A MODERN AND COMPETITIVE BUSINESS TAX SYSTEM

A package of reforms to the business tax system will provide longer-term stability for business and a competitive business environment, promoting investment and innovation.

Paymaster General, Dawn Primarolo, said:

"This Government is pressing ahead with a pro-enterprise, pro-competition and pro-business agenda. We have delivered on economic stability and higher employment, now it is time to move forward with measures to boost productivity and close the gap with our competitors. Only on the basis of a dynamic, enterprising and productive economy can we generate the resources we need to put our public services on a secure long-term footing."

Promoting productivity, growth and jobs

The package confirms the recently announced measures:

A new R&D tax credit available to all companies not already qualifying for the SME R&D tax credit. As announced, this will operate as a simple volume tax credit payable to the company carrying out the R&D. Budget 2002 further announces that the credit will be payable at a 25% headline rate. This will provide an additional £400 million a year support for investment in new technology by UK industry. The new credit will build on the existing R&D tax credits for SMEs in increasing innovation and improving the productivity of the UK economy.
An exemption regime for capital gains and losses on substantial shareholdings will reduce the tax on UK business by £150 million a year and ensure that important business decisions on restructuring and reinvestment can be made for commercial, rather than tax, reasons.
A relief for intellectual property, goodwill and other intangible assets to encourage business to take advantage of new opportunities in the knowledge-based economy. It will be worth about £200 million a year to UK businesses, rising to a maximum of £350 million a year in the longer term.

In addition the Government is announcing:

A stamp duty exemption for transfers of goodwill to reduce the tax bill on transfers of business putting goodwill on the same footing as intellectual property;
A package of measures to tackle the avoidance of stamp duty on commercial property transactions, and a reform to stamp duty on land and buildings in the UK. This will ensure that in future stamp duty applies fairly to all relevant transactions, and pave the way for the introduction of electronic conveyancing. (see press notice REV 4 for further details);
a package of corporation tax cuts - reducing the starting rate from 10 pence to zero and the small companies' rate from 20 per cent to 19 per cent (see press notice REV/C&E 2 for further details);
A modernised and simplified regime for loan relationships, derivative contracts and foreign exchange gains and losses from 1 October 2002 to provide certainty and stability for business;

Modernising the business tax system

Changes to the North Sea tax regime to put in place a stable regime for the future to ensure a regime that raises a fair share of revenue on their profits while promoting long term investment:
- companies producing oil and gas from the UK or UK Continental Shelf will pay a supplementary charge of 10 per cent in addition to the current 30 per cent corporation tax;
- to encourage investment, a 100 per cent first year allowance for capital expenditure will be available to North Sea companies; and
- the Government intends, subject to consultation on the appropriate timing, to abolish North Sea Royalty.
a measure to modernise the taxation of foreign companies operating in the UK through branches. Capital will be attributed to a UK branch for tax purposes, based on the capital it would need to trade if the branch were an independent, free-standing company. This will bring the UK closer into line with established international practice, ensuring a level playing field between foreign companies (mainly banks) and their UK based competitors. The Government will be consulting on the technical detail of the legislation;
A consultation on further changes to the corporate tax system building on the reforms announced in this Budget and taking forward the Government's programme of modernisation of the corporate tax system to ensure that the UK remains the best possible place for business;
Reforms to the rules governing changes of accounting basis were announced on 1 August 2001. Draft clauses have been consulted on and revised clauses will be published in the Finance Bill;
Measures to protect the tax base and to root out tax avoidance whilst facilitating business efficiency and promoting competitiveness, including:
- restriction of the tax reliefs for expenditure on the production of "British qualifying films", subject to discussion with the industry on the details of the implementation. This will refocus the reliefs on the original intention of stimulating the production of films in the UK and to promote growth, employment, investment and opportunities in the British film industry. These changes will apply from 17 April 2002.
- a reserve power to bring within the charge to tax under the controlled foreign companies (CFC) legislation all CFCs that are located in overseas jurisdictions where harmful tax practices are prevalent. The reserve power will enable the UK to protect itself from the continuation of such practices in those jurisdictions.

Reducing regulation and compliance costs

A further package of measures will help reduce the tax and compliance burden on business - another essential step towards a more modern, flexible and efficient tax system, helping business thrive. Alongside improvements to capital gains tax - confirmed in the November 2001 Pre-Budget Report - these measures will help ensure that the UK is one of the most attractive locations for business investment. These measures include:

Further reform of the rules on deducting tax at source from corporate interest and royalty payments to reduce the number of occasions when tax has to be withheld at source;
Simplification of the rules for life insurance companies investing in venture capital partnerships, will reduce compliance costs and encourage investments. This measure will take forward recommendations made by Paul Myners in his review on institutional investment.
A package of measures simplifying the capital gains tax system, designed to help employees and business and typically reduce the tax compliance cost.
Consultation on the offshore funds tax regime.

