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Client Alert 09-140

April 2009

reedsmith.com

If you have questions or would like additional information on the material covered in this Alert, please contact the Reed Smith lawyer with whom you regularly work, or:

Harriet MorganLondon +44 (0)20 3116 3478 hmorgan@reedsmith.com

Fionnuala LynchLondon +44 (0)20 3116 3445 flynch@reedsmith.com

Annette BeresfordLondon +44 (0)20 3116 2830 aberesford@reedsmith.com

Rachel DavisonLondon +44 (0)20 3116 2889 rdavison@reedsmith.com

BUDGET 2009

Business Tax

Corporation tax rate

The main rate of corporation tax remains at 28 per cent. The main rate of corporation tax for companies’ ring fence profits remains at 30 per cent. The small companies’ rate (for companies with profits lower than £300,000) remains at 21 per cent. The small companies’ rate for ring fence profits remains at 19 per cent.

Capital allowances

There Government is introducing a new temporary first year allowance (FYA) of 40 per cent for qualifying expenditure incurred in the 12 month period following 1 April 2009 for corporation tax purposes and from 6 April 2009 for income tax purposes. At present, an annual investment allowance gives a 100 per cent allowance on the first £50,000 of qualifying expenditure on plant and machinery. This will continue to apply. In addition qualifying expenditure incurred in the relevant 12 month period in excess of £50,000 will now qualify for a 40 per cent allowance for that period rather than the usual 20 per cent. Excluded from the FYA is “special rate” expenditure (this includes long-life assets and integral features), expenditure on cars, and on assets for leasing.

The rates of writing down allowances otherwise remain the same at 20 per cent for expenditure on plant and machinery, 10 per cent for long life assets and for certain integral fixtures

Groups – Reallocation of chargeable gains

Currently where companies are within a group for chargeable gains tax purposes, they can elect to allocate to another group company any gain or loss arising on the disposal of an asset to a third party. In its current form, the legislation requires an actual disposal of an asset to a third party. However, chargeable gains or allowances can occur without there being a disposal outside the group such as where an asset has become of negligible value or where an asset is sold to a related party (such as an overseas associate). The new rules will remove this restriction for all gains or losses arising on or after the date on which the Finance Bill 2009 receives Royal Assent.

Overseas Profits

Reform of the taxation of overseas profits

Following a long period of consultation and much controversy, a package of new rules has been put together to implement three main elements of the proposed reform of the taxation of overseas profits

Dividends and other distributions received by UK companies from overseas companies will •largely be exempt from corporation tax.

Finance expense payable by UK members of a multi-national group of companies will be •subject to a cap equal to the consolidated gross finance expense of that group.

The Treasury Consents rules will be repealed and replaced by a post-transaction reporting •requirement.

In addition there will be consequential changes to the controlled foreign companies (CFC) regime. There is no further announcement of when we can expect the controversial and much debated major reform of the CFC regime.

The Government will shortly be publishing new draft legislation on the changes to be introduced this year. What follows is a description of the proposals based on the most recent draft but further changes may be made.

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Client Alert 09-140

April 2009

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It has been confirmed that the draft anti-avoidance provisions applicable to loan relationships and derivate contracts forming part of arrangements that have a tax avoidance purpose will not be included in the Finance Bill 2009. However, the case for further legislation in this area will be kept under review.

The changes to the taxation of distributions will apply to dividends and other distributions received on or after 1 July 2009. The new debt cap rules will apply to finance expense payable in accounting periods beginning on or after 1 January 2010. The changes to the CFC regime will also take effect on 1 July 2009 subject to transitional provisions.

Dividends

Under the current rules, dividends received from a UK company are exempt from corporation tax whereas dividends received from overseas companies are subject to corporation tax, with credit being given against foreign tax paid on such dividends. Credit is also given for tax paid on the profits out of which the dividend is paid where the UK recipient controls at least 10 per cent of the voting power in the overseas company.

The Government is proposing to introduce a single regime for both UK and overseas dividends. Under the regime all dividends are potentially taxable unless they fall within one of the following exemptions:

Distributions paid to a company that controls the company making the distribution.•

Distributions in respect of non-redeemable ordinary shares. This covers shares which do •not carry any present or future preferential right to dividends or to a company’s assets on its winding up. Shares are considered “redeemable” if their terms of issue require or allow redemption or there are any arrangements for the investing company to receive amounts substantially the same as the amount that might be payable on redemption or it is reasonable to assume that the investing company will or might become entitled to such an amount.

Distributions where the recipient, together with all connected companies, has not more than •a 10 per cent holding in the share capital of the paying company and an entitlement to not more than 10 per cent of profits available for distribution or of assets on a winding up. This is aimed at exempting receipts from portfolio holdings.

Distributions derived from transactions not designed to reduce tax. A transaction designed •to reduce tax would include transactions with the purpose of diverting profits from another company where they would have been subject to corporation tax or a higher rate of corporation tax. A reduction in tax will be disregarded where it is minimal, or where it was not the main purpose or one of the main purposes of that transaction to achieve that reduction.

Dividends paid on shares which are treated under UK GAAP as debt.•

However, a distribution will not qualify for exemption (even if it falls within the above criteria) if any of the following conditions is satisfied:

Broadly where certain interest returns are treated as distributions under existing provisions •such as where the rate of interest exceeds a reasonable commercial return or the amount is payable in relation to certain convertible securities.

A tax deduction is allowed to a resident of a territory outside the UK in respect of the •distribution.

The distribution is made as part of certain prescribed schemes the main purpose or one of •the main purposes of which is to obtain a more than negligible tax advantage.

The latest draft legislation sets out the following five prescribed schemes:

A scheme which involves a holder of ordinary shares being subject to side agreements •which effectively convert the ordinary share rights into preference shares.

A scheme which involves a shareholder making a payment or giving up a right to income in •return for an otherwise exempt distribution.

A scheme which involves payments not on arm’s length terms i.e. where excessive claims •to deductions are made in circumstances where the transfer pricing rules do not apply (for example because the management, capital and control tests are not satisfied), and where the compensation for the payment giving rise to such deduction is an otherwise exempt dividend.

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A scheme involving the manipulation of the CFC rules. This would include structuring a •company’s ownership so as to avoid a CFC apportionment and paying a dividend in a later accounting period (when the company is a CFC) out of profits made in an earlier accounting period (when the company was not a CFC). Acquisitions of foreign companies which are made wholly or mainly for commercial reasons will be excluded from this scheme.

A scheme in the nature of loan relationships where returns are equivalent to interest. This •type of scheme would use the distribution exemption to produce a return which is equivalent to interest.

Foreign dividends that are not exempt will not benefit from the onshore pooling rules (and thus will not give rise to eligible unrelieved foreign tax (EUFT) and not be eligible for the set-off of EUFTs). This means that excess foreign tax credits on such dividends will be lost where there is a high underlying tax rate. HMRC is considering the issue of relief in those circumstances. Non-exempt foreign dividends will generally continue to be eligible for underlying tax relief, unless they are taxable in the UK by reason of being tax deductible in another jurisdiction (in which case no underlying tax credit will be available).

It should be noted that it was originally proposed to exclude participation distributions (broadly, where the recipient directly or indirectly controls at lest 10 per cent of the voting power in the paying company) received by small companies from the dividend exemptions set out above. Following consultation, it was decided to introduce such exemptions for all UK companies, including small companies.

CFC

The current exemption from the CFC rules which applies where an overseas company distributes at least 90 per cent of its profits will be repealed. This is on the basis that the majority of such distributions will now be exempt. The current CFC rules also provide for an exemption where a foreign company qualifies as a holding company under the exempt activities test. This exemption will be removed for most holding companies, subject to a two-year transitional period.

