UK Budget

March 21, 2007

Highlights of the UK's 2007 Budget which was delivered on 21 March 2007:

Corporates

The main rate of corporation tax which applies to profits above £1,500,000 will become 28% from 1 April 2008 - it will remain 30% up to that date. The small companies rate which applies to profits below £300,000 will become 20% (currently 19%) from 1 April 2007 - the fraction used in smoothing the difference between the main rate of corporation tax and the small companies rate (usually referred to as marginal relief) will become 1/40 from 1 April 2007. These changes will not apply to companies with profits from oil extraction and oil rights from the UK continental shelf.
It has been proposed that research and development tax credit will be extended to companies with fewer than 500 employees which have an annual turnover not exceeding €100 million and/or who have an annual balance sheet total not exceeding €86 million - the current thresholds are 250 employees, annual turnover not exceeding €50 million and/or a balance sheet total not exceeding €43 million. This remains subject to approval under the EC state aid rules.
A minor amendment is also being made to vaccination research relief to correct an unintended error which allows for relief of an additional 150% deduction in certain circumstances as opposed to the intended 50% deduction.
The temporary 50% rate of first year capital allowances for small businesses spending on most plant and machinery will be extended for a further period of one year.
Changes are to be made to Enterprise Investment Scheme (EIS), Corporate Venturing Scheme (CVS), Venture Capital Trust (VCT) Scheme as well as Enterprise Management Incentive (EMI). For EIS, VCT and CVS new rules will require that such companies must have fewer than 50 full time employees at the date on which the relevant share securities are issued - previously there is no such restriction. There is to be a new investment limit whereby EIS, VCT and CVS must have raised no more than 2 million under any or all of the schemes in the 12 months ending on the date of the relevant investment. For EIS, VCT and CVS, changes will also be introduced to allow a qualifying trade to also be carried on by subsidiaries that are 100% subsidiaries of 90% subsidiaries of the parent, or 90% subsidiaries of direct 100% subsidiaries - this amends the strict direct subsidiary 90% rule. For VCT the 70% qualifying holding rule will be relaxed when it makes cash realisation on disposal of investments that are part of its qualifying holding for at least 6 months - the disposal will be ignored for the next 6 months for the purpose of the 70% test thus permitting reinvestment or distribution within that time. For the purposes of EIS, the current rules that require at least 90% of the funds to be invested within 6 months is extended to 12 months.
Major change has been announced for businesses claiming industrial building allowances ("IBAs") or agricultural building allowances ("ABAs"). There is to be a gradual withdrawal of ABAs and IBAs over the next 4 years and transitional provisions will be in place until when these allowances are withdrawn. The rates of allowances that apply to the plant and machinery will be reduced from 25% to 20% and that which applies to long-life assets will be increased from 6% to 10% - these changes apply from 2008/09.
Finance Act 2006 introduced new tax rules for the production of films by companies. Legislation is to be introduced in Finance Bill 2007 to allow companies to opt out of these rules and into general tax treatment. Such an election can only be made by companies incurring expenditure on production of films other than those for cinema (for example television productions). Furthermore such an election will apply to film which start principal photography in the period to which the return relates, as well as any later films. It will not be possible to reverse an election after the time limit for amending the return as passed.
Legislation will be introduced to apply to the use of sale and repurchase agreements ("repos") as a means of financing, to bring its taxation in line with their accounting and economic substance as finance transactions. This is to prevent them being used in arrangements involving tax avoidance.
The VAT registration threshold has been increased from £61,000 to £64,000 and the deregistration threshold has been increased from £59,000 to £62,000. These changes apply from 1st April 2007.
Record keeping requirements for businesses transferred as a going concern will be brought in line with other taxes so that VAT records will remain with the seller except in a few cases where the buyer will be entitled to those records. This change will come into effect for transfers made on or after 1st September 2007.
Joint and several liability for VAT which may go unpaid elsewhere in the supply chain has been extended to apply to certain electronic goods (including related parts and accessories) as well as the satellite navigation systems. Legislation will also be extended to allow "rebuttable presumptions" for the imposition of the joint and several liability to be amended by treasury order.

Real Estate

The SDLT treatment of exchanges of property between connected persons is to be changed so that two legs of the transactions will not be linked together in determining the rate of SDLT as is required currently. This means that, for example, the exchanges of property between a brother and sister where one is worth £300,000 is exchange for a property worth £220,000 will not be treated as if both were subject to SDLT at a rate of 4% (the rate applying for properties above £500,000); rather there will be a 1% charge on the property worth £220,000 and a 3% charge on the property worth £300,000.
Changes are to be made to provide that the payment of stamp duty land tax will no longer be required to accompany the SDLT return. The tax will still have to be paid by the filing date.
Relief for stamp duty and stamp duty land tax on transfers of surplus school land is to abolished with effect from 25 May 2007. Such transfers will, from that date, be within the general stamp duty land relief for statutory reorganisations.
A new time limited relief from stamp duty land tax for new "zero carbon" homes in the UK is to come into effect on 1 October 2007. The relief will be time limited for five years and will therefore expire 30 September 2012. The relief will provide complete removal of SDLT liabilities for all homes up to the purchase price of £500,000. Where the purchase price of the home is in excess of £500,000 then the SDLT liability will be reduced by £15,000.
An existing relief from the special rate of tax for service charges and sinking funds held on trust by registered social landlords and other social landlords will be extended to apply to all landlords i.e. those held by private sector as well. This change will take effect for income arising on or after 6 April 2007. Such funds are commonly held on bank deposits and the interest arising will be taxed at a lower rate of 20% (as opposed to 40%). Because most forms of investment income are taxed at source, no further tax will be payable.
Changes are to made to the VAT legislation following recent judgments of the European Court of Justice in the cases of Lennartz, Charles & Charles-Tijmens and Wollny. Currently where a property is used partly for business and partly for non-business is acquired by a business, it can recover all the VAT paid and then repay the VAT claimed on the non-business proportion over the "economic life" of the property. The changes announced include, inter alia, a ten year period over which VAT claimed is to be repaid back to the Revenue.