Press Notices

REV 3 Stamp Duty on UK land and buildings
REV/C&E 2 Supporting Small Businesses and Entrepreneurs

DETAILS

Promoting productivity, growth and jobs

A new R&D tax credit, to complement the SME tax credit introduced in Budget 2000, took effect from 1 April 2002. The new credit is given at a headline rate of 25 per cent. This will reduce the after tax cost of the full amount of qualifying R&D by 7.5 per cent for a company paying corporation tax at the standard rate.
A new exemption for gains and losses on substantial shareholdings, to provide business with the flexibility it requires to restructure rapidly in response to emerging global opportunities. The exemption, which took effect from 1 April 2002 applies where:
- an independent trading company or a company which is a member of a trading group disposes of a substantial shareholding in another company which is itself a trading company or the holding company of a trading group; and
- the investing company has held 10 per cent or more of the ordinary shares of the company invested in for a period of at least twelve months in the two years before the share sale.
A new regime for intangible assets will provide relief to companies for the costs of intellectual property, goodwill and other intangible assets. The new regime took effect from 1 April 2002 and:
- covers the cost of acquiring intellectual property, goodwill and other intangible assets providing relief where none had previously been available;
- ensures that relief for future acquisitions will be given on a consistent basis following, as far as possible, the amortisation reflected in companies' accounts.
The rules on stock valuation on the transfer of a business will be modernised with effect from Royal Assent to achieve a better fit with both the new intangibles and other existing tax rules.
Transfers of goodwill will be exempt from stamp duty, reducing the tax bill when businesses with goodwill are bought and sold. This exemption will put goodwill on the same footing as intellectual property (exempted from stamp duty in 2000);
A new regime for loan relationships, derivative contracts and foreign exchange gains and losses will take effect for accounting periods beginning on or after 1 October 2002, or earlier where special rules apply. It will:
- extend the scope of the financial instruments regime to give certainty of tax treatment to most derivative contracts, including those which had not been developed when the original rules were introduced;
- enable companies to get relief for bad debts in a wider range of circumstances; and
- merge the legislation on foreign exchange gains and losses into the loan relationships and derivative contracts system.
The legislation includes targeted anti-avoidance measures, effective from 26 July 2001, 19 December 2001 and 26 March 2002 to counter avoidance schemes involving:
- premiums and discounts on currency contracts;
- convertible, exchangeable and asset-linked securities; and
- relevant discounted securities.
Some relaxations have been made to the rules announced originally to ensure that normal commercial financing transactions are not hindered.
The reform of the loan relationships regime includes measures which, in line with the changes proposed in the Enterprise Bill, will facilitate the rescue of companies experiencing financial difficulties.

