ANALYSIS: Osborne perpetuates UK core conflict on tax with Budget 2016

Multinationals need to piece together the Budget provisions after more mixed messaging from the UK government

Aside from reasons to cheer for smaller businesses there was also some positive news for the oil and gas sector, while a new sugar levy was announced which will apply from 2018.

“Britain is blazing a trail,” said Osborne. “Let the rest of the world catch up.”

But businesses in the UK and overseas will be hoping the business tax system roadmap that has been published by Osborne and David Gauke, the financial secretary to the Treasury, will provide more certainty after another Osborne Budget which trod a tightrope of potential mixed messages.

A fresh £12 billion ($17 billion) crackdown on tax avoidance was announced alongside the decision to cut corporation tax to 17% by 2020.

“These latest announcements reinforce the commitments the UK government has made as an early adopter of the OECD’s BEPS proposals, while encouraging further investment in the UK by overseas businesses. This is a delicate balancing act,” said Michelle Quest, head of tax at KPMG in the UK.

“The government, already committed to reducing the corporation tax rate to 18%, has taken this further by reducing the rate to 17% by April 2020. This will make the UK rate the lowest among the G20 nations,” said Donald Drysdale, for ICAS, the professional body for chartered accountants in Scotland. “However, it is tempered by a comprehensive package of measures to tackle tax avoidance and evasion.”

Osborne announced the Budget on March 16 Photo by Gareth Milner

Alex Henderson, tax partner at PwC, also agreed Osborne has walked a tightrope, with all the Budget winners being counter-balanced by losers.

“For large corporates, the news is definitely mixed,” said Henderson.

Sandy Bhogal, head of tax at Mayer Brown in London, said multinational reactions will depend on the sector a particular business operates in.

"The property world and oil and gas sectors will have contrasting emotions, and the chancellor made yet further changes to the loss relief rules (with extensions being offered as to what losses can be set against different income streams but capacity being cut by reference to 50% on the amount of losses available, and to 25% for banks). Together with the further cut in the main corporation tax rate, people will have to revalue deferred tax assets after a Budget yet again."

Sectors aside, Nicholas Gardner, tax partner at Ashurst, said that, unlike small businesses, large multinationals are “not such clear winners and will need to weigh the reduction in corporation tax against other changes such as the reforms to interest deductibility, loss relief and the increases in the highest marginal rates for stamp duty land tax on commercial property”.

“The Budget states that tax avoidance and aggressive tax planning by multinationals is unacceptable and the government’s new business tax roadmap sets out a package specifically targeting multinational enterprises that are engaged in these activities,” added Drysdale.

Strong rhetoric on tackling avoidance is a mainstay of Osborne’s Budget speeches, with Chris Davidson, KPMG tax director, commenting that “over the past few years it has become almost traditional for the chancellor to announce a £5 billion package of [anti-]tax avoidance measures”. While this year’s package represents a big increase on that figure, some of the detail is still lacking.

“Today’s red book includes a very long list of measures as part of this package but these don’t appear to total £12 billion so currently it is not obvious where the full amount is to come from,” said Davidson, adding that while most components of the package are policy changes designed to make the system fairer rather than being directly aimed at evasion or avoidance, the majority of Osborne’s changes are “tinkering around the edges”.

Deeper inspection of the Budget measures indicates the main areas of avoidance activity as: targeting promoters through broader POTAS (Promoters of Tax Avoidance Schemes) measures; subjecting serial tax avoiders to a Serial Avoiders Special Regime; and legislating to introduce a new penalty of 60% of the tax due in all cases successfully tackled by the general anti-avoidance rule (GAAR).

“In respect of tax evasion, the long-threatened new criminal offence for offshore tax evasion will finally make its way to the statute books,” said Tessa Lorimer, Withers counsel. “This offence will remove the need for the Crown to prove criminal intent for the most serious cases of failing to declare offshore income and gains. The government has also announced its intention to increase the civil penalties for deliberate offshore tax evasion by linking the penalty to the value of the asset on which tax was evaded.”

Civil penalties as well as naming-and-shaming of those who enable offshore tax evasion has also been proposed.

Following the release of final BEPS recommendations at the end of 2015, Osborne also announced changes to interest deductibility rules.

He said the changes are aimed at countering multinationals that deliberately over-borrow in the UK to fund activities abroad and then deduct the interest bills against their UK profits. From April next year, interest deductibility will be restricted for the largest companies at 30% of UK earnings, while a group ratio rule would protect companies whose activities “justify higher borrowing”.