Debt cap rules

The Government will introduce a cap on the amount of intra-group finance expenses for which UK members of large multi-national groups can obtain a tax deduction. Broadly the UK group will not be able to obtain a tax deduction for finance costs which exceed the overall finance cost incurred by the world-wide group.

Following a period of on-going consultation the Government announced on 7 April 2009 that it would consider a number of changes to the draft rules as originally published. However, the Government has not yet published a revised draft of the rules. In the interim we have set out a summary of the likely shape of the new rules based on the 7 April announcement.

The debt cap rules work by comparing the financing expenses of UK group companies (the “tested amount”) with the financing expenses of the whole group (the “available amount”). No tax deduction is available to the UK group to the extent that the tested amount exceeds the available amount. The amount disallowed is allocated among the UK group companies. The group can elect for a corresponding amount of the finance income of the UK group to be non taxable.

Group tests and application to UK companies: The debt cap rules will apply only to “large” international groups of companies which have UK group members. Broadly a group is “large” if relevant members of the group have at least 250 staff or if it has both a turnover of at least €50 million and a balance sheet total of at least €43 million.

A group company is taken into account in the tested amount calculation and is potentially subject to a restriction on its allowable finance cost expense if:

it is tax resident in the UK or trading in the UK through a permanent establishment; and•

it is either the ultimate corporate parent of the group or a 75 per cent subsidiary of the •ultimate corporate parent.

The 75 per cent subsidiary test requires both legal and economic ownership using the same grouping test as applies for UK group relief purposes. The ultimate corporate parent must beneficially own or be entitled to (directly or indirectly) at least 75 per cent (a) of the ordinary share capital of the relevant company, and (b) of any profits available for distribution to equity holders of the company and any assets which would be available to equity holders on a winding-up. In addition the rules catch any member of the group if it is a party to a scheme the main purpose, or one of the main purposes, of which is to secure that the company is not a relevant subsidiary for the purposes of these rules.

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Calculation of non-allowable element: As noted the debt cap requires a comparison of the “tested amount” and the “available amount”. The tested amount is the aggregate of the net financing expenses of each UK group company as computed on an individual basis and taking account of both intra-group and external finance expense and income of that company. Only companies whose finance expense actually exceeds their finance income need to be taken into account.

The available amount will be the worldwide group’s gross consolidated external finance expense (both UK and non-UK). Any interest receivable is ignored and only the gross amounts payable are considered. These amounts are intended to be derived form consolidated accounts prepared in accordance with IAS or other acceptable accounting standards such as US or UK GAAP.

The finance costs to be taken into account for these tests are essentially interest and “interest like” expenses such as discount and premiums. Costs of hedging arrangements will be included to the extent that they only impact one group company and affect the amount of interest that would be payable/receivable. Finance costs of any finance lease are also included as are charges on wholly intra group debt factoring arrangements.

Excluded costs include impairment losses and loss reversals, profits or losses on acquisition or disposal of rights under a loan relationship and foreign exchange gains and losses. Also both finance expense and finance income in respect of short-term debt will not be taken into account. Short term mean debt with a fixed repayment date of less than 12 months and repayable on demand facilities. There will also be a de minimis exclusion for amounts which the Government “does not consider material” (further guidance is yet to be published).

It is proposed to exclude a group from the new rules entirely where the income generated from qualifying activities from certain financial business (being lending, insurance or dealing in financial instruments) represents substantially all of the group’s consolidated income for an accounting period. It is not yet know precisely what level of income will satisfy the “substantially all” requirement. The government is also considering whether it could introduce this test by reference to the financial business income of the UK group only.

Concerns had been raised that the rules could lead to UK holding companies which borrow from external sources having excess non-trading losses which they would not have much prospect of utilising. In response the Government has said that such companies will be able to elect for the relevant debt relationship to be disregarded entirely for debt cap purposes.

Disallowance of deduction/reduction of corresponding taxable income: Any group of companies subject to the debt cap rules will be required to submit a return stating the tested amount, the available amount, the total disallowed amount and the allocation of the disallowance. The group will have the option to make a statement that it is satisfied that the tested amount does not exceed the available amount for the accounting period, provided it is able to demonstrate on enquiry that it has systems in place to be able to support this statement. It was originally intended that the return would have to be signed by the proper officer for each relevant group company that was allocated a disallowance. However, HMRC are now considering whether to allow an authorised person to sign the return on behalf of all relevant group companies.

Provided the group makes a return, it can choose how the disallowed amount is to be allocated between the UK group companies provided that the amount allocated cannot exceed that company’s individual net finance expense.

If no return is made, there will be default rules to allocate the disallowance between the relevant group companies with net finance expense.

The group can also elect for an amount corresponding to the disallowable amount to be used to reduce the otherwise taxable net finance income of the UK group whether intra group or external finance income. Again, a group has autonomy in allocating the disregard among UK relevant group companies who have net finance income provided that a return is made. If no return is made, there will be default rules to allocate the disregard of income between relevant group companies with net finance income.

Gateway test: It is intended to introduce a ‘gateway test’ to reduce the administrative burden of performing the relevant calculations for groups where it is likely that no disallowance would arise. In outline, companies will not have to apply the debt cap provisions for any accounting period where the aggregate of the net debt figures is less than 75 per cent of the gross debt figure shown in the group’s worldwide consolidated accounts.

Targeted anti-avoidance rule: The rules will contain a targeted rule to counter the obtaining of a tax advantage where there are avoidance arrangements. Arrangements will exist where the main purpose or one of the main purposes of any person concerned in the creation or implementation of the arrangements is to enable the obtaining of a tax advantage. A tax advantage will include a decrease in the tested amount, an increase in the available amount

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and increases or decreases of debt that are taken into account in the gateway test. The test of whether there is a tax advantage will apply at group level rather than at company level.

Treasury consents

The existing legislation requires companies to obtain approval from HM Treasury before undertaking certain transactions involving subsidiary companies resident outside the UK. In particular, a UK resident company needed treasury consent:

(a) to cause or permit a non-resident company over which it has control to create or issue any shares or debentures; or

(b) where it owns, or has an interest in, shares or debentures in a non-resident company over which it has control to transfer (or to cause or permit to be transferred) any such shares or debentures.

Non-compliance with that obligation was a criminal offence.

This current legislation on treasury consents will be repealed and replace by a post-transaction reporting requirement that applies to transactions with a value of £100 million or more subject to a number of exclusions. Companies must make a report within six months of the transaction.

Double tax relief on dividends

Provisions will be introduced to ensure that the reduction in the corporation tax rate from 30 per cent to 28 per cent which took effect on 1 April 2008 does not unjustly affect the amount of double taxation relief available to companies receiving dividends paid by foreign companies in an accounting period straddling that date.

Currently companies are taxable on dividends received from overseas companies but can obtain credit for certain overseas taxes. The amount of this credit is restricted by reference to a formula (the ‘mixer cap’) which limits the amount of relief by reference to the corporation tax rate in force when the dividend is paid. The new rate of corporation tax of 28 per cent was introduced with effect from 1 April 2008.

Dividends paid in an accounting period straddling 1 April 2008 are taxable at a blended rate of between 28 and 30 per cent. However, for all dividends paid after 1 April 2008, the available credit for overseas taxes is capped by reference to the lower rate of 28 per cent as this is the rate in force at the date the dividend is paid. The new provisions will correct this mis-match by ensuring ensure that the mixer cap works by reference to the blended rate of corporation tax which applies for the relevant period and not the lower rate of 28 per cent.

Financial Transactions – Crisis Measures

Loan relationships: connected companies

The Government has confirmed that it will introduce in this year’s Finance Act two changes it has been consulting on for some time in relation to debt between connected companies. The changes will generally be welcomed.

