Update: Taxation

The so-called offshore 'amnesty', as HMRC has been at great pains to point out, is not an amnesty. It is, in fact, an 'offshore disclosure facility'. After months of speculation, HM Revenue and Customs (HMRC) announced in April that a reduced penalty regime would be made available. The main motivation for this move was to gather the tax due on offshore bank accounts held by UK residents, details of which HMRC had been able to force the banks to supply.

Apparently this pragmatic approach reflects the sheer number of these accounts, and the manpower which would be needed to follow up each one.

Far better for the exchequer's cash flow to encourage taxpayers to come forward. To summarise, those wishing to make a disclosure needed to register by 22 June 2007, with full disclosure and payment of the tax, interest and penalty to be paid by 26 November 2007. In return the penalty would be restricted to 10 per cent. The facility was not restricted to offshore bank accounts, but was extended to cover all 'overlooked' income sources. However, it was not guaranteed to be available in all cases. For example, if the source of the offshore stash was income or gains on which tax had been evaded, there would be more difficult questions to answer.

By early June around 6,000 people had registered, but a last minute rush was expected. Apparently HMRC hold details of offshore accounts for a staggering 400,000 people '“ and it has yet to speak to another 500 banks.

Private equity

In recent weeks there has been much press comment about the activities of the private equity industry, in part due to the successful bid backed by KKR to acquire Boots plc for £11 billion.

The coverage, largely unfavourable, has centred around the huge earnings of the successful private equity players, the alleged impact on the workforce of the companies they acquire, and the 'tax breaks' they enjoy.

On the last issue, much of the comment has been misinformed. The main tax advantages supposedly enjoyed are:

• The acquisition is often financed largely by debt. The cost of servicing the debt '“ interest '“ is deductible in calculating the company's taxable profits, whereas the cost of servicing equity finance '“ dividends '“ is not. This is true, but it does not take into account that a company providing the funds (provided of course that it is UK resident) would be taxable on interest received, but not on dividends, so overall the position would be tax neutral.
• The private equity partners' reward for a successful investment '“ the entitlement to shares, known as 'carried interest' '“ is subject to capital gains tax. If held for two years prior to disposal, the shares are likely to qualify for business asset taper relief of 75 per cent so that on a disposal the effective rate of tax will be 10 per cent. This led a leading private equity figure, Nicholas Ferguson, of SVG Capital to comment that he paid less tax than his cleaning lady. Also true, but it does not put the private equity industry in any different position to anybody else who holds shares in an unlisted trading company.
• Many private equity players are domiciled outside the UK. They are only liable to tax on non-UK income and gains on the remittance basis and are therefore able to organise their affairs so that they pay little or no UK tax. Again, this may be correct '“ and it is widely believed that labour donor and venture capitalist Sir Ronald Cohen is a member of this 'club' '“ but this is not an issue peculiar to private equity.
• The upshot of all of this is that some changes are likely to be made soon. These may be restricted to reclassifying 'carried interest' profits as trading income, but could equally spill over into the taper relief and domicile areas. People who are dependant on these should bear this in mind.

Finance Bill 2007

The Finance Bill was published on 29 March 2007. It is now customary that some of the draft legislation contains bad news not evident to even the keenest reader of the Budget press releases and this year is no exception.

Capital allowances '“ The allowances on agricultural buildings and industrial buildings are to be phased out. What was not apparent on Budget day was that annual allowances for expenditure incurred prior to that date would be withdrawn completely over a four year period, thus effectively withdrawing allowances which may well have been factored into previous investment decisions. This seems especially harsh given the trading conditions faced by many businesses in these sectors at the present time.

Partnership losses '“ It was announced in the Budget that tax avoidance schemes creating losses which non-active partners could set against their other income would be blocked.

This understandably caused little complaint outside of the promoters of the schemes themselves. However the proposals in Clause 24 and Schedule 4 of the Bill go much further and severely limit the ability of 'non-active' partners to claim such 'sideways' relief for legitimate trading losses. This is an unfortunate withdrawal of a legitimate tax relief for risk capital.

