Gordon Brown's budget may have been short of headline-grabbing figures, but solicitors face a host of technical challenges, writes Tarlochan Lall
The Budget headlines may have been dull but the devil is in the detail of the notes. Shell-shocked trust lawyers will no doubt be drawing breath after the announced inheritance tax (IHT) entry charge on the creation of virtually every trust (except those trusts created for the disabled) and the subsequent ten-yearly charges.
Business advisers have more technical changes to contend with, including changes to the enterprise investment scheme (EIS), changes to corporation tax group relief, and more anti-avoidance legislation. Share scheme lawyers may be shocked as well as puzzled by changes to the tax rules on the grant of options. Charities face anti-avoidance provisions as well as a welcome change to the tax exemption for trading profits.
Trusts
Accumulation and maintenance trusts and interest in possession trusts created after 22 March 2006 will, like discretionary trusts, face:
Existing accumulation and maintenance and interest in possession trusts are also caught. But the former can be kept in the safe harbour by ensuring that assets vest absolutely at the age of 18, otherwise they will face the periodic and exit charges from 6 April 2008.
The change penalises families using trusts. There is complete disregard for the non-tax motives for creating trusts, such as asset protection. Lawyers should immediately focus on ensuring these trusts remain in the safe harbour.
Businesses and investors
The annual investment limit for income tax relief on EIS investments is doubled to £400,000. However, the gross assets test that determines qualifying companies for EIS, venture capital trusts (VCTs) and corporate venturing schemes (CVSs) is more than halved to £7 million before investment and £8 million afterwards from 22 March 2006 for EIS and CVS investments and 6 April 2006 for VCT investments. Income tax relief for investors in VCTs will be granted at 30%, instead of reverting from 40% to 20%. VCT shares issued after 6 April 2006 must be held for a minimum of five years, rather than three years, to qualify for income tax relief.
There are changes to group relief to comply with European law following the decision in Marks & Spencer (Taxation) [2005] EUECJ C-446/03. Foreign subsidiaries resident (or with a permanent establishment) in the European Economic Area with losses that cannot be relieved overseas can surrender them to UK group members from 1 April 2006. The losses will be recomputed under UK tax principles.
The research and development tax credit scheme is extended to firms with 500 employees (previously 250 employees), subject to state aid approval from the European Commission.
Real estate
The derisory extension of the 0% stamp duty land tax threshold from £120,000 to £125,000 from 23 March 2006 will be accompanied by number of measures to simplify and clarify the rules on the tax.
VAT rules on the option to tax are being rewritten following a recent consultation.
UK real estate investment trusts (REIT) can be created from 1 January 2007. A conversion charge of 2% on the market value of investment properties will apply and may be spread over four annual instalments of 0.5%, 0.53%, 0.56% and 0.6%. Qualifying rental income and gains on the disposal of investment properties will be exempt from corporation tax within the REIT. A REIT must distribute at least 90% of its annual tax-exempt profits. The REIT must:
Additionally, at least 75% of a REIT's assets must be investment property; at least 75% of its income must be rental income; and interest cover on permitted borrowings must exceed 1.25%. Distributions from the REIT will be taxed as UK property income subject to deduction of basic rate income tax at 22%.
Share options
The exemption from tax on the grant of share options to employees has been withdrawn where the main purpose (or one of the main purposes) of granting the option is the avoidance of tax or National Insurance contributions. The retrospective change applies to options granted on or after 2 December 2004. Tax may be due under PAYE, with transitional provisions for options granted before the Finance Act 2006 is passed.
Practical difficulties in applying the new rules will include deciding whether the tax avoidance purpose exists and ascertaining the taxable amount. There is no clearance mechanism. It appears that 'plain vanilla' arrangements are safe but those with features added to utilise the exemption may be caught. Straightforward discounted options should also be fine, but not if they are part of more complex arrangements.
Charities
Charities with substantial donors and those that confer large benefits to their donors may be subject to new anti-avoidance rules. Charities carrying on a trade partly for primary charitable purposes or partly by its beneficiaries can completely lose their exemption from tax on trading profits. The exemption is being altered to preserve the relief to the extent that profits are reasonably attributable to the primary purpose or beneficiary trade.
Anti-avoidance
The disclosure regime is being extended to include the whole of income tax, corporation tax and capital gains tax. Hallmarks of tax avoidance will replace filters previously used. The legal professional privilege exemption for lawyers will remain in place but any schemes adopted by their clients will have to be disclosed by their clients.
Tarlochan Lall is a partner in the corporate finance and tax department of City-based law firm Charles Russell
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