Currently there is a potential mis-match in the tax treatment where a corporate lender releases a connected corporate borrower from a trade debt (or a debt incurred in a UK or overseas property business). In certain circumstances the lender is denied a deduction for the loss on the debt but the borrower may be taxed on its ‘profit’ on the debt release. Where a trade or property business debt is released on or after 22 April 2009, a connected borrower will now no longer be taxed on its ‘profit’ on the debt release. As before the lender company cannot obtain tax relief on the amount written off.

The second change amends the rules on the late payment of interest between connected companies for accounting periods beginning on or after 1 April 2009. Usually a corporate borrower can obtain a tax deduction for interest payable by it on an accruals basis in accordance with its accounting recognition. However, under the current rules, where a borrower pays interest to a connected creditor which is not within the charge to UK corporation tax (such as a non-UK resident creditor) more than 12 months after the end of the accounting period in which the interest accrues, the debtor will obtain a tax a deduction only when the interest is actually paid. The late payment of interest restriction will be amended so that it no longer applies and, a tax deduction will potentially be available for late paid interest on an accruals basis, where the relevant lender is resident in a territory with which the UK has an appropriate double tax agreement. This means that in future the late payment of interest rule will generally only apply where the lender is resident in a tax haven country. Equivalent changes will be made to the similar late payment rules applying to deeply discounted securities. If this relaxation of the rules is abused, an anti-avoidance provision will be introduced in a future Finance Bill.

Group relief – preference shares

As announced in December 2008, rules will be introduced with the aim of ensuring that companies which issue particular types of preference shares to investors are not de-grouped

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for tax loss relief and other tax grouping purposes. The rules are aimed at benefiting regulated financial institutions issuing preference shares to raise finance that qualify as Tier 1 regulatory capital but will apply to all corporates. On the whole this change should benefit corporate groups by extending the circumstances in which an issue of preference shares will not affect their tax group status.

Currently, one company can surrender tax losses to another company where they are within the same 75 per cent corporate ownership. This requires both legal and economic ownership by reference to (a) ordinary share capital (b) profits available for distribution to equity holders and (c) assets which would be available for distribution to equity holders on a winding up. Equity holders are holders of shares other than fixed rate preference shares and loans creditors other than in respect of normal commercial loans. At present fixed rate preference shares are defined as shares which carry rights to a dividend of a fixed amount or at a fixed rate.

It has become increasingly common for banking groups to raise finance by the issue of non-cumulative preference shares on terms that no dividend would be paid if it would breach the bank’s capital requirements. The concern was that the restrictions on paying a dividend could mean that they do not qualify as fixed-rate preference shares. The consequence of a company being de-grouped is that it could lead both to a de-grouping tax charge on issue and to a significant ongoing increase in the group’s tax burden. For example, a de-grouped company will be unable to surrender or receive losses by way of group relief.

Under the new rules a share qualifies as a preference share if it does not carry an entitlement to any dividends or if it carries a dividend right which satisfies the following tests:

First in each case the shares must carry a right to a dividend which represents no more than •a reasonable commercial return on the shares.

Secondly the rights must be to dividends of a fixed amount or at a fixed rate or at a rate •which fluctuates in accordance with a standard published rate of interest or the RPI or any similar such index.

Finally the company must not be entitled in any circumstances to reduce the amount of •or not to pay the dividend unless (a) at the time the dividend is or would be payable the company is in severe financial difficulty, or (b) it is prevented by law from so doing, or (c) a regulatory body (such as the FSA or overseas equivalent) recommends that the full payment is not made. There is a power to enable the Treasury to make regulations confirming when this test is met; it is hoped these will be forthcoming shortly.

The new rules will apply to accounting periods beginning on or after 1 January 2008 subject to an opt-out for shares issued before 18 December 2008 or pursuant to an agreement dated before 18 December 2008.

Trading loss carry back for business

Loss-making companies and businesses will benefit from a temporary extension to the extent to which trading losses can be carried back for off-set against profits of previous years. Under current rules, except in certain limited situations, losses can be carried back for off-set against profits of the preceding year only. It was announced in the Pre-Budget Report 2008 that losses arising in a specified twelve month period in 2008/2009 could be carried back for three years. The proposal was that the losses will be available for off-set against later years first with unlimited set off in the first year but an overall cap of £50,000 for the earliest two years. The Government has confirmed that this relief will be introduced and that it will also be extended so that it applies for a further twelve month period. This means that relief will be available on this basis for losses generated in accounting periods ending between 24 November 2008 and 23 November 2010 for corporates and in tax years 2008/9 and 2009/10 for unincorporated businesses.

Foreign dominated losses

In certain circumstances companies are able to use excess tax losses arising in an accounting periods against profits of prior and future periods. Where the company draws up its accounts in a currency other than sterling a mis-match can arise. For tax purposes the company’s profits are converted into sterling at the exchange rate when the profits were earned whereas losses are converted into sterling at the exchange rate in the period when the losses arose. This means that the amount of profits of prior and future periods which can be off-set against the relevant losses will to some extent depend on movements in currency exchange rates.

Legislation will be introduced to ensure that where a company incurs a tax loss computed in a currency other than sterling and then offsets that loss (or part of that loss) against profits in a different accounting period, the exchange rate for conversion of the losses into sterling will be the same rate as that used for conversion of the profits against which the losses are offset. In addition, where a company changes its functional currency, losses carried forward or back into periods across the change in functional currency will be converted into that other functional

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currency at the spot exchange rate for the date of change.

The new rules will apply for all accounting periods beginning on or after 29 December 2007 unless the company elects to defer the commencement date to the period beginning after Royal Assent is given to the Finance Act 2009.

Stock lending and repos

Currently no stamp duty, stamp duty reserve tax (SDRT) or capital gains charge arises on stock loan or repo arrangements on the transfer of share provided that equivalent shares are returned to the originator. There are potential tax charges however where no equivalent shares are returned.

New provisions will be introduced to prevent tax on chargeable gains, stamp duty or SDRT arising where a stock lending or repo arrangement terminates and stock is not returned to the originator under the terms of the arrangement due to the insolvency of one of the parties. The reliefs will apply where the insolvency of the borrower or lender occurs on or after 1 September 2008.

The provisions disapply the stamp duty/SDRT charge that would otherwise apply in an insolvency situation:

to a borrower under a stock lending arrangement or a purchaser under a repo where the •arrangement terminates on the insolvency of the borrower or purchaser;

to a lender under a stock loan or a seller under a repo which would otherwise be payable on •the purchase of replacement securities;

to a borrower under a stock loan or a seller under a repo on the purchase of securities to •replace any securities transferred to the lender/seller as collateral.

In addition the lender under a stock loan will be exempted from tax on any chargeable gain which it is deemed to make on the termination of the stock in insolvency cases. This relief only applies if the lender uses the collateral provided by the borrower to acquire replacement securities in the market. If this is not the case the lender is deemed to have disposed of the securities at market value for chargeable gains purposes.

Manufactured interest

Legislation will be introduced in the Finance Bill 2009 to prevent a recent decision of the High Court from affecting the tax treatment of real payments of manufactured interest. The High Court decision could result in payers being able to claim additional deductions for tax purposes that bear no relation to their economic position and recipients being taxable on amounts in excess of their actual income. Consequently, legislation will ensure that the tax treatment follows the treatment of the payments in company accounts prepared in accordance with Generally Accepted Accounting Principles and will apply to manufactured payments made before or after the Financial Secretary’s announcement of the measures on 27 January 2009. The legislation will apply to ‘deemed payments’ of manufactured interest made on or after 27 January 2009.

Hedging proceeds from future share issues

Rules will be introduced to remove the concern that a company could be subject to corporation tax on a rights issue where shares are issued in a currency other than its functional currency and the company enters into a currency derivates contract which seeks to hedge the currency risk. The new rules will provide that any exchange gain or loss arising on such a currency derivative contract will not brought into account for tax purposes unless overall there is an exchange gain made on the relevant derivative contract and that gain is subsequently distributed to shareholders. The new rules will apply to all relevant currency derivative contracts entered into on or after 1 January 2009.

