The UK Finance Bill 2014 was published in draft form on 10th December 2013 and the proposed legislation now enters a period of consultation, which will end on 4th February 2014. A full analysis of each and every measure introduced by the Finance Bill is beyond the scope of this Alert, but we aim to highlight some of the key measures introduced.
The areas covered by this Alert are as follows:
Disguised employment through limited liability partnerships – Impacting a number of industries, including service providers and private equity firms, this draft legislation aims to tackle perceived avoidance of UK National Insurance Contributions (NICs) by classifying as LLP members those who should, in the view of the UK tax authorities, properly be employees.
Partnerships with mixed members – Once again impacting a number of industries, this draft legislation aims to address perceived avoidance through tax-advantageous allocation of profits and losses to corporate or individual partners in partnerships (including limited liability partnerships).
Partnerships that are Alternative Investment Fund Managers (AIFMs) – These draft measures will impact the investment fund industry; the aim is to address the tax issues arising from the requirements under the Alternative Investment Fund Managers' Directive (AIFMD) to defer remuneration for "key staff."
Onshore employment intermediaries – A consultation document has been released containing proposals to address perceived tax avoidance through the use of UK companies to disguise employment as self-employment.
Offshore employment intermediaries – This may affect the use of agencies located offshore that employ workers to work in the UK; this has been perceived as a way to avoid UK withholding and NICs requirements, and anti-avoidance rules will be introduced from April 2014.
Dual contract arrangements – Impacting UK resident but non-domiciled individuals who have separate contracts of employment in relation to UK and overseas activity, draft legislation is due to be published in January 2014 as anti-avoidance in this area.
Value added tax (VAT) and place of supply rules – A general change impacting electronically supplied services has been introduced to bring supplies within the EU in line with international supplies for VAT purposes.
Capital gains tax (non-residents and UK residential property) – Although not introduced in the draft Finance Bill, it remains noteworthy that the government intends to consult on this area, which may impact certain property investment funds.
Offshore evasion strategy – Again, although not part of the Finance Bill 2014, this is key in an international tax context as demonstrating the UK's commitment to the recent surge in information sharing between jurisdictions.
Incentive arrangements – Responses have been issued to the recommendations of the Office of Tax Simplification (OTS) in relation to approved and unapproved share schemes; they will impact those involved in such schemes.
Employee ownership – Specific measures have been introduced in the Finance Bill to encourage what is regarded as "genuine" employee ownership, which may impact startup or incentive arrangements.
Other – Certain other provisions of the draft legislation and related documents are worth noting and are briefly summarised below.
Disguised employment through limited liability partnerships
The limited liability partnership (LLP) is a popular vehicle in the UK used by private equity firms, accountants, lawyers and many others. It combines the corporate personality of a company with the tax-transparent treatment accorded to a partnership. Historically, any member of an LLP is regarded for tax purposes as being self-employed—thus, employer withholding obligations through the UK's Pay-As-You-Earn (PAYE) system and accounting for employer NICs at 13.8 percent were not required for any LLP member. This resulted in perceived tax avoidance through LLPs being established in which certain members were treated in practice as employees, while the LLP reaped the tax advantages of them being technically self-employed.
Draft legislation now provides that, from April 2014, individuals will be regarded as "salaried members" of LLPs and, thus, employees for tax purposes, if three conditions are met. First, the individual must be wholly or substantially remunerated by way of a "disguised salary," which is defined as being a fixed sum, an amount calculated without reference to LLP profits or an amount which, in practice, is unaffected by such profits. Second, arrangements must be such that the individual does not have significant influence over the affairs of the LLP. Third, the individual's capital contribution to the LLP must be less than 25 percent of their "disguised salary" in a given year. In the case of the last condition, this will usually be determined at the start of a tax year, subject to certain adjustments. Anti-avoidance provisions apply so that arrangements designed to circumvent the new rules will be disregarded.
Duane Morris comment – While an anticipated change, this is of wide-ranging impact. All UK LLP structures should review their position going forward in relation to how members should be treated. Certain LLPs, notably those within the investment fund industry, should also bear in mind that allocations and reallocations of restricted securities, including carried interest, will be within the restricted securities regime and other anti-avoidance regimes if awarded to those with "salaried member" status.
