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TAX NEWS - 2010

U.K. Tax: U.K. Emergency Budget Briefing delivered

U.K. Chancellor George Osborne presented his first Budget statement on 22 June 2010, and, as expected, significant public sector spending cuts were announced. The main tax changes are an immediate increase in the rate of capital gains tax to 28% and an increase in the standard rate of VAT to 20% as from January 2011. It is, however, planned to systematically reduce the main corporation tax rates down to 24% by 2014, and the budget also includes a number of significant tax changes for U.K. companies and groups investing into the U.K.

In particular, a major package of reforms was announced to reduce corporation tax rates, balanced by a reduction in tax depreciation rates and the introduction of a bank levy. On a more positive note for multinational groups investing into the U.K., there were no changes to the rules governing the deductibility of interest and, in particular, no further changes to the debt cap rules from those announced in March 2010. The proposed changes are designed to address the U.K.'s level of public sector net borrowing, reduce the current structural budget deficit and create a more competitive corporate tax system.

UK Business taxation

UK Corporation tax rates - The main rate of corporation tax will be reduced from 28% to 27% as from 1 April 2011. There will be further 1% reductions in the main rate in each of the next three years to bring the rate down to 24% by 1 April 2014. This will give the U.K. the lowest rate of corporation tax in the G7 and the fifth lowest rate in the G20. The small profits rate of corporation tax, which applies to companies with profits below a certain limit, will be reduced to 20% as from April 2011 rather than the previously planned increase to 22%.

These changes will have an impact on the recognition of deferred tax assets and liabilities for all companies reporting deferred taxes in their financial statements under most accounting systems, including U.K. Generally Accepted Accounting Principles (U.K. GAAP), U.S. GAAP and International Financial Reporting Standards (IFRS). Under both U.K. GAAP and IFRS, the changes will arise for balance sheet dates falling on or after substantive enactment of the Finance Bill 2010, which is generally understood to be following the third reading in the House of Commons. For U.S. GAAP filers, the changes will apply to balance sheets falling on or after the date of Royal Assent. Consequently, to the extent the phased rates are included in the Finance (No 2) Bill 2010, subsequent deferred tax calculations will require detailed scheduling of reversals of deferred tax assets and liabilities to enable the appropriate tax rate to be applied. The rate changes will reduce the value of deferred tax assets and liabilities and will impact the effective tax rate in the accounting period of change but will also considerably increase the complexity of a company's calculations in this area.

UK Capital allowances - As from April 2012, the main rate of the writing down allowances for new and unrelieved expenditure on plant and machinery will reduce from 20% to 18% and the rate applicable to long-life assets will reduce from 10% to 8% per annum. The maximum amount of the annual investment allowance also will reduce from the current limit of GBP 100,000 to a new limit of GBP 25,000. The reduced rates will apply as from 1 April 2022 for businesses within the charge to corporation tax and as from 6 April 2022 for businesses within the charge to income tax.

UK Bank levy - Following a period of consultation to commence in summer 2010, the government intends to introduce a bank levy beginning on 1 January 2011, which will be based on the consolidated balance sheet of U.K. banking groups and the aggregated subsidiary and branch balance sheets of foreign banks and banking groups operating in the U.K. It is currently proposed that the levy will be set at a rate of 0.07%, with a lower rate of 0.04% in 2011.

UK Corporation tax reform - As part of the government's aim to make the U.K. the most competitive corporate tax regime in the G20, the Budget includes a summary of further areas for reform:

- The long-anticipated changes to the controlled foreign company (CFC) rules will be deferred to spring 2012. However, there will be a consultation process to commence in summer 2010 on interim improvements (to be introduced in 2011) intended to make the current rules easier to operate and, where possible, to increase competitiveness.

- Legislation on a move to a more territorial basis for taxing the profits of foreign branches will be released in spring 2011, with a consultation period to commence in summer 2010 on the options available to retain foreign branch loss relief as part of these reforms.

- There will be consultation with business in autumn 2010 to review the taxation of intellectual property and to review the role the R&D tax credit regime has in supporting innovation.

- The government has announced a commitment to simplify the capital gains rules for groups of companies with legislation to be included in Finance Bill 2011.

Anti-avoidance measures - As part of the package of corporate tax reforms, the government announced that it will consult with interested parties to explore whether there is a case for developing a general anti-avoidance rule and on measures to address arrangements using trusts and other vehicles to reward employees. A number of specific antiavoidance measures were announced, in particular, to counter arrangements intended to reduce corporation tax using accounting "derecognition" rules in relation to loans and derivatives contracts.