Hybrid mismatch rules will also be established to prevent complex structures that allow multinationals to avoid tax or to deduct the same expenses in more than one jurisdiction (double deduction). Withholding tax on royalty payments will also be strengthened, confirmed Osborne, while, going forward, the maximum amount of profits that can be offset using past losses will be restricted to 50% in any year. The chancellor said this will only apply to 1% of companies making profits above £5 million.

In banking, the 50% loss restriction already in place will be further reduced to 25%.

"These latest announcements reinforce the commitments the UK government has made as an early adopter of the OECD’s BEPS proposals, while encouraging further investment in the UK by overseas businesses. This is a delicate balancing act"

“The chancellor has set out his stall for how the UK will implement the OECD’s recommendations on imposing restrictions to tax relief for interest payments,” said Stella Amiss, international tax partner at PwC. “All UK businesses with borrowings will have to re-evaluate their tax position on the back of today’s announcement. The move will likely increase costs at a time of economic uncertainty.”

While such changes were flagged late last year, the 50% loss restriction was a surprise extra measure.

“Statutory restrictions on interest deductions were expected, but the restrictions on the use of losses is a shock,” said Genevieve Moore, partner at Blick Rothenberg.

Amiss added that the speed at which Osborne wants to make these additional restrictions to losses represents a “shock factor” for businesses now required to transition.

“This timetable risks introducing changes that even the OECD hasn’t worked to implement,” said Amiss. “Industries such as infrastructure and real estate will be looking closely at what has been said today… M&A deals could also be affected, if the additional cost of debt hasn’t been priced in.”

Jonathan Hornby, managing director at Alvarez & Marsal Taxand UK, said the changes in this area represent a major change in direction for the UK, which he says has been “historically generous when it comes to the treatment of debt”.

“The chancellor has confirmed that cuts to tax relief on debt interest will be implemented next year, despite calls for this proposal to be deferred or even abandoned,” he added.

Jeremy Cape, partner at Dentons, said that interest relief being capped at 30% of taxable earnings in the UK or based on the net interest-to-earnings ratio for the worldwide group will have a “big impact on an economy which has been used to unlimited arm’s-length interest deductibility”, while he said the withholding tax on royalty payments may also be significant:

“The Budget papers say the government “will extend withholding tax rights to cover all intangible assets such as trademarks and brand names, apply this tax to all payments connected with the activities of a business liable for tax in the UK, and introduce a domestic law to prevent our tax treaties being abused by royalty payments being routed through third countries to gain a tax advantage”. Could this be the true ‘Google tax’?”

Hornby agreed with Amiss’ statement that if concessions are not included in relation to the cuts to tax relief on debt interest then companies operating in heavily geared sectors such as infrastructure and real estate will have cause for concern.

A desire to be seen as leading the way internationally on tackling avoidance has motivated Osborne here, and Amiss said “it is not a surprise he is moving ahead of other G7 nations to adopt international recommendations on tax relief given to business for borrowing costs”.

Osborne says the Budget measures show that Britain is “blazing a trail” for the world to follow

Osborne wanted to send a message to international investors that Britain remains ‘open for business’ and the announcement on corporation tax means that, by 2020, the UK will have the lowest rate in the G20.

“A further reduction in the corporate tax rate to 17% closes the gap with Ireland to 4.5 [percentage points], making the UK even more attractive for large international companies,” said Nilesh Shah, head of tax at London chartered accountants Blick Rothenberg.

Moore said the Budget message is: "Come to the UK, establish your business here and pay UK tax at this unprecedented low rate. Britain is still open for business."

But Kevin Nicholson, head of tax at PwC, also acknowledges the mixed messages emanating from a government keen to marry policies of aggressive tax competition alongside aggressive rhetoric – and in some cases, aggressive action – against avoidance activity.

"With the cut in corporation tax, the Chancellor continues to tread a tricky tightrope of luring business through lower tax rates while showing he is tough on avoidance,” said Nicholson. “The drop in corporation tax isn't all it seems - as the tax base is widening through limiting deductions against profit.”

Largely in response to continuing oil price volatility, Osborne announced a number of changes for the oil and gas industry, with particular relevance for Scotland, including the reduction of the petroleum revenue tax (PRT) rate to zero.

Restrictions on interest deductions were expected, but the 50% loss restriction – and the speed at which this will be done – was a shock additional measure

“We’re also going to help one of the most important and valued industries in our United Kingdom that has been severely affected by global events,” said Osborne. “The oil and gas sector employs hundreds of thousands of people in Scotland and across our country. But the oil price has continued to fall. So we need to act now.”