Financial services compensation scheme: payments representing interest

The interest element of a compensation payment made by the Financial Services Compensation Scheme (FSCS) will be subject to income tax. The FSCS is a statutory fund of last resort for customers of authorised financial services firms. It is an independent body, set up under the Financial Services and Markets Act 2000. The FSCS pays compensation in circumstances where a firm is unable, or likely to be unable, to pay claims against it.

Compensation paid by the FSCS to customers of defaulting financial institutions usually includes an amount representing accrued interest from the last date interest was paid to the customer to the date that the financial institution defaulted (or to the date of maturity for a fixed term deposit if later). In tax terms such amounts are not likely to be regarded as actual interest under the current rules. The rules will be amended so that payments made by FSCO representing accrued interest will be taxable as though they were actual interest so that the recipient is in the same position as if interest had been paid by the defaulting financial institution in the normal way.

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Funds, REITs and Alternative Finance

Authorised investment funds – new elective regime

Currently AIFs are exempt from UK tax on chargeable gains but pay tax at a lower special rate of 20 per cent on their taxable income. Broadly, AIFs are treated as companies, so that distributions made to their investors are treated as dividends and are not tax deductible. (This is subject to specific rules for “bond funds.)

As announced last year the Government is proposing to introduce an elective regime whereby in effect investors in the fund will be taxed on certain income receipts as though they held the assets directly. An AIF which makes the election will have to stream its income into dividend receipts and other “interest” income. UK dividend income will remain non taxable in the fund and will be distributed to the investor as a dividend and will be taxable in the hands of the investor as such. The fund will receive a tax deduction equal to the amount of all other “interest” distributions. In the hands of investors, such distributions will constitute payments of yearly interest.

An AIF will only be able to make the election where certain conditions are satisfied. No details are in the Budget press release but from the latest consultation it seems likely that the AIF will need to meet a “genuine diversity of ownership” condition” similar to that which currently applies to property authorised investment funds.

The new rules will apply from 1 September 2009

Authorised investment funds (and equivalent offshore funds) – certainty on trading or investment

Legislation will be introduced to give AIFs and UK investors in equivalent offshore funds greater certainty as to when transactions undertaken by the fund will be treated as trading or investment activities.

AIFs are taxable on trading income at the special lower rate of 20 per cent but are exempt from tax on their gains. UK resident investors in equivalent offshore funds which are “reporting funds” under the proposed new offshore funds regime will be subject to tax on income which includes trading profits. Under the new rules there will be a “white list” of transactions which when undertaken by a qualifying fund will not be treated as trading transactions. The fund will have to meet a genuine diversity of ownership test to qualify. This is intended to confine the benefit to funds which are made available to a wide range of investors only.

There will also be rules designed to ensure that financial traders cannot shelter profits from tax by routing them through an AIF or equivalent fund. Traders who hold interest in funds which qualify for the white list treatment will be required to calculate realised and unrealised profits on such interest and include then in their own trading results.

New definition of offshore funds

The Government has confirmed that it will be changing the definition of offshore fund for the purposes of the offshore fund legislation. Currently the definition is based on the regulatory definition of collective investment scheme as set out in the Financial Services and Markets Act 2000. The new definition will use a characteristics based approach which has been the subject of detailed consultation with the funds industry. There will be specific exemptions to ensure that fixed share capital arrangements that do not share key characteristics of open ended arrangements will remain outside the definition. The new definition is intended to be simpler and to provide more certainty to investors. However it is also intended to counter advantages being obtained where an offshore arrangement is technically outside the current definition of an offshore fund but the arrangements are economically the same. The new regime will take effect from 1 December 2009.

Changes to the Investment Manager Exemption

The Investment Manager Exemption enables UK investment managers to provide professional trustee services and brokerage and investment management services in the UK to a non-resident person without exposing the non-resident to UK tax (other than tax deducted at source if any).

The Investment Manager Exemption is restricted to income arising in connection with investment transactions carried out by the Investment Manager on behalf of the overseas person. The definition of “investment transactions” currently includes lists of transactions in various pieces of legislation. Following changes to the Investment Manager Exemption in the Finance Act 2008, it is intended to replace the current lists of investment transactions with a single list set out in the Investment Manager (Specified Transactions) Regulations 2009 which have been published in draft. The draft Regulations set out the following broad categories of investment transactions:

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transactions in stocks or shares•

transactions in relevant contracts (options, futures and contracts for differences)•

transactions involving loan relationships or related transactions•

transactions in units in collective investment schemes•

transactions in securities•

transactions in buying or selling foreign currency•

transactions in carbon emission trading products.•

It is expected that the Regulations will come into force in the course of 2009.

Opaque tax treatment for contract based offshore funds

Certain offshore funds formed on a contractual basis will no longer be treated as tax transparent for UK chargeable gains tax purposes. Currently funds such as unit trusts are treated as though they were a company and as though the units were shares for chargeable gains purposes. This means that UK investors in such vehicles are potentially taxable on any gain realised on a disposal of units in the unit trust. The new rules will mean that individual investors in a contract based fund will similarly be treated as making a taxable disposal for chargeable gains purposes on the sale of its interest in the fund. Investors will not however be concerned with capital gains arising to them in relation to dealings in the underlying assets.

Partnerships are not affected and will remain transparent for both income and chargeable gains purposes.

The new treatment will apply to investments in contract based offshore funds on or after 1 December 2009 but elections can be made for the new treatment to apply retrospectively back to the tax year 2003/2004. For the time being the new treatment will apply to non corporate investors only but the Government will consult with industry in relation to extending the regime to corporates also.

Taxation of distributions from offshore funds

With effect from 22 April 2009 individuals who receive distributions made as dividends from offshore funds will be entitled to the non-payable dividend tax credit where the fund largely invests in equities. This availability of the credit had been withdrawn due to concerns that some funds were seeking to exploit the availability of the credit by locating their cash or bond fund ranges offshore for tax avoidance purposes.

Where the offshore fund holds more than 60 per cent of its assets in interest bearing (or economically similar) form, any distribution will be treated in the hands of the UK individual investor as a payment of yearly interest. No tax credit will therefore be available to the individual in receipt of distributions from such an offshore fund.

Real estate investment trusts (REITs)

The Finance Bill 2009 will include a number of changes to the REITs regime which will take effect from 22 April 2009.

Where a company has joined the REIT regime it is tax transparent in respect of profits arising from its property rental business (subject to a number of qualifying conditions). Property rental companies or groups can elect to join the REIT regime if they meet certain entry requirements and, on an ongoing basis, if they meet the conditions for staying in the regime. The requirements include conditions relating to the company itself, to the properties it rents, and to the nature of its business and assets.

The proposed changes are:

Groups of companies will be prevented from restructuring their activities in a way that would •allow them to meet the REIT conditions whilst letting properties between members of the group. Companies will not be able to take part in the regime unless at least 75 per cent of their gross income derives from letting properties to tenants.

Owner occupied properties will be excluded from the tax exempt business of the REIT.•

Companies with ‘tied premises’ will no longer be potentially excluded from joining the •regime. These are premises through which goods supplied by a trader are sold or used by another person where the trader has an interest or estate in the premises (the main application of the ‘tied premises’ provisions is to the brewing trade).

REITs are currently only able to issue one class of ordinary share and non voting fixed rate •preference shares. In future they will be able to raise funds by issuing convertible preference shares.

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One of the qualifying conditions for REIT status is that at least 75 per cent of the REIT’s •assets are involved in its property rental business. Currently there are different definitions of asset for group REITS and single company REITs. A new single definition will be introduced using the accounting position.