Phizackerley and Arctic Systems

Phizackerley is yet another case for the IHT adviser to bear in mind, and a further complication for the nil rate band will trust (Phizackerley v Revenue & Customs [2007] UKSPC SPC00591).

In outline, the special commissioner found that a debt payable by Mr Phizackerley to a discretionary trust established under the will of his wife was not deductible in calculating his taxable estate for IHT purposes.

This was because the debt related to an asset '“ her share in the family home '“ which was derived from him. He had previously provided all the funds to buy the house but had gifted her a half share.

The long running Arctic Systems case (Jones v Garnett [2005] EWCA Civ 1553) was heard by the House of Lords on 5 June 2007 ((2007) 151 SJ 718, 08.06.07). The case concerns the application of Section 660A Taxes Act 1988. In essence, can the owner of a 'one man' company give shares in that company to his wife and save tax by declaring dividends, thus using her basic rate band. More particularly, the case examines whether an ordinary share in a company may be regarded as 'substantially a right to income'.

The case has been running for years, and whichever way it is decided (and my money is on the taxpayer), let us hope we get some clear guidance to help those in a similar position complete their self-assessment tax returns.

'Buy-to-let tax shock'

This story appeared in The Times on 29 May. It seems that HMRC has held meetings with representatives of the accountancy profession, to ask how they can help buy-to-let investors to pay 'the right amount of' (read 'more') tax.

Apparently there are over 400,000 buy-to-let landlords in the UK, yet only 285,000 people file the land and property pages with their tax return. The clear implication is that 115,000 landlords are outside the system. Furthermore, many of those completing returns have incorrectly claimed expenses, in particular deducting the whole of their mortgage repayments, as opposed to just the interest element. Maybe more landlords will be smoked out under the 'amnesty' provisions. In the long run if HMRC choose to devote resource to cracking down on landlords who do not make appropriate declarations, there must be enough information available for them to expect a reasonable degree of success.

Construction industry scheme

The new tax scheme for the construction industry came into force on 6 April 2007. A special set of rules has applied to the construction industry since the 1970s. It was introduced to prevent what was perceived as widespread tax evasion by subcontractors who either did not declare all of their income or were outside of the tax system altogether. It provided that unless a subcontractor held a certificate, the contractor was obliged to deduct tax when making payments. The new system reflects HMRC's view that the previous arrangements were not robust enough and did not provide them with the information they needed to monitor what was happening in the industry as a whole. Under the new regime a centralised database will provide them with a much greater deal of information about payments within the industry. The subcontractor may still apply to register for gross payment but the conditions are more stringent. The right to receive gross payments may be cancelled at 90 days notice if the subcontractor ceases to comply with the relevant conditions. Subcontractors who do not meet the conditions to receive payments gross may be registered to suffer a 20 per cent deduction, and those who are not registered must have tax deducted at 30 per cent. This scheme imposes onerous administration duties on contractors, but it is essential that they comply with these because if they do not, then their own right to receive gross payment could be withdrawn.

IHT: discounted gift schemes

HMRC has published guidance in relation to discounted gift schemes. These are investment policies which may be effected through insurance companies which essentially enable an individual to obtain an immediate reduction in the value of his taxable estate for IHT purposes. The guidance is most helpful in that it provides clarity for those who may consider such arrangements. In particular it enables the companies marketing policies to provide an accurate guide as to the level of discount which will be achieved.

Employment status

HMRC will periodically arrange to visit employers to check on their compliance with the PAYE rules. One favourite method of financing these visits is to reclassify casual or 'self-employed' workers as employees thus making the employer liable for the income tax and national insurance which should have been accounted for under the PAYE system. For a worker to be classified as an employee their relationship with the 'employer' must display certain characteristics. One of these is mutual obligation. In the case of Parade Park Hotel & May v Revenue & Customs [2007] UKSC SPC00599, the special commissioners held that there were insufficient mutual obligations and May was therefore not an employee. The facts were slightly unusual, but nevertheless could be helpful to businesses facing such status disputes.