Simplifying capital gains taxation

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Simplifying capital gains taxation IN THE 2007 PRE-BUDGET REPORT THE government indicated that it was committed to simplifying tax legislation, particularly in the areas of VAT, anti-avoidance and

1 Simplifying capital gains taxation IN THE 2007 PRE-BUDGET REPORT THE government indicated that it was committed to simplifying tax legislation, particularly in the areas of VAT, anti-avoidance and corporation tax for related companies. The government has now published a consultation document, Simplification Review: capital gains rules of companies a discussion document, in relation to simplifying certain aspects of the existing capital gains rules for groups of companies. BACKGROUND The initial discussions between the government and businesses focused on outlining criteria that should be included within the capital gains rules for companies. A general consensus was reached in which it was agreed that: capital profits should be subject to taxation; a group should typically be viewed as a single entity, with its capital profits taxed on a realisation basis; symmetry of treatment should apply between gains and losses and intra-group transfers should generally be tax neutral; and gains and losses should be based on the economic profit or loss arising for a group. The proposals outlined in this article have been guided by the policy themes referred to above. In addition, the government has confirmed that any reforms arising from this review will be consistent with the requirement that the underlying policy and anti-avoidance functions of the existing regime are to be preserved. PROPOSED CHANGES Following initial consultation and dialogue with businesses and representative bodies the government proposes to simplify the capital gains rules for groups in the three areas outlined below. Capital losses after a change of ownership Capital loss buying is a term used to describe any scheme in which a company is acquired by a new group primarily for the purpose of securing access to its capital losses, whether these are realised or latent. Following the introduction of the three Targeted Anti-Avoidance Rules (the TAARs) in December 2005, the government believes that some of the existing legislation pre-dating the TAARs, which focuses on capital loss buying (ie Schedule 7A to the Taxation and Chargeable Gains Act (TCGA) 1992), can now be repealed. Following the simplification review, the remaining rules would only be required to address the streaming of losses acquired in the context of commercially driven acquisitions, where obtaining a tax advantage is not one of the main motivations. The government has identified the following options to simplify the current capital loss buying rules: a) repeal only those parts of Schedule 7A to the TCGA 1992 that are no longer required following the introduction of the second TAAR (s184d, TCGA 1992); b) align the change of ownership rules retained within Schedule 7A with the approach of the second TAAR; c) repeal the loss-buying rules in Schedule 7A and introduce a permissive rule that allows realised capital losses to be carried forward without restriction in cases where the losses relate to a trade or business that continues in a recognisable form; or d) repeal the loss-buying rules contained in Schedule 7A without replacement. The underlying policy and anti-avoidance functions of the existing regime must be preserved in any reforms arising from the simplification review. Ian Reid, associate, Jones Day ireid@jonesday.com 2 The In-House Lawyer September 2009

