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Budget 2008: Anti-avoidance measures

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12th Mar 2008
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Recent budgets have contained an ever-increasing swathe of anti-avoidance measures, and this year's was no exception. Here's a run-down of HMRC's latest fire-fighting techniques.

Manufactured payments and income tax

As announced by ministerial statement on 31 January, legislation will be introduced in the Finance Bill 2008 to prevent tax advantage gained through the manufactured payments regime.

Typically these would be payments that are representative of interest or dividends paid on securities such as gilts or shares, and generally arise as part of a sale and repurchase ('repos') or stocklending. These are routine between financial institutions seeking to meet obligations or borrow short-term money, but have been used in limited circumstances by individuals of high net worth who have been set up as passive scheme users.

In such schemes the individuals seek to obtain relief for making a manufactured payment but derive no loss from the wider transaction. Apart from the promoter's fee, the transactions leave the individuals flat in economic terms, but are capable of eliminating all of the individuals' liability to income tax in a given tax year.

HMRC says the new legislation will feature a targeted rule that denies relief for any manufactured payment "paid as part of a scheme or arrangements where one of the main purposes is to secure a tax advantage".

Double taxation

Some UK residents seeking to avoid UK income tax have been diverting their income into a foreign partnership comprised of foreign trustees. The income remains that of the UK resident as he or she will be a beneficiary of the foreign trust. Users of this scheme have used a provision called the Business Profits Article, common to most tax treaties, to exempt the partnership profits from UK tax – not only for the foreign partners but also for the UK beneficiaries.

The Finance Bill 2008 will retrospectively clarify previous legislation on this issue. Firstly, it will make clear that tax treaties do not exempt UK residents from UK tax on any profits of a foreign partnership to which they are entitled. Secondly, it will ensure that the Business Profits Article cannot be read as preventing the income of a UK resident who is chargeable to UK tax.

Reference numbers

Promoters of designated tax avoidance schemes are currently obliged to provide timely information about those schemes to HMRC. The co-promoter rule relieves a promoter of this obligation if there is more than one promoter of the same scheme, and another promoter has already disclosed it. The Finance Bill 2008 means HMRC will now issue a scheme reference number (SRN) to each disclosing promoter, who will then be required to pass it on to any clients implementing the scheme, who are themselves also obliged to report back to HMRC.

The co-promoter rule will be amended so that co-promoters are only relieved of their obligation to disclose if they have already been issued with an SRN for their scheme from HMRC. All promoters will be obliged to send a copy of their disclosure to their co-promoters.

While existing legislation means implementing clients have to pass their SRN on to HMRC on implementation, the promoter often presents them with an SRN as soon as the scheme is available. This legislation will be amended so that such SRNs will have to be reported to HMRC immediately upon their receipt.

Clients will further be obliged to pass the SRN on to any other person party to the same scheme and who may be likely to gain a tax advantage from it.

Capital allowances buying and acceleration

Previously it has been possible to avoid corporation tax through passing on the balancing allowance for plant or machinery, where the write-down value is substantially higher than its market value, when selling trades – often to a profitable group who will have no intention of carrying on the trade long-term. A loss-making company may be sold to an unconnected profitable group prior to the trade (rather than the company) being sold to a third party shortly afterwards, for example. That unconnected profitable group would then be entitled to a balancing allowance equal to the difference between the market value of the plant or machinery and its written down value. This can accelerate the rate at which expenditure is written off for tax purposes, making capital allowances available earlier for the profitable group (which has no long-term interest in the trade) than they would have been had the trading company simply been sold direct to the ultimate buyer.

The new measures will counter this by taking effect whenever there is a cessation of trading generating a balancing allowance where "one of the main purposes of [that cessation] is to create that balancing allowance".

Leased plant or machinery

Businesses have been avoiding tax by leasing in and out the same machinery at a tax loss, or leasing plant in return for a capital payment or premium which currently escapes taxation. Minor changes will clarify the rules on these sale and finance leasebacks, affecting on transactions entered into on or after 13 December.

Financial products avoidance

Large companies have been avoiding tax on returns from investments that are economically equivalent to interest. Similarly, companies have been leasing plant or machinery and selling the right to lease rental income. HMRC will take a "principles-based" or generic approach to this in the Finance Bill 2009. In the mean time, legislation will be introduced in 2008 to specifically block the following schemes:

  • Avoiding corporation tax by receiving interest in the form of non-taxable distributions
  • Eliminating the tax on interest with credits for non-existent overseas tax
  • Avoiding corporation tax by adopting differing accounting treatments within the same group for convertible debt
  • Acquiring partnerships rights in advance for an amount equal to the discounted value of the rights, thereby disguising the generated interest
  • Disguising interest on partnership contributions by altering profit-sharing ratios within the partnership
  • Excluding transactions from the derivative contracts legislation so as to produce disguised interest

Legislation will also be introduced to stop 'share as debt' schemes. Common features of 'share as debt' schemes might be uncommercial rates of interest, depreciatory transactions, the spreading of disguised interest, and inconsistent exit strategies.

Controlled foreign companies

The Finance Bill 2008 will block schemes that rely on a partnership or trust to escape a Controlled Foreign Companies (CFC) charge. For example, an offshore trust owns a majority share in an overseas company, but the remaining UK shareholders retain the right to all of the company’s profits.

Interestingly, HMRC has said it "does not believe these schemes work but these measures will put the question beyond doubt". Wary of treading on the toes of big business perhaps, where such foreign trusts and special purpose vehicles (SPVs) are prevalent, the Revenue proposes to submit such schemes to a motive test. Therefore SPVs that exist wholly for commercial purposes will be exempt from the new CFC rules.

Otherwise, rights to income and assets will now be taken into account in determining whether UK residents control a foreign company.

Corporate Intangible Assets

Intangible assets that existed prior to 2002 are not part of the Corporate Intangible Assets Regime, and cannot be amortised on the balance sheet. Companies have been transferring pre-existing intangible assets in such a manner as to recreate them as post-2002 assets on their arrival. Clarification of related party rules is aimed at preventing this.

Restrictions on trade loss relief

Sideways loss relief that can be claimed by an individual (other than a partner) who carries on a trade in a non-active capacity will be restricted. Where a loss arises as a result of tax avoidance arrangements made after 12 March, no sideways loss relief will be available. Otherwise there will be an annual limit of £25,000 on the total relief an individual may claim from trades carried on in a non-active capacity.

A non-active individual is someone other than a partner who spends less than 10 hours a week, in a relevant period, personally engaged in activities of the trade "carried on commercially and with a view to the realisation of profits from those activities".

There are exemptions for the film industry and Lloyd’s underwriting business.

Repeal of obsolete provisions

Anti-avoidance legislation for 'dividend buying' (introduced in 1955) will be repealed. This relates to companies which bought shares shortly before the declaration of a dividend, received the dividend, and then sold the share – thereby suffering a loss as a result of the reduction in value due to the dividend payment. At that time the dividend was not taxable. Nowadays, of course, both share-dealers and exempt bodies (such as charities and pension schemes) take a tax hit on dividends.

Many exempt bodies with large portfolios now spend huge amounts of time calculating the tax due on dividends only to find out they have little or no liability. Accordingly sections 731 to 736 and associated provisions in the Income and Corporation Taxes Act (ICTA) 1988 will be repealed in their entirety. For insurance companies with non-life business, a new provision will be introduced which will only have effect when the distribution concerned exceeds £50,000.

Further repeals relate to transactions in securities (s703-709 ICTA, c1 p13 Income Tax Act 2007) and employment securities (for shares acquired between 1972 and 1987).

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