Andy Thompson argues there are catches to the Chancellor’s Budget 2016 tax rate cuts

Main tax rates

There is to be a further reduction in the UK corporation tax (CT) rate. It had already been announced that the main rate will fall from the current 20% to 19% with effect from April 1 2017 and then to 18% three years later. However, the rate from April 2020 is now planned to be 17% instead of 18%. This will further improve the UK’s international competitive position in that its CT rate is the lowest of all major countries (though some smaller states such as Ireland have still lower rates).

The rates of capital gains tax (CGT) are to be significantly reduced from April 6 this year. This does not affect companies as such, who are taxed at the CT rate on gains that they realize, but it affects the disposal of businesses by UK personal owners.

In general the higher rate of CGT, which is effectively the main rate for business owners, falls from the current 28% rate to 20%. However, the rate applicable to “carried interest”, which is relevant to private equity partners, will remain at 28%. The cut in the general rate largely reverses the increase (from the preceding 18% rate) made by the same Chancellor in the coalition government four years ago.

Taxes on banks

Banks will not benefit from the reduced CT rate. The additional rate for banks announced last year will remain at 28%.

There is also an intensification of the restriction on CT loss relief. Banks had already been made subject to a restriction whereby only a maximum of 50% of current and future taxable profits could be offset by losses carried forward from pre-April 2015. From April this year, that maximum rate will be cut to 25%. A 50% loss restriction of the same kind is now to be introduced also for all UK companies with annual profits above £5 million.

For many banks carrying forward big losses going back to the time of the “credit crunch”, particularly for cases like the UK operations of Bank America where heavy global losses in investment banking activities accrued around 2008 to their London-based operations, this restriction is significant.

The Chancellor has nevertheless announced that (with some retrospective effect) there will be an extension of the “exempt entities test” which excludes some essentially non-banking activities from the effects of the various special tax impositions on banks – i.e. the higher CT rate, the loss relief restrictions, and the bank levy affecting all banks that have large balance sheets and use wholesale funding. At first sight, however, this change not will give relief to the asset finance activities of UK deposit taking banks.

Interest payments

Consistent with recent OECD proposals for multinational tax changes targeting avoidance by global corporate groups, what might be described as a “tax leverage rule” is to be introduced from April next year. In general, for “the largest companies” this will restrict the deductibility of interest costs to 30% of annual corporate earnings. There will be some provisions to exempt “activities that require higher borrowing”.

This proposal will require careful scrutiny in the asset finance industry as it takes further shape, in terms of effects on both lessors and lessees. At first sight it appears that banks might be effectively exempted from the restriction.

However, it seems likely that for large lessee companies, any amounts within asset finance obligations that are accounted for as interest could be treated as such for this purpose. This would include the interest elements of all current finance leases, and of the “long funding leases” (LFLs) where the lessee rather than the lessor claims capital allowances (CAs) – and of repayments under HP-type agreements (i.e. hire purchase or conditional sale).

For those lessees who are subject to international financial reporting standards (IFRS), as most large UK companies will be, such a rule could affect the interest element of all rentals after the new IFRS 16 accounting standard takes effect in 2019.

Securitizations

It has been announced that following the final enactment of this year’s Finance Bill in the coming summer, HM Treasury will adopt regulations to make what appears to be a significant tax concession affecting securitization funding structures.

Such arrangements, though used most widely in residential mortgage funding, can be also be used to fund major asset finance portfolios. Their use has languished in the period since the credit crunch, which saw a widespread loss of confidence in securitization bonds; and any move that facilitates their revival would appear welcome.

This concession will remove any withholding tax that would otherwise be applied in UK taxation to “residual payments”. The latter arise from the customary over-collateralization feature in these arrangements, whereby the value of the relevant portfolios exceeds the sale proceeds of the securitization bonds. It would appear particularly relevant to non-UK investors in UK-based “special purpose vehicles” (SPVs).

Company cars

For the income tax charge on company car users, the percentages (subject to CO2 emission ranges) applied to the list price of the car will rise by 3% (i.e. to a maximum of 37%) from April 6 2019. These charges of course apply irrespective of the mode of fleet finance.

Credit reference agencies

The Chancellor announced a further extension in the arrangements agreed with major banks for the credit reference agencies (CRAs) to receive credit information on SMEs from the banks.

Nic Beishon, head of commercial at Equifax UK & Ireland, said: “The sharing of SME information among financial providers is an excellent initiative to increase competition in SME lending and improve borrowers and lessee access to competitive financing options. We are proud to have been selected as part of the government’s plans and believe it reflects our extensive experience in data insight across businesses and consumers, and our stringent security systems and procedures.”

Other announcements

In several of the enterprise zones (EZs) – i.e. economically disadvantaged areas of the UK subject to special fiscal incentives – there is to be an extension of the qualifying period for 100% CAs on plant and machinery.

These enhanced CA rates had been due to end for expenditure to be incurred from April 2020. However, they will now last for eight years from the commencement of each local EZ.

In the case of leased assets, lessors are ineligible for the enhanced CAs in the EZs. However, the lessee or hirer can claim them in respect of certain types of asset finance agreement (i.e. HP type contracts, where title to the asset passes to the hirer on completion, and LFLs).

The insurance premium tax rates are to increase by 0.5%, with the main rate (applicable to several types of insurance relevant to asset finance) rising to 10% of the pre-tax level of premium.

There is the usual package of anti-avoidance announcements, although there appears to be nothing new affecting equipment leasing (on which two changes were announced last November). The new measures include proposals to clamp down on “disguised remuneration” through the use of service contracts in place of employment contracts, such as may be potentially relevant to businesses in all economic sectors.

The economic background

In common with global conditions, there has been some deterioration in the UK economic outlook in recent months. The growth of gross domestic product (GDP), and more particularly that of output per head, is now estimated – and forecast in the coming years – to be less impressive than assumed in the Chancellor’s Autumn Statement less than four months ago.

Nevertheless continued GDP growth in the range between 2.0% and 2.2% is forecast by the Office of Budget Responsibility (OBR) for each calendar year from now to 2020, following 2.2% growth in 2015. This represents a stronger outlook than for any other major advanced economy.

The UK public sector annual borrowing requirement is estimated at 2.9% in the fiscal year (i.e. April to March) now ending, compared with as much as 11.1% in 2009/10 in the aftermath of the credit crunch and banking collapses. It is still forecast to fall, at a slightly slower rate than in earlier projections, to 1% in 2018/19, moving into a small surplus in 2019/20.

The accumulated national debt in relation to GDP has roughly doubled since 2008, but is still projected to fall in the coming years – reaching ratios of 82.6% in the 2016/17 fiscal year, and 74.7% in 2020/21.

While the main OBR projections appear bullish, they are based on a “current policies” assumption which includes the UK remaining in the EU. In line with the OBR’s assessment, the Chancellor has warned of “extreme uncertainties” ahead in the event of a vote to leave the EU in the referendum to be held in June this year.