“The chancellor has announced a radical reshaping of the tax regime for the offshore oil and gas industry,” said Chris Bates, partner at Norton Rose Fulbright. “PRT applies to older fields, many of which are being decommissioned. Reducing the rate to zero, rather than abolishing the tax, will allow field participators to claim back historic PRT against decommissioning costs.”

The other big announcement for the sector was the reduction of the supplementary charge on oil and gas from 20% to 10%.

“At the same time the chancellor has confirmed that legislation will be introduced to remove any doubt that historic owners of fields who sell out their interest but retain liability for decommissioning costs will be able to claim full tax relief for those costs,” said Bates. “This will invigorate the opportunities for specialists in operation of late-life fields to enter the North Sea Basin.”

Alan McCrae, PwC’s UK head of energy tax, said the changes are a welcome boost for an industry that has faced a challenging and turbulent 18 months.

“Across the North Sea, this will reduce the rates from 67.5% for the older fields and 50% for the newer fields to 40% for all fields,” said McCrae, who sees this as a shrewd shift from a revenue-maximisation standpoint.

“It is a smart move that recognises that the tax prize for the Treasury at this stage in the life of the North Sea is not corporate taxes. Instead the government has more tax revenue to gain by doing all it can to protect investment and jobs and all the tax that goes with that,” he said.

While the mixed bag of Budget proposals for large businesses will need digestion and careful impact analysis, small businesses had much to cheer after Osborne’s speech. A headline-grabbing announcement came in the form of dramatic cuts to business rates for small and medium-sized enterprises (SMEs), effective from April 2017.

The existing maximum threshold for small business rate relief will rise from £6,000 to £15,000, while the threshold for the higher rate will rise from £18,000 to £51,000.

"The Chancellor continues to tread a tricky tightrope of luring business through lower tax rates while showing he is tough on avoidance. The drop in corporation tax isn't all it seems - as the tax base is widening through limiting deductions against profit"

“Business rates are the fixed cost weigh down on many small enterprises. At present, small business rate relief is only permanently available to firms with a rateable value of less than £6,000,” said Osborne. “Today I’m more than doubling it, and I’m more than doubling it permanently.”

Osborne said that in terms of impact, the changes mean that, from April next year, 600,000 small businesses will pay no business rates at all.

“That’s an annual saving for them of up to nearly £6,000 – forever,” he claimed.

Robert Gordon, CEO of Hitachi Capital, welcomed the changes, saying they would simplify the outdated business rates system for the UK’s 5.4 million SMEs.

“Reducing red tape and giving businesses clarity over the amount of tax they have to pay is fundamental at a time when many are struggling with an overly complex regulatory environment,” said Gordon.

The small business rates relief has been temporarily doubled for many years and businesses have grown accustomed to relying on such a tax cut.

Phil Vernon, PwC’s business rates leader, said the permanent extension was always on the cards, but that Margrethe Vestager, European competition commissioner, might have cause to review the regime under European state aid rules.

“It was just a matter of time before this increase became a permanent fixture, but we will need to see how this increase ties in with EU state aid restrictions,” said Vernon.

While the Budget largely drew cheers from SMEs, smaller businesses could be indirectly hit by changes to the taxation of banks and insurers.

“Increasing the tax burden on UK banks [by restricting their ability to offset losses incurred before 2015 against their current profits] by yet another £2 billion over the next five years makes it harder for them to lend to small businesses,” said Roy Maugham of UHY Hacker Young. “They money they pay in tax can no longer be used to reserve against loans to SMEs.”

Among the other measures announced in his speech, Osborne confirmed a reduction in the rate of capital gains tax, effective three weeks from today (March 16) – though gains on residential property and carried interest will remain subject to the old rates.

“The reduction in the rate of capital gains tax form 28% to 20% (and 18% to 10%) is a significant boon for investors,” said Chris Groves, partner at Withers. “Coupled with the extension of entrepreneurs’ relief to long-term shareholdings, the chancellor is creating an environment that will stimulate investment in business by entrepreneurs.”

Another headline-grabber from the Budget was the announcement of a sugar levy on companies in the soft drinks industry.

“This new regime will be effective from 2018, giving the industry the opportunity to prepare. Any amounts raised will fund additional school activities,” said Jonathan Riley, head of tax at Grant Thornton UK. “Again, we see taxes justified on the grounds that they are funding a specific policy.”

Nicky Strong, legal consultant at Bond Dickinson, points out that soft drinks companies will foot the bill, as the new levy should not be passed on to consumers.

“The levy will be calculated on the total sugar content of these drinks, and will be charged direct to producers and importers, rather than being added to the price paid by consumers.”

Changes to the use of losses could impact M&A deals, if the additional cost of debt hasn’t been priced in