Partnerships with mixed members
Measures have been introduced with effect from 5th December 2013 that impact partnerships (including limited liability partnerships) with both individual and corporate members. The anti-avoidance rules are aimed at situations in which individual members also control corporate members and allocate excessive profits to such corporate members, which the individuals still have the "power to enjoy." Since UK corporation tax rates are much lower than those applicable to individuals, these arrangements have proved popular. Going forward, the new rules mean that excessive profits given to corporate partners will be reallocated to the individual partners involved. Related provisions apply to excess loss allocations to individual partners.
Duane Morris comment – Although this change is expected, many parts of the draft legislation appear less clear and terms such as "reasonable to suppose" will need examining on a case-by-case basis. Those using partnership structures involving both individual and corporate partners should consider whether or not the rules might apply to them. Private equity firms should note that, while standard profit-sharing arrangements in their structures are unlikely to be affected, any planning previously done in this area may need to be reviewed.
Partnerships which are AIFMs
New legislation, which will apply from April 2014, is designed to assist partnerships or LLPs that are AIFMs under AIFMD. AIFMD provides that certain individuals regarded as "key staff" for AIFMD purposes are required to defer certain amounts of their remuneration. Since partnerships are tax transparent, such deferral was rendered challenging without the use of a corporate partner, which, as described above, may now result in the application of the new anti-avoidance provisions. Accordingly, draft rules provide that an AIFM may allocate all or part of its "restricted profit" to the partnership or LLP itself, where it will be taxed at the additional rate of tax (currently 45 percent). When ultimately allocated to an individual partner, credit will be given for the tax paid.
Duane Morris comment – This represents an unusual departure from the transparency of a partnership or LLP structure in terms of the potential to allocate a profit share to the partnership or LLP itself, which, technically speaking, cannot generally receive an allocation for tax purposes. It can be viewed as disappointing that the AIFMD issues were not addressed by means of an exemption to the anti-avoidance rules in relation to mixed partnerships described above, since representations on this point were made. There is still some absence of clarity in relation to the new rules, which will hopefully be addressed in the consultation process.
Disguised employment through onshore intermediaries
The government has long been concerned by the use of intermediaries to disguise employment relationships and reduce tax and NICs. Recently, it has become focused on the fact that certain "agency" companies are supplying the services of those regarded as self-employed to other parties when the reality is that they are employees of the agency company. The consultation published on 10th December invites comments on ways to address this. Of specific concern is the exploitation of one test of "self-employment" for agency workers, namely whether an individual is obliged to perform services personally. HMRC is concerned that arrangements are being entered into where the right of substitution exists but never occurs in reality.
Duane Morris comment – The government has stated that it does not intend to target the genuinely self-employed so that any legislation will need to be tightly drafted. The period of consultation now being entered into is welcome in addressing this issue, which, while present, may not be as widespread as the government may consider. Care should be taken to ensure that any legislation does not inadvertently catch legitimate arrangements.
Disguised employment through offshore intermediaries
This measure is linked to the anti-avoidance in relation to onshore intermediaries. Broadly speaking, the government wants to address arrangements in which an offshore company with no UK presence employs individuals to provide their services to companies in the UK. Such arrangements can circumvent UK tax and NICs obligations since the individuals are not UK employees. The draft legislation provides a mechanism for deemed employment in the UK.
Duane Morris comment – These measures are to be expected and generally do not appear to be unreasonable.
Dual contract arrangements
Individuals who are resident in the UK but who are not domiciled there may use the remittance basis of tax on income from employment exercised wholly outside the UK. This means their income from overseas employment is taxed in the UK only if it is "remitted" (brought in) there. This has resulted in internationally mobile executives entering into "dual contract" arrangements in which they have one employment in the UK and another, separate, employment overseas—the earnings from the latter not being subject to UK tax and often arising in a low-tax jurisdiction. It has long been the case that HMRC has been sceptical of such arrangements being truly separate employments, save in very limited circumstances, and it now seems to be the case that such scepticism will be put on a statutory footing in the Finance Bill 2014. From April 2014, overseas earnings from dual contract arrangements will be taxed in the UK, unless a tax charge comparable to that in the UK is paid in the overseas jurisdiction. Legislation will be published in January 2014 in relation to this area.