Modernising the business tax system

In last year's Budget the Chancellor made it clear that, in considering the next steps for North Sea taxation, the Government's approach would be guided not by short-term factors but by the need for a regime that raises a fair share of revenue and promotes long-term investment in the North Sea. In line with this commitment, the Government has now decided on the reforms it wishes to bring forward.
It is widely recognised that the present North Sea fiscal regime does not strike the right balance between promoting investment and taking an adequate share of revenue derived from a national resource. The Government has therefore decided to introduce from today a supplementary charge on profits from the production of oil and gas in the UK and on the UK Continental Shelf (UKCS). The charge will apply at 10 per cent, in addition to the standard corporation tax rate of 30 per cent, and will only affect companies producing oil or gas in the UK or on the UKCS. In virtually all respects, the supplementary charge will be calculated on the same basis as normal corporation tax, although there will be no deduction for financing costs against the 10 per cent charge.
The Government wants to encourage long-term investment in the North Sea. From today, therefore, most capital investment in the North Sea will qualify for an immediate 100 per cent allowance against general corporation tax and the supplementary charge, rather than the 25 per cent allowance currently available.
The Government intends, subject to consultation on the appropriate timing, to abolish North Sea Royalty, which applies only to older fields. Some - but not all - of the fields that pay Royalty are nearing the end of production. The Government therefore wants to consider the future of Royalty in relation to future investment in older fields and field decommissioning.
These changes put in place a sustainable regime for the long term. They strike the right balance between the need to raise a fair share of tax for the nation and the need to promote long-term investment.
Recent OECD work shows that the UK rules on attributing capital to branches of overseas companies are out of line with international practice. The proposed reform will address this weakness, by attributed to a UK branch of a foreign company a share of the company's capital (i.e. share capital and retained profits) for tax purposes, based on the capital needed if the branch were an independent, free-standing company. The new regime will apply to accounting periods starting on or after 1 January 2003. There will be consultation on the technical detail of legislation, based around draft clauses to be published shortly
This reform will bring the UK closer into line with established international practice. It will help ensure that the treatment of foreign company branches here in the UK is similar to that of both UK companies and foreign companies with UK subsidiaries. This will ensure a level playing field and enhance competition. The reform will also mean that foreign company branches pay a fairer share of UK corporation tax, reflecting the profits they make from their UK activities.
The consultation on further reforms of the corporate tax system will:
- consider the case for bringing the remaining taxable gains of companies into an income regime as a natural extension of the changes introduced in this Budget, including an approach for land and buildings that might mirror that for intellectual property;
- examine the merits of rationalising the schedular system; and
- review the scope for greater alignment between the treatment of investment and trading companies.
- The consultation document will be issued in the summer. Changes of this sort would have to take account of a range of issues including the special position of businesses such as life assurance.
A package of VAT anti-avoidance measures which will help to protect the tax base, remove distortions and ensure that businesses pay their fair share of tax, including:
- blocking a scheme used to avoid VAT on second-hand goods, particularly in respect of business cars;
- following consultation, legislating at the earliest opportunity to block loopholes in the VAT treatment of face-value vouchers; and
- ensuring that the VAT recovered by the largest partially-exempt businesses fairly reflects their level of taxable activity.

The changes to film tax relief will include a measure to restrict the main tax relief, for British qualifying films with budgets not exceeding £15 million, to production expenditure which has been paid at the time the film is completed, or is unconditionally payable within four months of the date the film is completed.

The reserve CFC power to bring within the charge to tax made by the CFC rules all CFCs that are located in overseas jurisdictions where harmful tax practices are prevalent, would give the UK the power to protect itself from the continuation of such practices in those jurisdictions. The charge to tax made by the CFC rules is limited, in effect, to CFCs which predominantly receive certain limited types of (mainly passive) income, or which meet certain other conditions. However, it is not appropriate for any CFCs to be outside the charge to tax in the CFC rules when they are located in jurisdictions where harmful tax practices are prevalent. And so the measure introduces the reserve power for the Treasury to make regulations specifying jurisdictions where all CFCs would fall within the charge to tax of the CFC rules. The Chancellor is determined to promote fair tax competition and to take effective action against jurisdictions that do not remove their harmful tax practices. He hopes that jurisdictions will remove those practices so that it will not be necessary to make regulations designating any of them.

Reducing regulation and compliance costs

Further changes to the system of deducting tax at source from corporate interest and royalty payments will ensure that from October 2002:
- Companies will not have to deduct tax from interest, royalties, annuities and annual payments paid to specified bodies that are exempt from UK tax and who would otherwise simply have to reclaim that tax at a later stage. The rules for deducting tax from payments made by local authorities will be aligned with those that apply to companies;
- UK companies will be able to make royalty payments to non-residents without deducting tax where they have a reasonable belief that the non-resident would be able to reclaim the tax under a double taxation treaty; and
- UK financial dealers will be able to pay interest without deduction of tax in the course of financial trading, so strengthening their competitiveness in this major international industry. Securities houses will be subject to the same regime as banks for deducting tax at source on interest payments to individuals.
A simplification of the calculation of capital gains arising to life companies and friendly societies investing in certain venture capital partnerships, avoiding the need for the valuation of unquoted shares, normally a complex and burdensome task:
- the investment by the life company in the partnership will be treated as a single asset, acquired when it became a partner;
- capital gains on disposals (including part-disposals) of that asset will be calculated by reference to distributions from the partnership to the company, rather than to the values and sale proceeds of the underlying shares;
A number of measures to simplify and modernise the VAT system, including implementation of EU-wide standards on VAT invoicing, and abolition of outdated VAT provisions concerning the recovery of debts and the production of printed matter.
A package of measures simplifying capital gains tax (CGT), produced after extensive consultation, including the following measures to help employees and business:
- employees may acquire shares on the same day via different share option schemes. Exercising the options may give rise to an income tax charge in some schemes but not in others, and where it does employees sometimes sell shares in order to pay the tax. The CGT rules do not, however, identify the shares sold as the shares that produced the income tax liability. These rules are being changed so that employees will be able to elect for a different rule that will typically reduce any CGT liability on that sale; and
- incorporation relief rolls over the CGT charge when a business and its assets are transferred to a company. Instead the charge arises when the shares in the company are sold. Businessmen and women will now be allowed to elect that the relief does not apply. This will reduce the tax cost in some cases where the shares are sold before the full benefit of business assets taper relief can be realised.
A consultation on the offshore funds tax regime. The Government has decided to consult with fund managers and other interested parties on how the current regime for taxing investment returns from overseas collective investment schemes, or 'offshore funds' as they are commonly known, might be improved. Since their introduction in 1984, the rules have changed little. However, over that period a number of commercial, regulatory and tax developments have had a significant impact upon the worldwide investment funds sector. In the light of these changes the existing rules may no longer be the best way of delivering the original objectives of the scheme. The Government will therefore consult on:
- whether the regime should be retained, and if so what reforms can or should be made to it; or
- whether the regime should be abolished, and if so what arrangements can or should be put in its place.

