-employed individuals following the release of a technical consultation in August 2016. Individuals who have outstanding loans from employment relationships (in effect locked-in since the release of the 2010 disguised remuneration rules), as well as members of limited liability partnerships that have made use of such relationships should assess the possible tax liabilities arising.
Tax Avoidance and Evasion
The Government announced that it is investing further in HMRC to increase its activity on countering avoidance and taking cases forward for litigation, which is expected to bring forward over £450 million in revenue by 2021/2022. Additionally, a new legal requirement will be introduced to correct any past failures to pay UK tax on offshore interests within a defined period of time, with new sanctions for those who fail to do so.
Additionally, a consultation will shortly be published on a new legal requirement for intermediaries arranging complex structures for clients to notify HMRC of the structures and the related client details. No more detail has been disclosed on this yet, but it is likely to have a significant impact on the financial services industry and continue the global theme of increased transparency to tax authorities.