Duane Morris comment – Those involved in dual contract arrangements will need to review them with care in the light of any draft legislation. HMRC guidance already means that it is unusual for such arrangements to be free of risk. It remains unknown at this time what will be regarded as an acceptable level of overseas tax in the light of the new rules.
VAT place of supply rules
Legislation has been drafted to tax intra-EU business consumer supplies of telecommunications, broadcasting and e-services in the EU member state in which the consumer is located. These services are currently taxed in the member state in which the business is established. The changes will take effect from 1st January 2015 and implement already agreed-upon EU legislation, ensuring that these services are taxed fairly in the EU member state of consumption.
To save the need for businesses affected by these changes to register for VAT in other member states, a mini one-stop shop will also be introduced from 1st January 2015. This is an IT system that will give businesses the option of registering in just the UK and accounting for VAT due in other member states using a single return.
Duane Morris comment – These are welcome changes to bring intra-EU supplies in line with similar services supplied internationally.
Capital gains tax – non-residents and UK residential property
Although this was not detailed in the draft Finance Bill, it has been announced that non-UK residents disposing of UK property will be subject to UK capital gains tax on gains arising from such disposals. This will take effect from April 2015, and the government will consult as to how it is to be introduced.
Duane Morris comment – This follows on from legislation introduced in the past year imposing tax obligations in relation to residential property of a certain value owned by "non-resident, non-natural" persons. Certain property fund structures may be affected, as may foreign individuals investing in UK residential property. As stated, consultation on this measure is anticipated. It now looks likely that such consultation will commence in around May 2014, although it could be earlier.
Offshore evasion strategy
Again, although not part of the Finance Bill itself, HMRC will, in early 2014, launch a project to ensure that is it ready to exploit data received under the various new exchange-of-information agreements it has entered into with other countries. Further details have not yet been released, but this proposal appears to be part of the government's strategy of aggressively pursuing those who seek to conceal assets offshore to avoid UK tax.
Duane Morris comment – There is no doubt that worldwide exchange of information between tax authorities is fast becoming the norm. Potentially affected UK taxpayers would be wise to address their situation at an early stage.
Share incentive arrangements in the UK are notoriously complex, and the OTS has been active in addressing such arrangements to achieve the goal of true incentivisation. On the day of publication of the Finance Bill 2014, HMRC has issued a final response to the OTS consultation alongside related legislation. In relation to HMRC-approved schemes, the focus is on a new system of self-certification for such schemes, which represents a significant departure from the prior system of having to receive formal approval from HMRC on plan rules, etc. In relation to unapproved schemes, the responses and related legislation deal with certain specific aspects, including share-for-share exchanges and rollover relief, application to internationally mobile executives and certain valuation issues.
Duane Morris comment – Broadly speaking, the changes proposed are welcome and will enable incentive arrangements in the UK to operate in a less complex manner. However, share scheme and equity incentive plans are more complicated than might first be apparent, and seeking appropriate advice is a prudent course of action.
Three new tax reliefs will be introduced to encourage indirect employee ownership. From April 2014, disposals of shares that result in a controlling interest in a company being held by an employee ownership trust will be exempt from capital gains tax. Transfers to such trusts will also be exempt from inheritance tax, provided certain conditions are met. From October 2014, bonus payments made to employees of indirectly employee-owned companies which are controlled by an employee ownership trust will be exempt from income tax (to a cap of £3,600 per year).
Duane Morris comment – These measures reflect the government's desire to encourage what they see as "genuine" employee ownership.
Certain additional measures have been introduced in the Finance Bill or documents published pursuant to it. On the positive side, the government has stated that it plans to make no additional changes to the rules relating to loans to participators in close companies. Equally, anti-avoidance rules have been published in the areas of the worldwide debt cap, double taxation relief and controlled foreign companies, total return swaps and the worldwide debt cap. Furthermore, although enacted with effect from October, the recent changes to the transfer pricing rules in the area of compensation adjustments warrant a reminder.