2 The government currently favours either option b) or c). Since the introduction of the second TAAR, it has become apparent that the old loss-buying rules are no longer needed to fulfil an anti-loss-buying function. Alternatively, those rules could focus on the streaming of losses realised in a company before a change of ownership. Stakeholders have also expressed a strong preference for avoiding the complexity of any time-apportionment or market-value elections. The government is also conscious that a permissive rule should reduce the administrative compliance burden. Option a) would still leave in place many of the mechanical and complex rules, including the time apportionment and the market-value provisions. In the government s view, it would be unduly burdensome for companies to establish the pre- and post-entry elements of the loss, and therefore this option is not the preferred one. Option d) is not considered viable in the government s view on the basis that the rules within Schedule 7A are relevant for the purposes of restricting the use of losses following a change in ownership of the company in question, and thus in performing the required streaming function. In the author s view, option c) would be the preferred option on the basis that it would best achieve the objectives of the simplification process without having a negative impact on the underlying policy and anti-avoidance functions of the current tax regime. Under this option the complex mechanical rules contained in paragraph 7 of Schedule 7 can be repealed and replaced with provisions that clearly set out when and in which circumstances capital losses can be utilised by groups. Under this option it is likely that there would be no requirement to time-apportion losses realised after a change of ownership on the disposal of pre-entry assets that would significantly reduce compliance and administration costs incurred by businesses. Value shifting and depreciatory transactions The value-shifting rules have been identified as particularly complex and therefore a priority for simplification. Furthermore, there is clearly some overlap The degrouping charge ensures that if a company leaves a group, holding an asset acquired via a tax-neutral transfer from a group member within the past six years, any gain or loss deferred at the time of the transfer is cystallised. between the value-shifting rules and The government considers that adopting the depreciatory-transaction rules. The option 1) would not be sufficient. Additional government has recognised the need to rules would be needed to ensure that address the current position and simplify an adjustment would result following a these rules. transaction that would be within the current value-shifting rule at s31 of TCGA 1992 but Any new rule addressing value shifting would not within s176 of TCGA need to apply to a transaction that results in an understated gain or an overstated loss. Due to the potential difficulties that option The rule would be required to negate the 1) would involve, the government s current effect of transactions reducing the value view is that option 2) is the more viable. of a company in a group in circumstances The author agrees that it makes sense where the economic value taken out of the for option 2) to be adopted on the basis shares remains in the group. No adjustment that the current value-shifting rules are would be appropriate where the movement overly complex and are in urgent need of of value represents income or gains already simplification. However, as always, the devil taxed within the group. is in the detail and it will be particularly interesting to see how the government The government has confirmed that the drafts a set of simple rules to apply to core legislation in s30 of TCGA 1992 should transactions that result in an understated be retained, given its wider application: for gain or an overstated loss. example, to transactions involving companies that take place outside a group context. During the initial discussions, numerous The government considers that it should stakeholders raised the concern that in the be possible to prevent s30 applying in absence of any time limit to the depreciatory circumstances where a reduction in value is transactions rules, a significant compliance caused by either the payment of a dividend cost is imposed on companies seeking to or the transfer of an asset within a group. ensure that the rules do not catch previous transactions. Unfortunately, the government The government has identified the is concerned that by introducing a time following three options to simplify the limit to s176 option 3) commercially current value-shifting rules: driven transactions that did not result in any economic loss could nonetheless produce 1) extend the existing depreciatory allowable tax losses. transaction rules to allow for an adjustment to gains on shares Degrouping charges (including the creation of a gain); The degrouping charge ensures that if a company leaves a group, holding an asset 2) retain the existing depreciatory acquired via a tax-neutral transfer from a transaction legislation and create a new group member within the past six years, value-shifting rule dealing with groups any gain or loss deferred at the time of the of companies; or transfer is cystallised. 3) in addition to the above, align the time During discussions, stakeholders reluctantly limit for adjustments between the two agreed that some form of degrouping sets of rules to six years (to match the charge is necessary to protect the tax present provision in s31 of TCGA 1992). system. Without such a charge it would be September 2009 The In-House Lawyer 3