The rules will also clarify how to apportion funds arising from a disposal of assets which are •partly used for the property rental business and partly for non-rental purposes

The rules will amend the conditions that a company does not need to meet at the time of •joining the REIT regime. There are currently two conditions: that the shares are listed on a recognised stock exchange and the company is not a close company. Currently, those conditions are linked so that a Company can give notice to enter the REIT regime if it expect to be close on the first day of its first accounting period as a REIT by reason only that its shares have not been listed on a recognised stock exchange within the preceding 12 months. The proposed change will uncouple those conditions so that either or both the conditions do not have to be complied with on joining the regime. Further details of this change are awaited.

Improvements to venture capital scheme

The Government has announced a number of improvements to the Venture Capital Schemes (i.e., the Enterprise Investment Scheme (EIS), the Corporate Venturing Scheme (CVS) and the Venture Capital Trust (VCT) scheme).

The CVS, VCT and EIS rules currently require investee companies to use 80 per cent of funds raised in a qualifying activity within 12 months of issue or commencement of the qualifying activity and the balance within a further twelve months. This rule will be relaxed so that all funds raised must be used by the investee companies within 2 years of the share issue or, if later, within 2 years of commencement of the qualifying activity.

For EIS, in addition:

There will no longer be a restriction on the use of monies raised by the issue of non EIS •shares. The requirement will be removed that the investee company must use money raised from the issue of other non EIS shares which are of the same class as EIS shares and are issued on the same day as EIS shares within the same time limits as apply for the EIS shares themselves;

Currently where EIS shares are issued before 6 October in any tax year, an investor can •carry back the related income tax relief to the previous year. The carry back is restricted to half of the subscriptions in the period subject to a cap of £50,000. This will be changed so that income tax relief relating to shares issued at any time in a tax year can be carried back up to an extended cap of £500,000; and

An anomaly will be removed which currently prevents investors from obtaining roll-over relief •for chargeable gains purposes on a share for share exchange.

Most of these changes take affect from 22 April 2009. The extension of the carry back for EIS purposes applies for the tax year 2009/2010 and onwards.

Alternative finance arrangements

Legislation will be introduced to provide stamp duty land tax (SDLT) and capital gains tax relief for persons using land asset backed securities in alternative finance arrangements. The current rules provide that where land assets are issued as securities in alternative finance arrangements, SDLT arises on both the transfer of the land asset to the bond issuer and the eventual return of the asset back to the person seeking to obtain finance. There is also a potential charge to SDLT arising to bond-holders. The new provisions will remove this SDLT charge on transfers of property to and from the bond issuer and ensure that no charge arises to the bond-holders.

Provisions will be introduced to ensure that such arrangements are capital gains tax neutral and will not give rise to a gain on which a tax liability could arise and that the person obtaining the finance will be entitled to capital allowances whilst the land asset is held by the bond issuer for the purposes of the bond.

The new rules will apply with effect from the date of Royal Assent to the Finance Bill 2009

Anti-avoidance

Principles based approach to anti-avoidance

The Government has been consulting for a prolonged period on the introduction of “principles based” anti-avoidance rules in two scenarios. Previously the approach has been to introduce piece meal detailed legislation aimed at particular situations. The intention is to replace these specific rules with broader rules of more general application but based on clear principle. The

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rules are aimed at preventing companies entering into arrangements to avoid tax on returns from investments that are economically equivalent to interest and on sales of rights to income streams without selling the underlying asset.

Disguised interest

The Government’s concern is to prevent companies being able to structure transactions as giving a form of equity return when in substance the return is of an interest nature. This could give an advantageous tax result as the UK corporate lender would not be taxable on the return in circumstances where the borrower is not concerned with obtaining a tax deduction for the expense.

The principle is that returns that are economically equivalent to interest are to be taxed in the hands of the corporate lenders and borrower as if they were interest under the loan relationship rules. A return is economically equivalent to interest if all of the following apply:

It is reasonable to assume that the return is by reference to the time value of the amount of •money in relation to which it arises.

The return is at a rate reasonably comparable to a commercial rate of interest.•

At the time the taxpayer enters into the arrangement, there is no practical likelihood that the •return will stop arising in accordance with that arrangement.

The new rules will only apply where the main purpose or one of the main purposes of the arrangement is to secure that the return is not brought into account as income for corporation tax purposes.

There is an exclusion where the return is brought into account as income under the rules relating to either trading income, derivatives contracts, intangible fixed assets or loan relationships. There is also an exclusion where all of the following apply:

The arrangement producing the return involves fully paid up shares. Shares are fully paid •up if there is no actual or contingent liability to meet unpaid calls on the shares or to make a contribution to the capital of the issuing company that could affect the value of the shares.

The return under the arrangements only reflects an increase in the fair value of the shares. •“Fair value” means the price that a knowledgeable and willing purchaser acting at arm’s length to the seller would pay for the shares.

The shares are in a company that is not a controlled foreign company or if it is a controlled •foreign company its profits are apportioned to the shareholder under the CFC rules or (would be so apportioned but for certain exemptions applying).

The aim of these provisions is stated to be the provision of “a safe harbour for all straightforward intra-group share investments so that it becomes unnecessary to consider whether an arrangement produces a return economically equivalent to interest, or whether the arrangement might be viewed as tax-driven”.

The legislation will apply to arrangements to which a company becomes a party on or after 22 April 2009 but will also apply to certain arrangements in place before that date which are within the scope of the existing disguised interest rules.

Redeemable preference shares

Non-participating or fixed rate preference shares accounted for as a financial liability are not caught by the disguised interest rules described above. Instead separate provisions will in certain cases tax the shareholder as if it had made a loan. In outline, these rules apply where:

The share would be accounted for as a liability in accordance with generally accepted •accounting practice.

The share is designed to produce a return which equates in substance to the return on an •investment of money at a commercial rate of interest.

The issuing company and the investing company are not connected companies.•

Corporation tax would not be chargeable on distributions made in respect of the shares.•

The investing company’s purpose or one of its main purposes is an unallowable purpose •(broadly where a main purpose is tax avoidance).

The shares are not holdings in an open ended investment company, unit trust or offshore •fund that are otherwise treated as rights under a loan relationship

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In such cases, the shareholder is to be taxed under the loan relationship rules as if returns on the shares were interest rather than distributions.

The new rules will take effect from 1 April 2009, subject to transitional provisions.

Transfers of income streams

These provisions will ensure that profits received on the transfer of rights to future income streams where the asset is not also transferred are taxable as income to the extent that they would have been taxed as income if the transfer had not taken place. The aim of these rules is to stop transactions whereby an income stream is sold to a company which would not be taxed on the income. In the absence of these provisions the seller would neither be taxed on the income nor usually on the sales proceeds.

Under the new rules the taxable amount is the actual consideration for the transfer or an amount equal to the market value where the consideration is substantially lower than the market value. The Government states that the market value rule is to be applied only exceptionally where it is clear that the transaction is not made on an arm’s length basis or that the transaction has been structured to make it appear that the consideration is less than the actual value given. The deemed income will generally be treated as arising when the income is recognised in the transferor’s account in accordance with generally accepted accounting principles.

The rules do not apply if the consideration is charged to tax as income of the transferor or brought into account in calculating its taxable profits or the transfer is by way of security only. There is also an exclusion where the transfer of the right to income results from a grant or surrender of a lease or the grant of an oil license.

Provisions will be introduced so that generally the transferee company is taxable only on the difference between the acquisition cost and the income stream. Where the transferee is a company the consideration is treated as debt falling within the loan relationship rules. Under these rules only the finance return as recognised for accounting purposes should be chargeable to tax.

The new legislation will apply to all transfers of income taking place on or after 22 April 2009.

Taxation of intangibles for corporates

Under the corporate intangibles regime which took effect on 1 April 2002, credits and debits arising in respect of intangible fixed assets (e.g. royalties, gains / losses on sale etc) are treated as income rather than capital.

