UK taxation of businesses: the business tax road map

UK Budget 2016

Global Publication March 2016

The Government has published its long term plans for how businesses will be taxed; while corporation tax rates will be lowered, there are a number of measures to ensure that the “right amount” of tax is paid. This includes adopting many of the OECD international tax avoidance measures on base erosion and profit shifting (BEPS), including a cap on interest relief.

Since 2010, corporation tax rates have been reduced in stages – it is currently set at 20 per cent. The aim is that this will be reduced to 17 per cent in 2020. This will mean that the rate of corporation tax will be the lowest among the G20 countries. Alongside this, the Government has made the UK a much more competitive regime for international groups, by moving many elements of the UK tax system onto a territorial basis, exempting tax made by foreign branches and modifying the rules for the taxation of subsidiaries situated in low tax countries (the CFC regime) so that they should in principle only apply when profits have been diverted from the UK.  The UK also has an exemption for the sale of trading subsidiaries; the Government has promised to keep this competitive.

However, alongside this reduction in rates and positive changes to the tax system, the Government has introduced a series of measures designed to combat what it sees as tax avoidance and profit shifting. It is not alone in this; the BEPS project will result in potentially radical changes to the international tax system. The UK Government has been a leader in this and is intending to continue to set the pace. The first main change was the introduction of a new tax in 2015, the diverted profits tax (DPT); DPT was designed to prevent profits which should be taxed in the UK from being diverted away from the UK.  It has been much criticised but the Government expects that it will result in an additional £1.4bn becoming tax payable by 2020. Further changes will follow. These include:

  • anti-hybrid measures – where (principally) finance transactions are taxed differently in the jurisdiction of the payer, such as where the payment is intended to be tax deductible and the jurisdiction of the payee (where it is intended that it will be exempt);
  • interest deductibility - the UK traditionally has had very generous rules for interest relief. Previous Governments have considered changes to these but generally have left them intact. From April 2017, there will be a restriction for relief; this is dealt with below;
  • patent box - the UK has a 10 per cent tax rate for certain patent income; the scope of this is to be tightened;
  • exchange of information and country by country reporting - the aim of these is that businesses will have to file reports showing how their revenues break down internationally and these will be exchanged across tax authorities.

The most significant measure will be the changes to the rules on interest relief. These are intended to apply from April 2017. The intent is that tax relief for interest payments will be capped at 30 per cent of EBITDA for those groups which have more than £2m of net UK interest expense. There will be a number of exceptions to this general rule; there will be special rules for UK infrastructure projects and the banking and insurance sectors. There will also be rules to deal with companies whose earnings are volatile. In addition, there will be an overall cap by reference to the worldwide group’s third party borrowing expense. Many countries have similar regimes which are generally very complex in their drafting and their application. Larger groups, especially those with significant interest expense (such as private equity or capital intensive businesses) will have to grapple with them.

Other than BEPS related measures, there are a number of other measures to ensure that tax is paid on UK generated or source income (in addition to DPT). These include:

  • strengthening the withholding tax rules on royalties. A domestic anti-avoidance provision will be introduced to prevent the routing of royalties through a country, with whom there is a double tax treaty in place (so there is no withholding tax). This will be watched with interest, as it marks another use of UK domestic law to stop treaty abuse. The range of payments subject to withholding will also be widened.
  • taxing non-UK property developers where the development is in the UK.

The final counter-balance to the reduction in rates is the introduction of further restrictions on carried forward loss relief (outside the existing rules, which largely only apply where there is a change in ownership). In 2015, rules were introduced to restrict this loss relief for banks to 50 per cent of their profits. This will apply to other types of company with profits in excess of £5 million from April 2017. While the oil and gas sector will not be affected, infrastructure companies which have significant start-up costs and tax depreciation may be caught. The percentage that banks can offset will be reduced to 25 per cent (but with effect from April 2016).

Banks will continue to be subject to two further tax measures – the bank levy, which will be restricted to UK balance sheets (in broad terms) from 2021 and a bank surcharge (an additional corporation tax charge of 8 per cent), which is already in force.

These measures will together result in significant changes to the UK business tax system. Some will be welcomed; others will not. What is important is that the Government continues to consult fully on their detail and businesses have enough time to react to the new rules, so that the inevitable uncertainty is minimised. There is a balancing act for the Chancellor; if the measures are too complex and not fully thought through, businesses will be negatively impacted and the UK will no longer be competitive.

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