In line with its previously announced policy of allowing for periods of consultation over changes to the tax system, the Government released today draft clauses to be included in the 2011 Finance Bill and a number of consultations. The Bill and explanatory notes run to somewhere in excess of 500 pages, and cover a number of aspects where consultation exercises have already been underway.
It is certainly encouraging that taxpayers are being given the opportunity to review and comment on draft legislation before the Budget on 23 March and publication of the Finance Bill on 31 March. In many ways though the proof of the Government’s commitment to overhauling tax policy making will be reflected in the way in which responses to the draft legislation published today are dealt with.
Equally, simply publishing reams of draft legislation does not of itself give us certainty. It remains the Government’s intention to introduce retrospective legislation to block avoidance schemes where it considers it necessary, and there remains the risk of unintended consequences in such cases.
Further, and importantly, there remains a real need to address areas of very unhelpful and very significant uncertainty, such as, for example individual residency rules. We very much hope to see the commitment to predictability, simplicity and stability reflected in a series of clearer rules.
The main announcements today were:
Employee benefit trusts (EBTs) and Employer financed retirement benefit schemes (EFRBS)
Following on from the Government’s various announcements that EBTs and EFRBS would be prevented from affording employees a reduction or deferral of tax liabilities, draft legislation has been released as part of the Finance Bill 2011 and will have effect from 6 April 2011, with anti-forestalling measures applying from today.
This could be the death of EBTs and EFRBS. Sums contributed to such trusts and earmarked for employees will now be subject to PAYE and NICs, preventing the deferral of taxation and therefore significantly impacting upon the attractiveness of new EBTs and EFRBS.
Under the FSA’s recently announced Remuneration Code, some employers will be required to defer the payment of bonuses to a future period. EBTs and EFRBS had offered a tax efficient structure for employers to defer the payment and taxation of bonuses to employees until a future date, while giving the employees comfort that the funds would be available at that time. This will no longer be possible.
Loans and the provision of assets
Loans and other assets provided to employees from existing EBTs and EFRBS will now be subject to PAYE and NICs, which will severely restrict the use of funds in existing EBTs and EFRBS and is likely to lead to many being wound up.
Tax free distributions to ex-employees’ families
Whereas previously trustees of an EBT could make tax free distributions to the members of an ex-employee’s family, provided that the distribution was not indirectly for the ex-employee’s benefit, the new rules include provisions taxing any distributions to an employee, ex-employee or a person “linked” with them.
In the past employees have attempted to step outside the employment taxation provisions by relocating abroad and then receiving distributions free of income tax. New rules have been introduced which have the effect that any part of a distribution which is for duties performed within the UK will remain subject to income tax.
Employee share ownership plans (ESOPs)
Certain activities carried on by ESOPs that use EBTs as a warehouse or market for shares allocated to employees are protected from the new tax charges, but some arrangements may inadvertently fall foul of the new rules.
A glimmer of hope
Existing EBTs and EFRBs may still offer employees the opportunity for sums earmarked for them to continue to roll up tax free and outside their inheritance tax net, until such time as distributions are made.
New EBTs and EFRBS may still offer employers the opportunity to add funds, albeit upon which PAYE and NICs must be paid by the employee, to trusts which are outside the employee’s inheritance tax net, without triggering an immediate inheritance tax charge at 20%, and which offer a tax free roll up of funds.
There may therefore be some scope for the continued use of EBTs and EFRBS in future.
Annual allowance charge and lifetime allowance charge
As previously announced, the annual allowance (the limit on amounts that can be contributed to pensions each year) will be £50,000 for pension input periods from 2011-12.
The level of the lifetime allowance (the maximum value a pension can reach without adverse tax consequences) is lowered to £1,500,000 from 2012-13 onwards. Transitional provisions provide protection from the lifetime allowance for those who have built up pension savings on the expectation that the lifetime allowance would remain at the current level of £1,800,000.
Requirement to buy an annuity removed
From 6 April 2011 the effective requirement to buy an annuity by the age of 75 (recently extended to 77) will be removed and the alternatively secured pension rules repealed. Individuals will be able to leave their pension funds invested in a drawdown arrangement and to make withdrawals throughout their retirement, subject to an annual cap. The maximum withdrawal of income that an individual will be able to make from most drawdown funds on reaching minimum pension age will be capped at 100 per cent of the equivalent annuity that could have been bought with the fund value. This maximum capped amount will be determined at least every three years until the end of the year in which the member reaches the age of 75, after which reviews to determine the maximum capped withdrawal will be carried out annually.
Individuals able to demonstrate that they have a secure pension income for life of at least £20,000 a year will have full access to their drawdown funds without any annual cap. All withdrawals from drawdown funds will be subject to tax as pension income. An individual making a withdrawal from a drawdown pension fund during a period when they are resident outside the UK for a period of less than five full tax years will be liable for UK income tax on that withdrawal for the tax year in which they become UK resident again.
Most of the rules preventing registered pension schemes from paying lump sum benefits after the member has reached the age of 75 are being removed. The tax rate for all lump sum death benefits is set at 55 per cent, apart from death benefits for those who die before age 75 without having taken a pension, which will remain tax free.