The regime applies, generally, to companies’ intangible fixed assets and goodwill created on or after 1 April 2002 or acquired from an unrelated party on or after that date. Intangible fixed assets and goodwill created or acquired prior to that date remain subject to the rules on chargeable gains. Goodwill is specifically excluded from the regime (and thus subject to the rules on chargeable gains) if it was internally generated by a business that commenced before 1 April 2002, unless or until that business is acquired by an unrelated party.

According to the Budget Report, there have been avoidance schemes whereby goodwill has not been treated as intended by the intangible fixed assets regime. The Finance Bill 2009 will therefore include legislation to confirm the treatment of goodwill to prevent further avoidance.

The legislation will confirm that for the purposes of the intangible fixed assets regime, goodwill includes internally generated goodwill. All goodwill is treated as created in the course of carrying on the business in question. Goodwill is treated as created before 1 April 2002 where the business was carried on at any time before 1 April 2002 by the company or a related party. Otherwise goodwill is treated as created on or after 1 April 2002.

The legislation will have effect on or after 22 April 2009 and will be treated as always having had effect. For example, it will prevent future debits in respect of goodwill where a business, which commenced before 1 April 2002, has been acquired from a related party before 22 April 2009.

Corporate transparency: personal tax accountability of senior accounting officers of large companies

The Government proposes to introduce rules to ensure that the accounting systems in operation within large companies liable to UK taxes and duties are adequate for the purposes of accurate tax reporting. Broadly, a company is ‘large’ if it exceeds two or more of the following three thresholds: (1) turnover of not more than £25.9 million, (2) balance sheet total of not more than £12.9 million, and (3) not more than 250 employees.

Senior accounting officers of large companies will be required to:

take reasonable steps to establish and monitor accounting systems within their companies •that are adequate for the purposes of accurate tax reporting; and

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either certify annually that such accounting systems are adequate for the purposes of •accurate tax reporting or specify the nature of any inadequacies and confirm that such inadequacies have been notified to the company auditors.

Such companies will be obliged to notify HMRC of the identity of the senior accounting officer.

Cases of careless or deliberate failure to comply with the above obligations will attract penalties both for the company and for the senior accounting officer personally.

These obligations will apply to returns for accounting periods beginning on or after the date on which the Finance Bill 2009 receives Royal Assent. There may also be transitional arrangements.

Administration and Compliance

Procedure for reclaiming income tax, capital gains tax and corporation tax overpayments

Changes are to be made, with effect from 1 April 2010, to the time limits within which claims •should be made, and requirements to be met for a repayment of tax by HMRC.

From 1 April 2010 repayments of tax must be claimed within four years from the end of the •period for which the return was made.

There will no longer be a requirement that the overpayment was a result of a mistake in a •return and that it was made under an assessment.

No repayment will be given where the return followed the general practice at the time it was •made, or where the mistake is governed by another statutory claim.

The implementing measure will explicitly state that HMRC are not liable to repay an amount •except as provided by the measure or another provision of the Income and Corporation Taxes Act 1988. It will also enable claimants to determine the amount to be repaid, subject to HMRC’s right to enquire into a claim within the enquiry window for claims, normally 12 to 15 months, and to recover any related underpayments.

The new legislation will set out the basis on which claimants will be able to determine the •amount to be repaid, and when they can make a claim.

Current restrictions on the right of appeal will be removed with the result that appeals to the •courts will be allowed on the same grounds as they would for appeals against other matters.

Payments and repayments of tax and tax debtors

The Finance Bill 2009 will introduce three separate changes to the current law:

Voluntary managed payment plans (MPPs). MPPs will allow taxpayers to spread their income •tax or corporation tax payments equally over a period straddling the normal due dates, without incurring interest or penalties on late payment. They will not be available before April 2011.

HMRC will be given the power to collect small tax debts through the PAYE system, subject •to existing safeguards protecting the level of taxpayers’ income. This will allow debtors with a source of PAYE income to spread their payments and reduce HMRC costs.

Companies and businesses will be required to disclose to HMRC the address and contact •details of tax debtors with whom HMRC has lost contact. This new obligation will take effect on the date when the Finance Bill 2009 receives Royal Assent.

Compliance checks – record keeping, HMRC information powers and time limits for assessments

The Finance Act 2008 amended and consolidated the rules governing the keeping of records, HMRC information powers and time limits for making assessments. These rules will now be extended to cover environmental taxes (aggregates levy, climate change levy and landfill tax), insurance premium tax, stamp duty land tax, stamp duty reserve tax, inheritance tax and petroleum revenue tax. The commencement date for the extended rules is expected to be 1 April 2010.

The extended rules will also include new inspection and information powers (including a modernised valuation power) for HMRC, which will allow HMRC (among other things) to:

inspect statutory records•

require third parties to provide information•

visit business premises to inspect records, assets and premises.•

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Penalties will be imposed for failure to allow an inspection and failing to comply with an information notice. The new Upper Tribunal will have the power to impose a new tax geared penalty.

There will also be legislation to align time limits for assessments and claims which currently vary across the taxes. Time limits will be harmonised at four years for claims and mistakes, going up to 20 years for deliberate inaccuracies. The new time limits are not expected to take full effect until 1 April 2011.

Penalties for late filings of returns and late payments of tax

The Finance Bill 2009 will replace the current penalty rules, which vary for different taxes, with new aligned penalty regimes for late filing and late payment in respect of the following taxes:

income tax, corporation tax, PAYE, national insurance contributions and the construction •industry scheme (CIS);

stamp duty land tax and stamp duty reserve tax; and•

inheritance tax, pension schemes and petroleum revenue tax.•

Although the penalty regimes will be broadly aligned for the above taxes, they will be modified for PAYE and CIS. For the first time, penalties will be imposed on employers who are late in making monthly PAYE and NICs payments and companies paying corporation tax late. Further, it is intended to remove late payment penalties where taxpayers have agreed a time to pay arrangement with HMRC, but to impose higher penalties in cases of prolonged or repeated delay.

Where the obligation to make a return is annual or occasional, the penalty for late filing is an immediate £100, followed by daily penalties of £10 per day (annual obligations only) for returns that are more than three months late, running for a maximum of 90 days. Once a filing is more than six months late, the penalties become tax geared. Penalties relating to late payments of tax are generally tax geared.

Modified rules apply to late filings of CIS returns and late payments of PAYE.

The implementation of the new penalties is to be staged over a number of years starting with penalties for late payment of PAYE which will be brought in from April 2010.

It is intended that the penalty regimes applying to the remaining taxes administered by HMRC (VAT, climate change levy, aggregates levy, landfill tax, air passenger duty, excise duties and insurance premium tax) will be aligned through legislation in the Finance Bill 2010.

Interest harmonisation

The rates of interest imposed on overpayments and late payments of tax currently vary between the different tax regimes administered by HMRC. These are:

income tax•

corporation tax•

VAT•

PAYE•

class 4 National Insurance Contributions•

construction industry scheme•

environmental taxes (aggregates levy, climate change levy and landfill tax)•

excise duties (alcohol, fuel, tobacco, oils), gambling and air passenger duty•

stamp duty land tax and stamp duty reserve tax•

inheritance tax, insurance premium tax, pension schemes and petroleum revenue tax. •

The Finance Bill 2009 will create a harmonised interest regime for all taxes and duties administered by HMRC, with the exception of corporation tax and petroleum revenue tax. The rate of interest will be based on the Bank of England base rate and will be automatically updated 13 working days after any change.

The new interest regime will provide for a single rate of simple interest paid by HMRC on overpayments across all taxes, duties and penalties listed above other than quarterly instalment payments for companies. A single rate of simple interest will similarly be charged on late payment of taxes, duties and penalties.

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Interest on late payment by the taxpayer will be charged from the date tax was due until the date it is paid. Interest on repayments will be paid by HMRC from the later of the date the tax was due and the date the tax was actually paid until the date repayment is made.