NOTES FOR EDITORS

R&D Tax Credit

A consultation on extending R&D tax credits to all companies was announced in Budget 2001, with the consultation document "Increasing Innovation", which set out the choice between an incremental credit (given to companies that increase R&D spending), and a volume credit (given to all companies undertaking qualifying R&D).
The November 2001 Pre-Budget Report confirmed that a volume tax credit would be introduced and announced further consultation into detailed design options, set out in the document "Designs for Innovation".
On 26 March 2002, the Chancellor confirmed that the credit would be a "simple volume" design, which rewards companies for the full amount of qualifying R&D they undertake. This Budget announces that the rate of relief will be 25 per cent.
A Regulatory Impact Assessment has been prepared and is available on the internet.

Exemption for substantial shareholdings

A Regulatory Impact Assessment and a summary of comments on the draft legislation published on 27 November 2001 are available on the Inland Revenue website.

Loan relationships, derivative contracts and foreign exchange gains and losses

The legislation announced today has been the subject of extensive consultation begun in 2000 and leading, shortly after the 2001 Pre-Budget Report, to publication of a Technical Note entitled "Loan Relationships, Derivative Contracts and Foreign Exchange Gains and Losses", which contained draft legislation.
A Regulatory Impact Assessment has been prepared and is available on the internet at the Inland Revenue's web site

Controlled foreign companies (CFCs)

The CFC rules are designed to stop UK companies reducing their tax liabilities by diverting profits to foreign companies under their control, which are situated in low tax jurisdictions. The rules work by, broadly, charging UK parent companies of CFCs on an amount equal to the profits that would otherwise avoid tax.
There are a number of exemptions from the CFC rules to ensure that the rules only deal with controlled foreign companies that are used for the purpose of reducing UK tax.

Capital Gains Tax Simplification

As part of his Enterprise for All announcement on 18 June 2001, the Chancellor of the Exchequer opened a consultation to simplify capital gains tax within the existing policy framework. The Government is very grateful to the 24 organisations and individuals who replied to the consultation and also to the members of the Capital Gains Tax Review Group who explored options with the Inland Revenue. A summary of replies to consultation is published on the Inland Revenue's website.
The Government remains committed to exploring opportunities for further simplification of capital gains tax, specifically looking at the scope for simplifying:
- the taxation of part disposals of shares and units acquired in monthly purchase schemes; and
- foreign currency transactions, for example, it can be complex to calculate gains where there are multiple deposits and withdrawals from a foreign currency bank account.

Life companies and friendly societies investing in venture capital partnerships

The Myners' report entitled "Institutional Investment in the UK: a review" was published in March 2001. The Chancellor announced at Budget 2001 that the Government would be taking forward all of the report's recommendations. A link to the Myners report can be found on the HM Treasury website.

Offshore funds

The offshore funds regime was introduced in 1984. It governs the taxation of all UK resident investors in overseas collective investment schemes or 'offshore funds'.
Its purpose is to counter the use of particular types of fund to convert income flows into capital gains. Prior to its introduction, a UK resident investor could accumulate income in a particular type of offshore fund and, when the investment was realised, be subject only to capital gains tax rather than having to pay income tax on the accumulating income.
The operation of the scheme has attracted increasing comment in recent years, not least because of the nature of the compliance obligations a fund has to meet annually if its investors are to preserve capital gains tax treatment on the disposal of their interests. One of the main aims of the consultation exercise is to identify ways to make the scheme, or any successor to it, more user-friendly.

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Budget 2002 Press Notices: index