With effect from 6 April 2011, IHT will not typically apply to drawdown pension funds remaining under a registered pension scheme, including when the individual dies after reaching the age of 75. Also with effect from 6 April 2011, IHT anti avoidance charges that apply where a pensioner omits to take their retirement entitlements (e.g. a failure to buy an annuity) will be removed.
Tainted Charity Donation rules
Many charities and donors will be familiar with the onerous Substantial Donor Rules introduced in the Finance Act 2006. Under these rules, charities can face a charge to tax when they enter into ‘relevant transactions’ with ‘substantial donors’.
The Substantial Donor Rules generated significant negative feedback from charities and advisers, the main criticisms being: the unintended consequences on charities and donors, an increased administrative burden and the potential to discourage large but wholly legitimate donations to charity.
After a period of sector consultation, draft legislation has now been released. This includes new anti-avoidance rules that will replace the Substantial Donor Rules with a ‘purpose test’ designed to catch ‘Tainted Charity Donations’ (TCD).
The existing Substantial Donor Rules were heavily criticised for being drafted in such a way that donations that provided no benefit to the donor were nevertheless caught as tax avoidance.
The draft TCD rules seek to address this by introducing a new ‘purpose test’. This test seeks to catch donations that are linked to ‘arrangements’ which have as their aim (or one of their aims) to provide direct or indirect benefit to a donor or a person connected to him or her. This benefit could come from the charity that receives the donation or a ‘connected charity’, though benefits which are acceptable under the Gift Aid scheme are ignored. Key to this test is whether the donation and the ‘arrangements’ would have been entered into independently of one another.
Breaching the rules – new liability for the donor
One aspect of the existing law which has been the source of particular criticism was the fact that the burden of breaching the rules fell squarely with the charity and not the substantial donor.
In describing the new TCD rules, HMRC’s new approach is that the donor (as opposed to the charity) is the ‘primary target for recovery’ of any tax relief that should not have been given. However, the draft legislation does not entirely shift the burden from charities, which can remain jointly and severally liable for a new tax charge in certain circumstances.
A new concept of ‘associated donations’ is also introduced. A donation of this sort is connected to the ‘arrangements’ and can become ineligible for tax relief by association even if not in fact ‘tainted’ itself.
The end of ‘substantial’ donors
The draft legislation removes the minimum threshold of £25,000 given in one year or £150,000 over a period of 6 years. This means that in principle, a donation of any size could be caught as a ‘tainted’ donation.
The TCD rules are designed to introduce an element of common sense into an area that has been fraught with complexity and uncertainty. Whether on close analysis they achieve this is yet to be seen. The draft legislation is complex. This new regime must be translated in a way that enables charity trustees, donors and fundraisers to be clear about what is and what is not permissible.
Furnished holiday lettings
In a blow to the tourism industry, particularly in remoter rural areas, changes announced in the June Budget to the tax treatment of furnished holiday lettings have been confirmed.
Whilst it is good news that the rules have not been repealed in their entirety, the cost to HMRC is estimated at only £1.5m whereas the impact on many rural businesses which provide holiday accommodation is likely to be significant.
Changes to the letting requirements have been confirmed with effect from April 2012, and so a letting business will only be considered a trade if a property is available for letting for 210 days in a year and is actually let for 105 days in that same year. This is a 50% increase on the current requirements and will be difficult to achieve in areas where the tourist season is short. Curiously there is what is described as a ‘period of grace’ for one or two years if businesses are not able to meet the 105 day actual letting requirement but it is unclear exactly how this will apply in practice.
If the commercial letting of furnished holiday accommodation is treated as a trade, losses can currently be set against other income. This has been important in supporting the tourism industry in the UK as many holiday accommodation businesses do not make a profit. From April 2011, it will only be possible to set losses against income from the same furnished holiday letting business; there will no doubt be debate as to exactly what ‘the same letting business’ means if a business consists of a number of properties. Owners of furnished holiday letting businesses will have to consider whether their business remains viable and this is likely to have an effect on the number of holiday accommodation bed-spaces that are available.
For those who may not be able to satisfy the new rules going forward, they will need to consider carefully whether they should sell or gift their business before the grace period expires in order to qualify for capital gains tax reliefs, including entrepreneurs’ relief, business asset roll-over relief and relief for gifts of business assets. After this date no capital gains tax reliefs will be available which will mean that many businesses will suffer in the long term.
There is no mention of business property relief for inheritance tax purposes. It was hoped that there would be some clarity as to what is required in order to qualify for inheritance tax relief. For the time being the only advice is to be as active as possible in the letting business and to provide as many services as possible in addition to the pure availability of accommodation.
Data gathering powers
HMRC will be given additional powers to collect data from certain third parties for use in its compliance activities. HMRC will be able to issue a “data-holder notice” to a relevant data-holder requiring the provision of relevant data. The categories of data-holder include beneficiaries, settlors and trustees of a settlement. The power may be used for collecting data for the purposes of risk assessment, and for obtaining third-party data in connection with specific tax checks.
A draft protocol was issued today dealing with the circumstances in which the Government will use retrospective tax legislation, in some cases to reduce liabilities, but most often to prevent a loss to the Exchequer in cases of tax avoidance. The existing approach is to make an announcement, the date of which is the date from which subsequently announced legislation takes effect. Notwithstanding its commitment to consult with regard to tax changes, the Government wants to retain the ability to use retrospective legislation in this manner and has issued a draft protocol for doing so for consultation.