For those taxes where HMRC currently charge and pay interest, rates will be aligned by Treasury Order and will have effect shortly after the date on which the Finance Bill 2009 receives Royal Assent. For other taxes, the harmonisation will be implemented over a number of years. Interest on late payments of PAYE is expected to be introduced from April 2010. It is expected that legislation to apply the harmonised interest regime to corporation tax and petroleum revenue tax will be introduced in the Finance Bill 2010.

HMRC Charter

HMRC will be prepare and maintain a Charter setting out standards of behaviour and values which HMRC will be expected to meet when dealing with taxpayers and others. Further, the Commissioners for HMRC will be required to report annually on how well HMRC is doing in meeting the standards in the Charter.

The Charter must be in place by 31 December 2009, and HMRC plans to launch it by autumn 2009.

Value Added TaxThe temporary reduction to the standard rate of VAT to 15 per cent ends on 1 January 2010. On and after 1 January 2010 the standard rate of VAT will revert to 17.5 per cent.

Taxable turnover limits

1 May 2009 1 April 2008

Registration – last 12 months or next 30 days over £68,000* £67,000

Deregistration – next year under £66,000* £65,000

* These increased thresholds will also apply to acquisitions from other European Union Member States.

Simplifying the procedure for opting to tax land and buildings

Taxpayers who wish to opt to tax supplies of land and buildings, in respect of which they previously have made exempt supplies, require the formal permission of HMRC to do so unless any one of four automatic permission conditions apply. In an attempt to simplify the opting to tax procedure and prevent taxpayers from having to apply to HMRC for formal premission, HMRC will introduce a new wider automatic permission from 1 May 2009. Further details are not yet available.

Cross-border VAT changes

The Finance Bill 2009 will introduce a number of changes to modernise the VAT system for cross-border trading and to counter VAT fraud.

Changes to the place of supply of services rules

The liability to VAT in respect of cross-border supplies of services generally follows the place where such services are deemed to be supplied. The current basic rule (for supplies to both business and non-business customers) is that the supplies take place where the supplier has established its business (subject to a number of exceptions).

From 1 January 2010 the new general place of supply rule will be:

business to business supplies: the place where the customer is established;•

supplies to non-business customers: the place where the supplier is established (as before).•

The new basic rule will be subject to the following specific provisions:

Supplies of cultural, artistic, sporting, scientific, educational, entertainment and similar •services, and services of valuation and work on goods are currently taxed where they are performed. This will remain unchanged for services to non-business customers. For supplies to business customers the following new rules will apply:

– from 1 January 2010, valuation and work on goods will be taxed where the customer is established under the new general place of supply rule;

– from 1 January 2011, most supplies of cultural, artistic, sporting, scientific, educational, entertainment and similar services will be taxed where the customer is established under the new general place of supply rule.

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Services relating to land will continue to be deemed supplied where the land is situated.•

Short-term hire of means of transport (up to 30 days or 90 days for vessels): the place of •supply will be where the vehicle is put at the disposal of the customer.

Long-term hire of means of transport will follow the new general rule from 1 January 2010. •However, from 1 January 2013 the place of supply of long-term hire to non-business customers will be where the customer is established (except in the case of the hire of pleasure boats which will be deemed to be supplied where the boat is put at the customer’s disposal if the supplier has an establishment there).

Restaurant and catering services will be treated as supplied where they are physically •performed. Where those supplies are made on board ships, aircrafts or trains as part of transport in the EC, the place of supply will be the place of departure.

Intermediary services supplied to business customers will follow the general rule from •1 January 2010. Intermediary services supplied to non-business customers will continue to be supplied at the same place as the service which is being arranged.

Transport of goods: supplies to business customers will follow the general rule. The place of •such supplies to non-business customers will be the place where the transport takes place, apart from intra EC transport which is supplied in the place of departure.

Supplies of certain intangible services, e.g. legal services, will continue to be treated as •supplied where the customer belongs when provided to non-business customers outside the EC.

Ancillary transport services (e.g. loading, unloading, handling) will follow the general •rule when supplied to business customers. Supplies of these services to non-business customers will continue to be taxed where performed.

The place of supply of passenger transport services, the use and enjoyment provisions and •electronically supplied services (for non-business customers) will remain unchanged.

In most cases where cross-border supplies of services are made to business customers, VAT will be accounted for under the ‘reverse charge’ procedure. This means that the supplier zero-rates the supply, and instead the customer accounts for VAT on the supply at its own place of belonging. Where the customer receives the supply of cross-border services for the purpose of making taxable supplies, the VAT is recoverable as input tax so the net VAT liability will be zero. Where the customer is exempt or partially some or all of the VAT incurred on receipt of the cross-border services will be irrecoverable. Shifting the place of supply to the recipient’s country should provide a fairer more level playing field in relation to intra EC supplies of services. Under the current rules the recipient’s choice of supplier may be influenced by what rate of VAT applies in a particular country. Under the new rules the rate of VAT in the recipient’s own country will apply to the majority of services received wherever the supplier is located. Also the new rules will avoid the difficulties recipients often have in seeking to recover VAT in other overseas jurisdictions under the cumbersome procedures currently in place.

Changes to the time of supply rules

The deemed time of supply (the ‘tax point’) determines when VAT is brought into account.

In the case of cross-border services received in the UK by businesses which are required to account for VAT on those supplies under the reverse charge procedure, the following new rules on the time of supply will apply from 1 January 2010:

Single supplies: the tax point will occur at the earlier of when the service is completed and •when it is paid for.

Continuous supplies: the tax point will be the earlier of the end of each billing or payment •period and the time of payment.

Continuous supplies which are not subject to billing or payment periods: the tax point will be •the earlier of 31 December each year and the time of payment.

EC Sales Lists

Under current VAT legislation, EC Sales Lists only have to be completed by businesses that make cross-border supplies of goods. From 1 January 2010 EC Sales Lists (ESLs) will also need to be completed by UK businesses that make cross-border supplies of services where the VAT incurred in respect of such services will be accounted for by the customer under the reverse charge procedure. Such ESLs should include the following information:

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(a) the VAT registration number of the businesses to which the services were supplied; and

(b) the total value (excluding VAT) of those supplies to each of these businesses.

In addition to this, further legislation will be introduced in the course of 2009 which will provide for a quicker exchange of information between EC member states in order to counter fraud. In particular this will:

reduce the time available to businesses for submitting ESLs from the current six weeks to 14 •days for paper and 21 days for electronic submission;

reduce the length of time available for HMRC to collect, process and exchange ESL data •with the tax authorities in other EC member states to one month in total; and

require monthly ESLs for goods where the value exceeds £70,000 in a quarter. •

VAT refund procedure

The cross-border refund system enables a business which incurs input VAT on expenditure in a member state where it is not established and makes no supplies to recover that VAT, provided that it would have constituted input tax had it been established in such member state. The VAT cannot be recovered through the VAT return in the normal way. Under the current system, the business must reclaim it directly from the member state where the VAT was incurred (the member state of refund).

From 1 January 2010 a new electronic VAT refund procedure will replace the current paper based system. Businesses established in the UK will submit claims for overseas VAT electronically to HMRC rather than direct to the member state of refund. Similarly, overseas businesses will make their claims for refund of UK VAT electronically in the member state where their business is established.

The main changes from the paper based system are:

businesses will be able to submit claims up to nine months from the end of the calendar year •in which the VAT was incurred, rather than six months as at present;

tax authorities will have four months, rather than six months, to make repayments, unless •further information is requested in which case the deadline extends up to a maximum of eight months;

the member state of refund will pay interest in cases where the business meets all its •obligations but deadlines are not met by the tax authorities; and

all EU member states will be required to afford a right of appeal against non-payment in •accordance with the procedures of the member state of refund.