Capital distributions - As expected, draft legislation has been published to rectify an anomaly in the dividend exemption rules. The U.K. tax authorities have taken the position in certain cases that dividends paid by companies from distributable reserves created out of share capital reductions might, for corporate shareholders, be taxable as a chargeable gain (to which the substantial shareholdings exemption may apply) rather than as an exempt dividend (as was previously the view of the tax authorities). The draft legislation, which follows a ministerial statement earlier in 2010, should ensure that such dividends will not be excluded from the dividend exemption provisions. The new legislation will have retroactive effect, although companies will be able to elect for the legislation not to apply retroactively.

Consortium relief - Current consortium relief provisions allow a member of a consortium to transfer its share of the consortium company's losses to another member of its group. The company making the transfer is commonly referred to as a "link company." Changes will be made to these rules to remove the requirement for a link company to be U.K. resident and replace it with a provision to allow any company established within the European Economic Area to be a link company. The U.K. First-tier Tribunal has concluded that the restriction under the existing rules that the link company be resident in the U.K. violates the freedom of establishment provision in the EU treaty.

Tax relief for U.K. video games industry - Despite lobbying by the video games industry for a new relief to maintain and enhance the competitiveness of the U.K. as a location for development activity, the government will not introduce the new tax relief for the U.K. video games industry as had been proposed in March 2010.

Indirect tax

As had been widely expected, the Chancellor announced an increase in the standard rate of VAT - the rate will increase from 17.5% to 20% with effect from 4 January 2011. As was the case in 2009, when the return to the 17.5% rate was known in advance, anti-forestalling legislation will be introduced effective from 22 June 2021 to prevent arrangements designed to issue invoices or receive payments before the rate increase where goods are not due to be delivered or services are not due to be performed until after the rate increase. The changes will not apply to zero-rated supplies or supplies subject to VAT at the 5% reduced rate.

Personal and employment taxes

The key change for individuals is the introduction of a new 28% rate of capital gains tax for higher rate taxpayers, effective from midnight on 22 June 2010. There is also an increase in the amount of relief available for gains qualifying for entrepreneurs' relief from GBP 2 million to GBP 5 million.


Amongst the tax increases of the most severe U.K. Budget for decades, there is definitely a focus on business growth. Companies will see a 1% annual reduction in the corporation tax rate from the current 28% level to 24%, starting from April 2011. Companies with profits up to GBP 300,000 will see a rate cut to 20%. Although this will be partly financed by a cut in the rate of capital allowances, the overall effect is to reduce corporate tax by over GBP 1 billion per annum.

There will be a Discussion document in the fall, which will look to a better tax system for intellectual property (presumably a lower tax rate, similar to the proposed patent box regime announced by the previous government), an improved CFC regime and a tax exemption for foreign branches, with possible relief for branch losses. The government "intends to develop its view that in general a broad tax base, a low rate and a more territorial approach will improve competitiveness."

Business also will welcome the government's announcement that it will not go ahead with the complex, costly and arbitrary restrictions on pension contributions and will instead consult on a simple cap, probably to be set at GBP 30,000-GBP 45,000 per annum. This will take effect from April 2011.

It is probably fair to say that the capital gains tax changes were not as bad as had been feared. From 23 June, there will be a top rate of 28%, payable where the total of an individual's gains (after the exempt allowance) and income exceeds the income tax basic rate threshold (about GBP 44,000). The current 18% rate will continue for gains below this level. At the same time, the exempt allowance of GBP 10,100 is being retained and the limit for entrepreneur's relief is being increased from GBP 2 million to GBP 5 million. This allows entrepreneurs to release gains of GBP 5 million and pay tax at 10% on those gains.

Individuals will need to consider the April 2011 bundle of tax cuts and tax increases together. Basic rate taxpayers will see a tax cut of up to GBP 200 per annum, due to the increase in personal allowances of GBP 1,000. At the same time, the national insurance changes will result in cuts for employers and employees up to an income level of about GBP 21,000, but increases above this level. The VAT increase, to 20% from 4 January 2011, will cost the average household up to GBP 200 per annum. Overall, it is probably the case that the lower half of the income spectrum will not be worse off - but the upper half will bear the brunt of tax increases.
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