3 possible to avoid corporation tax on profits from the sale of assets by transferring an asset into a newly incorporated company whose shares have been set up with a high tax-base cost and then selling the company (rather than directly selling the asset) so that there is no gain. Businesses and their advisors identified the following problems with the current degrouping-charge regime: The six-year time limit rules create a significant administrative burden. On occasions it can be difficult for certain companies (particularly when groups merge) for the new owners to know precisely what transactions have occurred in the acquired companies over that period. Economic double taxation can potentially arise as a result of the operation of the degrouping charge rules. The rules are mechanical rules, with no test of purpose and no mechanism to reduce the amount of a charge where double taxation would arise. The current degrouping charge targets the wrong company. At present, a chargeable gain is imposed on the transferee company. However, the economic gain being taxed arose during the period the asset was owned by transferor. Consequently, any tax due is payable by the transferee unless there are commercial arrangements to reimburse any charge, or the vendor and purchaser group companies jointly agree to make an election to transfer the gain to another company in the vendor group. The way that these rules interact with the provisions in Schedule 7AC to the TCGA 1992 (the substantial shareholdings exemption (the SSE)). It was identified that the degrouping charge can arise in respect of a trade asset owned by a trading company, yet the share sale that gives rise to the degrouping event would itself be an exempt disposal for chargeable gains purposes by virtue of the provisions in the SSE. The government has identified the following six options to simplify the current degrouping charge rules: 1) introduce a facility to make a just and reasonable adjustment to the degrouping charge through a taxpayer election where the present rules give a result that does not reflect a true economic profit; 2) introduce a mechanism to switch off the degrouping charge in those circumstances in which the whole gain is realised at the shareholder level and to replace the exceptions in the present s179(2) TCGA 1992; 3) leave the degrouping charge as it stands, but look for a means to adjust the base cost of the shares in the company being sold so that the degrouping charge, and any gain or loss on the share sale, reflects the true economic profit from the whole transaction, thereby eliminating any excess degrouping charge; 4) amend the degrouping charge rules so that any charge will arise either in the transferor company or the group s principal UK company, providing for elections to subsidiaries if necessary; 5) reduce the six-year limit in the degrouping charge rules to three years; or 6) replace the current degrouping charge with a principle-based TAAR. The government s current view is that the most viable options are 1) and 4). The government believes that option 1) would be an effective means of ensuring that the correct outcome is reflected in the degrouping charge and is the preferred option. The government is, however, concerned that some protection may be required to ensure that the just and reasonable adjustment may not be used where the degrouping charge is less than what the actual economic outcome would be. For the purposes of option 4), it is envisaged that the degrouping charge would be payable by the group making the disposal (rather than the company that is sold holding the asset). Accordingly, s179a(3) could be repealed on the basis that there would be no need for taxpayers to elect for the gain to be transferred to the original group. In the author s view a combination of options 1), 4) and 5) should be adopted. It should be possible for the government to draft a set of provisions in which the transferor company is responsible for the payment of any degrouping charge, while also providing for an adjustment if the charge does not give a result that reflects the true economic profit. The author would also like to see option e) adopted to align the period with the time limits for stamp duty. INTERACTION WITH SUBSTANTIAL SHAREHOLDING EXEMPTION During the initial consultations, certain businesses indicated that parts of the SSE rules can present difficulties for businesses organised on a divisionalised basis. These problems arise in part due to the fact that it is often necessary for these businesses to restructure their operations to make an exempt share-level disposal of a trading operation. An additional issue for divisionalised businesses that need to reorganise their assets into a corporate entity prior to sale is that they are likely to incur degrouping charges as a consequence. Following discussions with businesses and representative bodies, the government is proposing that the degrouping-charge rules should be disapplied in respect of trade assets in those circumstances where a disposal of shares in a group company qualifies for the exemption under the SSE regime. The intention is that this proposal would remove one of the difficulties encountered by divisionalised trade groups in planning around the degrouping charge when seeking to benefit from the SSE. NEXT STEPS HM Treasury and HM Revenue & Customs (HMRC) intend to discuss options with businesses and other interested parties to consider in detail the challenges and opportunities presented by the ideas outlined in the discussion paper. The government welcomes comments on the proposals outlined in this discussion paper with a view to developing more detailed proposals and draft legislation. Any comments should be received by HMRC on or before 30 September By Ian Reid, associate, Jones Day. ireid@jonesday.com. 4 The In-House Lawyer September 2009

