Spring awakening: Private client changes in the Budget
David Kilshaw and Sophia Watsham review the Spring Budget and the changes introduced by the latest Finance Bill from the private client perspective
The Finance (No. 2) Bill 2016 (which for ease is here referred to as the Finance Bill) was published on 24 March 2016. It may have contained over 570 pages, but it did not give private client practitioners what they most wanted: fuller detail on the changes relating to non-domiciled residents (non-doms), which are scheduled to be enacted from 6 April 2017. The Finance Bill was silent on this key area; HMRC in fact announced that all non-dom legislation will be enacted in the 2017 Finance Act.
Despite the Bill's silence on the topic, there was one important piece of news in the non-dom arena on Budget day. It was announced that there would be a rebasing of assets for capital gains tax (CGT) purposes for non-doms becoming deemed domiciled on 6 April 2017.
This is a positive development, but problems and questions remain as to its scope. Will it apply to assets held in trusts or only those held personally? If the latter, does that mean there will be an emptying of trusts before April 2017? It also appears that this will be a one-off opportunity - if an individual becomes deemed domiciled after the 'D-day' of 6 April 2017, they may not benefit.
It is likely to be some time before we get deeper clarity on these issues and so, pending this, non-doms will continue to be frozen in uncertainty.
The Finance Bill did, however, introduce a number of changes to CGT, which will seek to influence the behaviour of private clients.
The first change of interest was the chancellor's main Budget surprise - a reduction in the rate of CGT. From 6 April 2016, the chancellor has reduced the 18 per cent rate of CGT to 10 per cent and the 28 per cent rate falls to 20 per cent. The new rates will be available to individuals, trustees, and personal representatives.
In an interesting development, the chancellor made this a targeted reduction: the lower rates will not apply to the disposal of residential property and carried interest. The Finance Bill refers to these as 'upper rate gains'. The Budget day press release was quite specific as to the reasons for this: the CGT cut was 'intended to provide an incentive for individuals to invest in companies over property'. Those holding UK residential property as an investment have been repeatedly targeted in recent Budgets.
The lower CGT rate can be expected to influence how private clients approach their investment decisions - it makes capital returns even more attractive than income ones.
Areas that may come under review include
the use of UK resident family investment companies. These will continue to be useful to
roll up income (particularly as the government also announced a further reduction in the corporation tax rate to 17 per cent from 1 April 2020), but will be less advantageous where the company makes gains.
We would also expect to see more taxpayers seeking the extraction of funds from offshore trusts as capital payments, such that they match to capital gains, and we may even see a reduction in the number of individuals looking to emigrate from the UK to avoid a CGT liability.
The second key CGT development was the creation of a new relief - 'investors' relief' - which is modelled on entrepreneurs' relief. Again, the Budget day press release provided a clear insight into the chancellor's thinking, stating that 'extending entrepreneurs' relief to external investors is intended to provide a financial incentive for individuals to invest in unlisted trading companies over the long term'.
The conditions for the relief are to be found in schedule 14 of the Finance Bill. The relief provides for a 10 per cent CGT rate on qualifying gains of up to £10m on the disposal of ordinary shares in unlisted trading companies. The relief is only available where the shares have been subscribed for new consideration in cash and the shares were fully paid up by way of a bargain at arm's length.
The definition of what constitutes a 'trading company' is, for now, to be the familiar one used for entrepreneurs' relief, but the government did announce that it would review this definition for both investors' relief and entrepreneurs' relief.
There are a number of other conditions.
The shares (which must remain ordinary shares throughout) must be held for at least three years prior to disposal. The three-year period will start on 6 April 2016, although the shares could have been issued on or after 17 March 2016, that being the day after Budget day. As with entrepreneurs' relief, there is a lifetime cap of £10m.
The investor, and any person connected with them, cannot be an officer or employee of the company (or of a company connected with the company). As with most modern reliefs, there is a general provision to the effect that the relief will not be available if there was a tax avoidance motive in the subscription. In addition, there will be a list of ways in which shares once issued can be disqualified from the relief.
The main concern in practice will be to ensure that an investor does not receive 'any value', other than insignificant value, from the company at any time in the restricted period. The period of restriction begins one year before the shares are issued (and so potential investors will need to bare their souls before investing) and ends immediately before the third anniversary of the date the shares are issued.
There is a long list of ways in which an investor may receive value. Some will be expected and easily monitored, such as the repayment of share capital. However, other ways will fall into the 'tricky' category - for example, the provision of a facility to the investor - and may prove difficult to monitor in practice. The 'insignificant value' exclusion will offer little comfort, given that in monetary terms it is set at £1,000.
While the relief is to be welcomed, and does not appear to have the monetary limits that are found with the enterprise investment scheme, it remains to be seen how widely it will be used.
The relief does not address two of the main problems in this area. First, private company shares are often very illiquid; a tax-enhanced exit is only attractive if there is an exit at all. Second, the relief requires that the key conditions - for example, around the status of the company - are maintained while the shares are held, and these conditions may be beyond the control of a minority investor who is not a director. For these reasons, it is unlikely that investors' relief will ever overshadow its big brother, entrepreneurs' relief. We expect qualifying for this relief might be considered a 'nice to have' rather than an incentive to invest.
The chancellor took the Budget as an opportunity to give entrepreneurs' relief a little tidy up - the Finance Bill changes are not so much new as re-adjusting earlier changes.
There are three such changes, the first two being backdated to 18 March 2015. First, the definition of a 'trading company' is extended so that a company that holds shares in a joint venture company is to be treated as carrying on a proportion of the activities of that company. Second, there are extensions to the definition of 'associated disposals'.
The third change is backdated to 3 December 2014 and allows the relief to be claimed in
respect of the disposal of goodwill on the incorporation of a business, provided the taxpayer holds less than 5 per cent of the shares
in the acquiring company. Relief is available where the claimant holds more than a 5 per cent interest if the acquiring company is to be sold to
a third-party owner.
We may conclude from the chancellor's Budget that he is keen to encourage investment in UK companies, both from a corporate and a personal tax perspective. The government has long been saying that the UK is 'open for business' and this Budget certainly seems to encourage grassroots investment by UK resident individuals, in a way which is targeted and seeks to prevent the abuse of the reliefs against the intention of the government.
Those holding UK residential property, either as an investment or as a second home, will consider themselves again hard done by as a result of the reduction of the CGT rate not applying to residential property. SJ
David Kilshaw is a tax partner and Sophia Watsham a senior manager at EY