Heather Self and Catherine Robins, partners at leading law firm Pinsent Masons, explain which major changes to corporate tax reforms have been affected by the election
Before Theresa May’s ill-fated decision to call a general election, major changes to the corporate tax system were proceeding through Parliament.
A new restriction on interest deductions for companies, reforms to corporate tax loss relief and reforms of the substantial shareholding exemption were all due to come into force on 1 April 2017 and were contained in the Finance Bill, published on 20 March.
It was less than ideal that major changes, like the interest restriction, were due to take effect before the Finance Bill became law. By late June, it was expected that the final version of the legislation would be drafted and for the Finance Bill to be passed in July, in the usual way.
The announcement of the general election threw all this into turmoil. The provisions were removed from the Finance Bill, which was rushed through before the election. Businesses were assured by the then Financial Secretary to the Treasury, Jane Ellison, that the removed provisions would be included in a Finance Bill after the election. However, there was no confirmation that the start date would remain 1 April, and with the civil service in pre-election ‘purdah’, no assurances were forthcoming from HMRC. The safest course of action has been to assume that the start date would remain as planned.
At the time of writing, we still do not know whether the new rules will be backdated to 1 April 2017 or even whether the provisions will definitely get through a hung parliament in a second Finance Bill.
It seems unlikely that the Labour party would vote against measures designed to prevent tax avoidance, but it is conceivable that there could be opposition, perhaps to the exemption for infrastructure projects, designed partly to ensure that PFI contracts continue to be viable.
This uncertainty matters because the corporate interest restriction is a major change to the UK tax system. It is being introduced in response to the recommendations made by the OECD in connection with its base erosion and profit shifting (BEPS) project, designed to reduce tax avoidance by multinationals.
The rules are intended to prevent multinationals from loading up UK companies with high levels of debt to reduce taxable profits, whilst shifting business profits to low tax jurisdictions, such as tax havens, so little or no tax is paid. However, the restriction will catch commercial transactions as well as those with a tax avoidance motive.
The new rules will hit groups with a net interest expense of more than £2million. Tax relief for interest and certain other financing costs in respect of new or existing loans will be limited to the lower of:
- 30% of tax-EBITDA, which will broadly be profits chargeable to corporation tax, excluding interest, tax depreciation such as capital allowances, tax amortisation, relief for losses brought forward or carried back and group relief claimed or surrendered; and
- the adjusted net group-interest expense of the group for the period – this is the ‘modified debt cap’ and is designed to ensure that the net interest deduction does not exceed the total net interest expense of the worldwide group.To maintain investment in the UK’s infrastructure sector, there will be an exclusion for interest paid on public infrastructure projects, which will include some rented properties.Major changes to corporate loss relief were also due to be introduced from 1 April 2017. These reforms increase flexibility in how carried forward losses can be used, including by way of group relief. However, companies with profits in excess of £5million will suffer loss restrictions and will only be able to offset 50% of their profits against losses carried forward in a single year. They will also be particularly burdensome for groups that suffered substantial losses in the financial crisis of 2008. Like the corporate interest restriction, this measure is estimated to raise a significant sum – around £0.5billion in 2017-18.
- The restrictions are likely to affect businesses which have large upfront costs, such as those that invest significant sums of money in R&D before being able to generate a profit.
- Calls for the reforms to be delayed to ensure that the rules work as intended have, to date, fallen on deaf ears. David Cameron’s government was keen to be seen to be leading the way in the fight against international tax avoidance. The measures are also estimated to raise some £1.1bn in 2017-18, which means that delaying them would increase the black hole in the government’s finances.
- The new rules include a group ratio rule, to help groups with high external gearing for genuine commercial purposes, by substituting the group ratio rule for the fixed ratio rule, if it gets a better result for the group.
Changes to the substantial shareholdings exemption were also due to take effect for disposals from 1 April 2017. These changes are beneficial and should make it easier for the relief to be claimed. They remove the condition that the selling company has to be a trading company or member of a trading group, and remove the requirement for the target company to be trading immediately after the sale.
These reforms also introduce a new category of SSE, where the selling company is owned by certain specified ‘qualifying institutional investors’. Again, the uncertainty puts companies in a difficult position, as they could be making disposals now that could result in tax liabilities if the changes do not come into force from 1 April.
In the midst of all the current uncertainties that businesses are facing over the economic outlook, as well as Brexit, it is not unreasonable for groups to expect to know how they will be taxed on activities in the current financial year.
It is to be hoped that it will not be too much longer before we hear definitely whether these provisions will be introduced as originally planned.
Heather Self and Catherine Robins are partners at Pinsent Masons.