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Reduction in Corporate Tax Rates
In the Emergency Budget on 22 June this year, George Osborne confirmed the Government's stated intention to reduce the headline rate of corporation tax. A recent report by the World Economic Forum ranked the UK as 84th out of 133 countries in terms of competitiveness of the tax system. The Chancellor had previously cited this report as justification for wholesale reform of corporate taxes.
The headline rate of UK corporation tax will be cut to 24% as part of a phased reduction from 2011 to 2014. The current rate of 28% will reduce to 27% from 1 April 2011, 26% from 1 April 2012, 25% from 1 April 2013 and 24% from 1 April 2014. This measure goes slightly further than expected although a phased reduction to 25% had been widely anticipated by business. Taxand UK analyses the impact of the new corporate tax rates, what this really means for businesses investing in the UK and who, ultimately, are the winners and losers.
At first glance a four percentage point reduction in the headline corporation tax rate seems to be extremely good news for all UK business. Before celebrating, however, you should question how the Chancellor will pay for this reduction. Will UK companies be able to keep the tax saving from reduction in rates?
Corporation tax had previously been expected to make up around ?42bn of tax revenues in 2010-11 if there had been no significant changes to the system. Therefore one might expect that each reduction of 1% in the headline rate of tax would cost the Exchequer ?1.5bn. On that basis, a reduction in the headline rate of corporation tax by four percentage points would cost ?6bn. This does not take account of any behavioural change in the Board Rooms of multinationals and in any event the Chancellor will be hoping that the Emergency Budget will help to reverse the trend of UK PLC's leaving our shores and attract some inward investment as well.
In the current economic climate it is simply not possible for the Government to suffer an annual reduction in tax revenues of ?1.5bn without making up for the shortfall elsewhere. The Chancellor had to expand the base to make up for these lost tax revenues. The main measures introduced that expand the base were a cut in the rate of capital allowances (tax depreciation) on plant and machinery from 20% to 18% and on long life assets from 10% to 8%.
Lowering the rate but expanding the base
A recent example of the government lowering the rate but expanding the base occurred in 2007 under Gordon Brown. At that time, the rate of corporation tax was lowered from 30% to its current rate of 28%. This was paid for by a reduction in the rate of capital allowances on plant & machinery from 25% to 20% and the phasing out of industrial buildings allowances (IBAs) entirely. There were notable winners and losers. In general, industries that are not very capital intensive such as financial services were clear winners as they were able to benefit from a reduction in rates without paying for the expansion in base that occurred with the withdrawal and reduction of allowances. Notable losers included the airports, manufacturing companies and the hotels industry that relied heavily upon IBAs to mitigate their effective rates of tax. Companies in any capital intensive industry will remember this time well as their effective rates of tax increased to pay for the lower rate.
Similarly to the changes in 2007, where there is a reduction in rate of corporation tax paid for by cutting rates of capital allowances one would expect to see the financial services sector as a whole emerge as winners. However, the Emergency Budget was also used as an opportunity for the UK to introduce a Banking Levy. This means that the financial services sector will in fact pay more tax as a whole but the reduction in rate will temper the overall impact of the introduction of the Banking Levy.
Dogs that did not bark
Another example of expanding the base would be to deny loss reliefs. The UK has a complex system that allocates losses for corporation tax purposes to the type of income or activity to which they relate. Mr Osborne may have been tempted to deny the offset of certain types of losses against other income. On this occasion this particular dog did not bark and the system of loss relief remains unchanged.
In the past, George Osborne has also called for a reform of the rules relating to interest deductibility in the UK. In the run up to the election he was quoted as saying 'By reducing tax breaks for debt we could potentially fund a significant reduction in the headline rate of corporation tax - a key determinant of our international competitiveness.' This lead to speculation that there could be further restrictions imposed on the deductibility of interest payable to UK companies in the emergency Budget. Again this has not been imposed which is excellent news for business.
Controlled Foreign Companies
The UK controlled foreign company regime is without doubt the most controversial component of the corporate tax system. The current state of play is that an updated discussion document was issued in January 2010 under the previous Government. This discussion document introduced a paradigm shift away from the fundamental assumption that any foreign activity is carried on for avoidance purposes and did much to halt the flow of companies leaving the UK.
The exemptions from the new regime will include a 'white list' of territories, a specific exemption for active IP companies, an increase in the de-minimis limit (which is currently a rather paltry ?50,000!) and an exception for group treasury companies.
Implementation of the reforms is now proposed to take place in 2011 and 2012 in a two stage process. Interim improvements in 2011 will be followed by wider reform in 2012. The Emergency Budget was silent on any further details.
Certainty in uncertain times
Our clients tell us that the most important factor in a tax system seeking to attract inward investment is certainty. The UK has done much in this area in recent times. As well as an extensive system of statutory clearances there is now the ability for companies to obtain non-statutory pre-transaction clearances and post-transaction rulings on almost any topic where uncertainty exists.
Additional areas for consultation include a complete exemption for branch profits which would sit very well with the participation exemption on dividend income and the stated intention to move the UK tax system to a more territorial approach.
The Emergency Budget has been generally well received by business but perhaps one criticism of the Chancellor is that he failed to take the opportunity to further clarify the regime with regard to controlled foreign companies. This would surely have been worth much more than an additional 1% reduction in the headline rate of corporation tax when it comes to attracting inward investment. Tax advisors and their clients will be watching for developments in this area throughout the coming months.
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