Personal Tax

Income tax and national insurance contributions

Increase in top rate:• From April 2010, the top rate of income tax will be 50 per cent for those individuals who earn more than £150,000 of taxable income. In addition, top rate earners will pay an increased rate of 42.5 per cent on income from dividends and an increased 50 per cent rate on trusts income. The new rates and thresholds are shown in the table below.

Reduction of personal allowance: • From 2010-2011 the income tax personal allowance will be subject to a single income limit of £100,000. For those individuals who earn more than £100,000, their personal allowance will be reduced by £1 for every £2 they earn over this amount until it reduces to nil. With effect from 6 April 2010 non-resident individuals who have been able to claim UK personal allowances and reliefs solely by virtue of being Commonwealth citizens will no longer be entitled to UK personal allowances and reliefs. The Treasury has said that it anticipates that the vast majority of individuals affected by this measure will still be able to benefit through other means, such as double taxation treaties.

National insurance contributions: • From 6 April 2011, the employee, employer and self-employed rates of national insurance contributions will increase by 0.5 per cent. Also from 6 April 2011, the primary threshold for national insurance contributions will be aligned with the weekly equivalent of the income tax personal allowance.

Pensions: • From 6 April 2011 tax relief on personal pensions contributions for those individuals who earn £150,000 and over will be restricted and tapered down until it is 20 per cent. Special measures have also been introduced, which operate to restrict individuals’ tax relief to the basic rate on pensions contributions made in excess of their normal regular pattern on or after 22 April 2009. These measures are intended to prevent an acceleration of

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pension contributions by individuals wishing to take advantage of the current tax relief prior to 6 April 2011. These measures will not apply to the following individuals:

– persons with income of less than £150,000 for the tax year and for both of the preceding two tax years;

– persons with income of £150,000 or more in the tax year or in any of the preceding two tax years who continue as normal with their existing pattern of regular pension savings and who do not make any additional pension savings;

– persons with income of £150,000 or more in any of the relevant tax years who make pension contributions in excess of their normal regular pattern provided that their total pension savings in that year do not exceed £20,000

Individual savings accounts (ISAs): • With effect from 6 October 2009 for those aged 50 and over, the ISA limits will rise to £10,200, up to £5,100 of which can be saved in cash. These limits will apply for all individuals with effect from 6 April 2010.

Taxation of personal dividends

Last year the Government extended the entitlement to a non-payable tax credit on dividends to individuals in receipt of dividends from overseas company where the individual holds less than a 10 per cent shareholding. The credit reduces the effective rate of tax on dividends for higher rate tax payers from 32.5 to 25 per cent. With effect from 22 April 2009 the entitlement to the credit will be extended to apply to all individuals with shareholdings of 10 per cent or more in an overseas company if the company is resident in a country which has a double taxation agreement with the UK which contains a non-discrimination article.

Taxation of distributions from offshore funds

With effect from 22 April 2009 individuals who receive distributions made as dividends from offshore funds will be entitled to the non-payable dividend tax credit where the fund largely invests in equities. This availability of the credit had been withdrawn due to concerns that some funds were seeking to exploit the availability of the credit by locating their cash or bond fund ranges offshore for tax avoidance purposes.

Where the offshore fund holds more than 60 per cent of its assets in interest bearing (or economically similar) form, any distribution will be treated in the hands of the UK individual investor as a payment of yearly interest. No tax credit will therefore be available to the individual in receipt of distributions from such an offshore fund and the tax rates applying will be those applying to interest.

The remittance basis: minor amendments

Individuals who are resident but not domiciled, or not ordinarily resident, in the UK for tax purposes have the option of using the remittance basis of taxation. Where the remittance basis applies, foreign income is only taxed when it is brought into the UK.

Following significant changes to the remittance basis regime which took effect on 6 April 2008, the Finance Bill 2009 will introduce a number of minor amendments to the regime:

There are currently a number of exemptions which allow an individual using the remittance •basis to bring property into the UK without triggering a UK tax liability where such property has been purchased from overseas investment and savings. The scope of these exemptions will be extended with effect from 6 April 2008 to include property purchased out of foreign employment income and foreign chargeable gains.

It will be clarified that individuals who have unremitted foreign income and gains of less than •£2,000 in any tax year are automatically taxed on the remittance basis without having to make a claim. Further, no claim will be required where an individual has total UK income or gains of no more than £100 which has been taxed in the UK, provided that no remittance to the UK has been made in the relevant tax year.

Legislation will be introduced which clarifies the interaction between the remittance basis •regime and the settlements legislation, in particular with regard to (a) transitional provisions which prevent certain income arising before 6 April 2008 from being taxed as a remittance if it is brought into the UK on or after that date, and (b) settlements which are settlor-interested.

The existing rules will be clarified to ensure that the £30,000 remittance basis charge •qualifies as UK income tax and capital gains tax of donors who make gift aid donations to charities so that such charities will be able to claim tax relief in respect of such donations. This amendment will take effect from 6 April 2008.

There will be anti-avoidance provisions, taking effect from 22 April 2009, which clarify the •definition of ‘relevant person’ for the purposes of the remittance basis and which prevent

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obtaining a UK tax advantage through bringing individual items from a larger set (e.g. a series of linked artworks) into the UK, where such set has been purchased out of overseas income and gains.

Individuals employed in the UK are currently required to file a tax return if they have also •received income from overseas employment in the same tax year. This obligation will be removed with effect from 6 April 2008 where such individuals have overseas employment income of less than £10,000 and overseas bank interest of less than £100 in any tax year, and all such foreign income is subject to foreign tax.

Rates of income tax and personal allowances

Income tax 2009-2010 2008-09

Starting rate band (savings income only) £2,440 £2,320

Tax rate 10% 10%

Basic rate band £37,400 £34,800

Basic rate 20% 20%

Savings rate 20% 20%

Dividend ordinary rate 10% 10%

Higher rate – income over £37,400 £34,800

Higher tax rate 40% 40%

Dividend upper rate 32.5% 32.5%

Top rate – income over* £150,000 n/a

Top tax rate* 50% n/a

Dividend top rate* 42.5% n/a

* These changes to take effect on and after 6 April 2010.

Personal Allowances 2009-2010 2008-2009

Income tax personal allowance £6,475 £6,035

Stamp Duty Land Tax

Rates

The “holiday” from stamp duty land tax (SDLT) announced by the Chancellor in September 2008 on acquisitions of residential property of not more than £175,000 has been extended. The £175,000 threshold will continue to apply to transactions between 22 April 2009 and 31 December 2009 inclusive. On and after 1 January 2010 the SDLT threshold will revert to £125,000.

Otherwise the rates of stamp duty land tax remain the same:

Value up to £175,000* nil

Over £175,000 -£250,000 1%

Over £250,000-£500,000 3%

Over £500,000 4%

* To revert to £125,000 on and after 1 January 2010.

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About Reed SmithThe information contained in this Client Alert is intended to be a general guide only and not to be comprehensive, nor to provide legal advice. You should not rely on the information contained in this Alert as if it were legal or other professional advice.

Reed Smith LLP is a limited liability partnership registered in England and Wales with registered number OC303620 and its registered office at The Broadgate Tower, 20 Primrose Street, London EC2A 2RS. Reed Smith LLP is regulated by the Solicitors Regulation Authority. Any reference to the term ‘partner’ in connection to Reed Smith LLP is a reference to a member of it or an employee of equivalent status.

This Client Alert was compiled up to and including April 2009.

The business carried on from offices in the United States and Germany is carried on by Reed Smith LLP of Delaware, USA; from the other offices is carried on by Reed Smith LLP of England; but in Hong Kong, the business is carried on by Richards Butler in association with Reed Smith LLP of Delaware, USA. A list of all Partners and employed attorneys as well as their court admissions can be inspected at the website www.reedsmith.com.

© Reed Smith LLP 2009. All rights reserved.

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