4 Cross-border VAT changes in 2010: immediate action required THE GOVERNMENT ANNOUNCED IN THE 2009 Budget that the cross-border VAT rules would be amended and there would be changes to the way the intra-eu reporting regime is operated. HM Revenue and Customs (HMRC) has published draft legislation and guidance setting out further information on the changes announced in the 2009 Budget. OVERVIEW This article provides an overview of the main changes to the cross-border VAT regime and intra-eu reporting regime that are being introduced from 1 January This article summarises how the changes will impact on businesses while highlighting those areas in which VAT accounting and reporting systems will need to be updated. The changes to the cross-border VAT rules announced in the 2009 Budget represent a significant reform of the VAT regime applying to services. The Budget also introduces important changes to the intra-eu reporting regime for goods. These changes, adopted by EU finance ministers in February 2008 and December 2008, will: business. This is the case for both business and non-business customers. From 1 January 2010 the rules will be amended to ensure that, as far as possible, VAT is due in the country in which the service is consumed (ie where the customer is established) rather than where the supplier is established. The result for UK businesses is that they will be liable to account for UK VAT on most services provided by their overseas supplier under the reverse charge provisions, rather then the supplier charging VAT. Services provided to non-business customers will still generally be liable to VAT in the country of the supplier. The changes will be phased in on 1 January 2010, 1 January 2011, 1 January 2013 and 1 January Changes to the time of supply rules Currently, the time of supply (or tax point) for cross-border supplies is generally the time when the supply is paid for. However, if the supply is non-monetary, the tax point will occur at the end of the VATaccounting period during which the service is performed. Businesses must make fundamental changes to their current VAT accounting and reporting processes to be ready for the commencement date of 1 January i) modernise and simplify the current rules relating to cross-border supplies of services; ii) make the recovery of VAT on purchases made in other EU countries more efficient; and iii) help to counter VAT fraud. To comply with the new rules, businesses will need to make fundamental changes to their current VAT accounting and reporting processes to be ready for the commencement date of 1 January CHANGES OUTLINED IN THE 2009 BUDGET Changes to the place of supply rules The place of supply rules determine the country where a supply of services is made and where any VAT is payable. They also determine, in circumstances where VAT is due on a supply, whether it should be accounted for by the supplier of a service of their business customer. The current basic rule is that VAT is due in the jurisdiction in which the supplier has established their Following the changes announced in the 2009 Budget, as of 1 January 2010, the rules will be governed primarily by when the service is performed. The changes will be introduced by secondary legislation later in the year. HMRC is aware of the practical difficulties that the new rules may present and is informally consulting with business groups to minimise additional burdens while remaining consistent with EU obligations. New ESLs for services and changes to ESLs for goods UK VAT-registered businesses that supply services where the place of supply is the customer s country will be required to complete EC Sales Lists (ESLs) for each calendar quarter from 1 January These new rules will apply only to services for which the customer is required to account for a reverse charge in their country. These new rules will enable tax authorities to check that VAT is being accounted for correctly by the business receiving intra-eu supplies of services. September 2009 The In-House Lawyer 5

5 HMRC is aware of the practical difficulties that the new rules may present and is informally consulting with business groups to minimise additional burdens while remaining consistent with EU obligations. UK VAT-registered businesses that supply goods to other EU countries already submit ESLs. From 1 January 2010 new rules will: the previous four quarters. This threshold will be reduced to 35,000 (excluding VAT) with effect from 1 January i) reduce the time available to submit ESLs (ie ESLs will have to be submitted within 14 days of the end of the calendar for paper returns and within 21 days for electronic returns); and Changes to the procedure for obtaining refunds of VAT paid in other EU member states A new electronic VAT refund procedure ii) as an anti-fraud measure, require the monthly submission of ESLs where the value of the supplies of intra-community goods (excluding VAT) exceeds 70,000 in the current quarter, or any of will be introduced across the EU for all claims submitted after 1 January 2010 to replace the current paper-based system. From 1 January 2010 businesses established in the UK will submit claims for VAT incurred in other EU countries on a standardised form to HMRC through the UK Government Gateway, rather than direct to the member state of refund as at present. NEXT STEPS: WHAT SHOULD BUSINESSES BE DOING NOW? Businesses should firstly consider (or obtain professional advice to confirm), whether they will be affected by the changes. If the new rules are likely to apply to businesses, they should consider whether any changes or updates will be required to their accounting systems before 1 January 2010 to account for VAT under the reverse charge, and/or to capture the information needed to submit ESLs. Businesses should also consider obtaining the VAT registration numbers of regular business customers in other EC countries for the purposes of complying with these new rules. By Ian Reid, associate, Jones Day. ireid@jonesday.com. 6 The In-House Lawyer September 2009

Corporate Capital Gains: Degrouping Charges (Simplification)

Corporate Capital Gains: Degrouping Charges (Simplification) Who is likely to be affected? Groups of companies. General description of the measure Legislation will be introduced in Finance Bill 2011 to