Insurance

Changes have been announced to remove an individual's entitlement of tax relief on any pension contributions he or she makes that are used to fund personal term assurance policies. This change will not effect the relief available on contributions by the employers. The changes are to come into effect for contributions made on or after 1 August 2007.
The Revenue is continuing with its consultation on the taxation of profits of life insurance companies. It will introduce legislation in the Finance Bill 2007 to set out the circumstances in which the profits of a life insurance company will be charged to corporation tax under Case 1 of Schedule D (i.e. normal corporation tax rules), rather than under the "I minus E" basis normally applying to such companies; (2) modify the treatment of structural assets held by life insurance companies; (3) remove the restrictions on the utilisation of allowable losses where a life insurance company disposes of units in authorised investments funds to a connected manager; and (4) allow tax exemption to be retained after the transfer of existing tax exempt business which is not life assurance business from friendly societies to life insurance companies. The transfer of friendly society business measure will have effect where transfer takes place on or after the Finance Bill 2007 receives Royal Assent. The remaining measures will have effect for periods of account beginning on or after 1 January 2007.
Life insurance companies have requirements for capital which cannot normally be met by straightforward borrowing. Instead life insurance companies use a variety of more complex arrangements including contingent loans and financial reinsurance contracts to meet these requirements. Legislation will be introduced in Finance Bill 2007 to simplify the tax law relating to some of these arrangements, and discussions will continue about others in the course of the ongoing consultation on life assurance company taxation.
Legislation is to be introduced in Finance Bill 2007 to repeal the current rules dealing with the tax treatment of general insurers' reserve. That is to replaced by a narrowly targeted rule to protect HMRC against tax loss. HMRC is to continue informal consultation with the industry on the replacement rule, some elements of which will be provided by regulations made under the new measure.
Legislation is to introduced in Finance Bill 2007 to clarify that where a policy or contract is held for less than a specified period, the amount of premium allowed in calculating gains on large, short term, policies and contracts is restricted to the true cost to the policyholder, taking into account the benefit to the policyholder of any commission rebate.
Legislation will be introduced in Finance Bill 2007 to clarify that the IPT definition of "premium" includes payments received by, or on behalf of, an insurer for a right to require the insurer to provide cover under a taxable contract of insurance, and therefore that too will be subject to IPT.

Individuals

The basic rate of income tax up to and including 5 April 2008 will remain 22%. This rate will decrease to 20% next year (2008/09). As part of those changes the starting rate of income tax, which is currently 10%, will be removed.
The taxation of dividends from non-UK resident companies will be brought in line with that of UK resident companies, subject to certain conditions. This will mean that only the higher rate tax payers will pay income tax at an effective rate of 25%, once the tax credit has been factored in.
Individuals providing their services through Managed Service Companies (very broadly, single member companies supplying services to one customer) will be taxed as if they are receiving employment income. This will mean that Managed Service Companies will have to operate PAYE (i.e. collect and account income tax as well as employer and employee national insurance contributions) on all payments received by such companies.
Directors who use an overseas property owned by a company which is tax resident in the UK whose sole activity is to hold that property will not face the benefit in kind tax charge for any private use of that property. Although the change is to be made in Finance Bill 2008 HMRC will not seek to tax anyone in the intervening provided, inter alia, there is no other activity in the company.
For 2007/08 tax returns and those of subsequent years, there will be two separate filing dates. For paper returns there will be a new date of 31 October and for electronic returns the date will remain 31 January. For tax payers filing paper returns who want Inland Revenue to calculate their tax for them the cut-off date will move from 30 September to 30 October to align with the new paper filing deadline.

Anti-avoidance and general measures

The legislation is also to be introduced to prevent companies buying the trading losses of corporate members of Lloyds who are leaving the market. The measure will stop companies gaining access to group relief where there is a change in the group relationship after losses are known but before they are recognised for tax purposes.
Legislation is to be introduced to counteract various arrangements that are designed to reduce or cancel the effect of the sale of Lessor Companies legislation introduced in Finance Act 2006.
Legislation is to be introduced by providing for Sharia-Compliant financial arrangements involving the issue of certain types of investment bonds ("sukuk") that are broadly equivalent to debt securities, to be taxed in a similar manner to such securities. Guidance has also been issued on the treatment of diminishing "musharaka" (partnership share) and "takaful" (insurance) products.
The Finance Bill 2007 is to remove restrictions in the offshore funds regime thereby allowing fund of fund structures to gain the status of distributing funds.
The anti-avoidance legislation which was introduced in Finance Act 2006 to apply to companies is now extended to apply to persons liable to capital gains tax as well (i.e. individuals, trustees and personal representatives). This will mean that where a person has entered into arrangements, the main person of those arrangements is to gain a tax advantage by creating an artificial capital loss, any resulting loss will not be an allowable loss for the purpose of capital gains tax.
A new single penalty regime is to be introduced for incorrect returns for income tax corporation tax, PAYE and NIC VAT where the penalty will be determined by the amount of tax understated, the nature of the behaviour giving rise to the understatement and the extent of the disclosure by the tax payer. It will also introduce a new concept of suspended penalties. This is expected to apply for return periods commencing after 31 March 2008.

If you have any questions or comments regarding the budget please contact Kassim Meghjee (kmeghjee@steptoe.com or +44 (0)20 7367 8088).