The corporate tax world in 2018
The Rumsfeld "known knowns" adage seems appropriate in these times. Donald Rumsfeld (former US Congressman) said: "As we know, there are known knowns; there are things we know we know. We also know there are known unknowns; that is to say we know there are some things we do not know. But there are also unknown unknowns – the ones we don’t know we don’t know."
The "unknown knowns" and "unknown unknowns" offer little comfort to the tax adviser. Even the ‘known knowns’ generate plenty to be worried about. The process of identifying the issues and working out what they mean provides some solace in a time of great uncertainty. This corporate tax review of 2018 is by no means exhaustive; just what has caught my eye.
The known knowns
Non-resident capital gains tax
The extension of UK capital gains tax to non-resident investors in real estate was announced at the end of 2017; but most of the activity to develop effective rules ready for it to take effect in April 2019 has taken place during this year. The government’s objective is to level the playing field between offshore and domestic investors, and in doing so, this measure aligns the UK with most other jurisdictions. Under the new regime, both direct sales of property by non-residents, and indirect sales, namely sales of interests in "property rich" vehicles, will be subject to CGT (corporation tax for non-resident companies). A trading exemption has been made available to lighten the effect of the rules for real-estate heavy trades, such as retail.
At the time of announcement, major concerns were raised by the funds industry. These arose from the widespread use of non-resident entities in fund and joint ventures to enable tax exempt investors such as pension funds and charities to invest in real estate alongside taxable investors without suffering more tax than they would if they held assets directly. The new CGT charge, without any easement for these structures, would have meant that exempt investors in fund structures could suffer tax charges; and structures involving multiple layers of holding vehicles could result in a single gain being taxed multiple times as the proceeds were repatriated through the structure to investors. The new funds regime within the rules addresses both of these concerns, either through the option to be transparent or the exemption to funds meeting certain conditions. And while a few traps for the unwary still exist, the policy making process from consultation through to draft legislation has demonstrated how a major change can be introduced in the least painful way possible.
Offshore receipts in respect of intangible property
Despite its innocuous name, the new rules for offshore receipts in respect of intangible property illustrate the UK’s creeping long arm in tax matters. In response to concerns raised during the consultation process, the government has proposed to tax low-tax overseas entities directly rather than withhold tax from payments. The new charging mechanism is designed so that a charge to UK tax will arise to a foreign entity where UK sales supported by intangible property (or rights over that property) are held by an entity in a no- or low-tax jurisdiction. A number of exemptions are also proposed, including a de minimis UK sales threshold (£10m); a local substance test; a local level of tax exemption; and a discharge if there is a full tax treaty with the UK. Multinational businesses with UK sales supported by intangible property held overseas will need to be prepared for this new charge from April 2019. And like a withholding tax, this new charge will be on the gross income realised by the overseas entity so no relief for costs are proposed. Pushing at fiscal boundaries in this manner may well inflame global trade relations at a time when the UK is seeking trade allies.
Intangible fixed assets
Another area under review has been the intangible fixed assets regime. The conclusions of this consultation were announced at the 2018 Budget and will see the rules relaxed for tax-neutral transfers of IP around a corporate group ahead of a share sale in circumstances where the share sale benefits from the substantial shareholdings exemption (SSE). For some time, the UK tax rules for intangibles contained an anomaly which made it difficult to carry out pre-sale reorganisations, or to implement group break-up transactions, without triggering a UK corporation tax liability. This much needed reform will be welcomed although the more radical reform involving the alignment of the rules between post-2002 assets and pre-2002 intangibles remains for another day.
At the 2018 Budget, the chancellor made a series of surprise capital allowances announcements, presumably as a way to mitigate poor investment levels in the face of Brexit. The once "permanent" annual investment allowance of £200,000 has been increased substantially (and temporarily) to £1m for two years from 1 January 2019. A new qualifying asset class has also been introduced meaning structures and buildings will now qualify for capital allowances at 2 per cent per annum on a straight-line basis. Since the abolition of industrial buildings allowance in 2007, there has been sustained lobbying to introduce some form of relief for expenditure on structures and buildings. Relief of this sort is near on ubiquitous in other jurisdictions. Despite the UK’s low headline rate of corporation tax (currently 19 per cent, reducing to 17 per cent from April 2020) the lack of relief has affected its effective average tax rate and will help with the UK’s "open for business" messaging.
The known unknowns
The daily, often hourly twists and turns of Brexit mean we know little about the future state of relations between the UK and the EU. Anything written here is likely to be out of date by the time it is published. However, as the clock hurtles towards 11pm on the 29 March 2019, the direct tax issues in a variety of scenarios are well rehearsed but worth a reminder.
In the event that the Withdrawal Agreement gets through UK parliament, it will mean that effectively the UK’s EU membership remains in place until the end of the transition period on 31 December 2020. This means there should be no immediate impact on the tax system.
In the event of no deal, the contingency plans of corporates will need to include a review of payment flows that rely on the EU Parent Subsidiary Directive or the EU Interest and Royalties Directive. It will be important to consider whether it will be possible to make a claim under an applicable double tax treaty to reduce the exposure to withholding taxes. The UK has good double tax treaty coverage across most EU member states but there are quirks that might catch some out.
Many EU jurisdictions’ domestic exemptions rely on the counterparty or shareholder being an EU member. This is true for certain member states in the use of tax losses within corporate groups. The presence of a UK company in a corporate group involving EU27 companies may act as a blocker in a fiscal consolidation, preventing relevant reliefs being available in the future and, in some cases, resulting in the clawback of reliefs obtained in past periods.
If a deal is forthcoming, the UK commitment in the Political Declaration (if it survives) to "open and fair competition" in relation to tax matters should minimise fears that the UK will become a tax haven. It also paves the way for cooperation, not only to resolve the unintended consequences of Brexit, but to work in partnership on international tax issues.
Taxing the digital economy
During 2018 the UK, EU and OECD (amongst others) have simultaneously been working on ways to tackle the challenges that digital businesses create for the international corporate tax system. The UK and EU have said they support a long-term overhaul of the international tax system however they recognise the time it might take to reach global consensus. To keep the pressure on international dialogue a series of interim turnover taxes on certain digital businesses have been proposed by various jurisdictions.
As of December 2018, the EU’s efforts appear to have stalled having come up against strong opposition from Ireland, Denmark and Sweden. The original proposal sought to tax the revenue streams from advertising; multi-party interfaces; and the transmission of users’ data derived from their activities. The EU’s latest proposal involves a 3 per cent levy focusing on advertising revenues. Despite its much reduced scope, it is unlikely to be waved through. The member states most opposed are likely to remain firm in their view that the challenges presented by the digital economy are best tackled at a global level through the OECD. The green light to a proliferation of unilateral digital service taxes has seemingly been pressed.
One such country, the UK, has been consulting on its own digital services tax. The scope of the UK’s version will cover social media platforms; search engines; and online marketplaces. The narrowly-targeted tax will be levied at 2 per cent on the UK revenues of businesses that are considered to derive significant value from the participation of their users. The new tax targets larger businesses that generate more than £500m in global annual revenues from the three business activities in scope although the first £25m of relevant UK revenue is not taxable.
Introducing a tax of this sort is not without difficulty. The low profit margin safe harbour calculation only reduces the rate of tax, rather than eliminating it entirely. This may mean some businesses will struggle to pay the tax due. The practical realities of identifying UK users will become a compliance headache – businesses will need to start tracking users' location which may or may not have been done with any accuracy before. A tax will certainly focus the mind, but navigating the effect of GDPR and virtual private networks (VPNs) may prove more trouble than it’s worth. The tax is set to apply from April 2020 and will be in place until an appropriate global solution is successfully agreed and implemented.
In a bid to move forward on a global solution the OECD published a report, Tax challenges arising from digitalisation, during the year. The report highlighted how big a challenge it will be for the OECD to reconcile a range of competing views. Assuming the OECD can work its magic (many were sceptical that BEPS would come to anything), the familiar and fundamental principles of international tax, like permanent establishments and profit allocation, should brace for change.
The unknown unknowns
It may have escaped your attention that 2018 was the first year in the last five that has not involved a general election or a referendum in the UK. It is not beyond the realms of possibility for either to occur in 2019. If a general election took place which resulted in a change of government, UK tax policy is likely to take a different course. The studious may want to re-familiarise themselves with the Labour Party’s 2017 manifesto and tax transparency and enforcement programme.
Under a Labour government, it seems likely that the main rate of corporation tax would increase to 26 per cent. As part of a "settlement" with business this could be supplemented with a raft of new levies ranging from an excessive pay levy to an employer care contribution. Even the inclusive ownership fund could be described as a tax on big business. There are also proposals to extend existing SDRT to cover a wider range of assets; a pledge to rebadge carried interest as income rather than capital; abolish the quoted eurobond exemption and a full-scale review of tax reliefs. It is just as well tax advisers cite keeping up to date with changing tax law as one of the reasons they love their job!
For those who feel like they have mastered the changes brought in under the BEPS action plans, you may be alarmed to hear that there are reports of BEPS 2.0. The G20 leaders issued a communique after their recent meeting in Buenos Aires at which they reaffirmed their commitments to the BEPS project. In a tweet following the meetings, OECD tax policy director, Pascal Saint-Amans, reported that: "President Macron mentions need for BEPS2.0. Exciting times!"
As highlighted above, the G20 and other major nations through the OECD have promised to work towards a consensus-based solution to address the impacts of the digitalisation of the economy on the international tax system. It is not clear whether BEPS 2.0 (for want of a better name) will only have the digital economy in its sight or if it will be a more ambitious global tax plan. France and Germany are said to advocate a globally agreed minimum rate of corporation tax, while the US sees its recent tax reform as a blueprint. There’s little doubt that BEPS is the gift that keeps on giving.
In Rumsfeld’s view the "unknown unknowns" should present the most difficulties. In this context, that might be underestimating Brexit!
This article was first published by Tax Journal https://www.taxjournal.com/articles/corporate-tax-world-2018-12122018