THE REFORM OF BUSINESS TAX

Transcription

1 THE REFORM OF BUSINESS TAX A suggested approach, which is applied in a review of current tax law for business David Martin OCTOBER

2 INDEX INTRODUCTION 3 TCGA CAA ITTOIA ITA CTA CTA

3 INTRODUCTION The tax base At present the UK has one of the most complex tax systems for business in the developed world. This paper argues that the main reason why this has happened is that we have a fragmented tax base with too many unnecessary tax rules. Capital gains are calculated separately from income, and income is split for assessment purposes into different categories. The capital allowances system sits uncomfortably within this framework. The rules for the separate categories are needlessly different - the timing of expenditure and the variations on the wholly and exclusively rule are just two of a very many examples that could be given. There is a complex set of rules to determine how profits and losses from different sources can or cannot be pooled together. Many more rules are unnecessarily ad hoc, lacking a sense of underlying principle. The first question to ask is - what are we actually trying to tax? This paper argues that tax on business should be based on the economic consequences of the transactions conducted by the business. The starting point for taxing a business is therefore simply to tax its profit. Case law now demonstrates that tax does not have a separate concept of 'profit' for its own purposes, so that if it is decided to have 'profit' as the tax base the starting point can only be accounting profit. But this paper recognises that small businesses should have simplified accounting procedures available to them to arrive at the starting figure of profit. Identifying the tax base in this way, rather than using the current fragmented tax base, provides the tax code with more secure foundations. The reasons for departing from the tax base to make particular adjustments should be easier to understand. The business world prefers the 'one-bucket approach' that is supported in this paper. This implies the pooling together of all gains and losses to produce a combined measure of profit or loss. Adjustments are still needed to the figure of profit to obtain the figure on which is tax is payable. But the report earlier this month published by the Office of Tax Simplification on competitiveness of the UK tax administration recommended that many sundry adjustments should be eliminated, particularly where the financial impact of such adjustments is small. This is a valid point to take just one example the law restricts the tax deduction available for car hire to 85% of the rental paid. But the restriction only applies to certain cars, and only applies to certain types of hiring, and complicated rules come into play where connected persons hire the same car. Having regard to the marginal 3

4 nature of the restriction and the complications that ensue is such a rule justified? This paper does not normally consider in detail the merits of such adjustments, but the review of tax law for business that this paper recommends should in due course extend to this. There are major advantages in aligning tax and accounting more closely. Tax becomes more accessible to the businessman who does not have specialist tax knowledge, the need for parallel tax accounts is reduced, and unacceptable tax avoidance becomes easier to identify and thus to counter with appropriate legislation. The tax code can be substantially improved as well as substantially reduced. It is often said that the reason why our tax is so complicated is because of a proliferation of reliefs. These reliefs are then exploited, and a cycle of HMRC antiavoidance measures followed by more sophisticated further avoidance by taxpayers ensues. While there is of course truth in this, the detailed examination of the tax code set out below confirms the diagnosis given above - actually the main cause of complexity is the fragmented and unsatisfactory tax base combined with too many ad hoc tax rules. This paper gives detailed consideration to the sections in the first six of the seven major Acts listed below to see what provisions remain necessary or appropriate under this approach (referred to as the 'one-bucket approach' or the 'suggested approach'). The Business Tax Act (abbreviated to BT Act ), published alongside this paper, is an attempt to show what a reformed tax code for business might then look like. The following major Acts apply to the taxation of business:- Taxation of Chargeable Gains Act [511 pages in Tolleys Tax] Capital Allowances Act [412 pages in Tolleys Tax] Income Tax (Trading & Other Income) Act [456 pages in Tolleys Tax] Income Tax Act [690 pages in Tolleys Tax] Corporation Tax Act [669 pages in Tolleys Tax} Corporation Tax Act [633 pages in Tolleys Tax] 291 sections and 12 schedules 581 sections and 4 schedules 886 sections and 4 schedules 1035 sections and 4 schedules 1330 sections and 4 schedules 1185 sections and 4 schedules Taxation (International and Other Provisions) Act sections and 11 schedules [261 pages in Tolleys Tax] 4

5 The numbers of sections and schedules mentioned above are only approximate because they do not take account of repeals or of new sections inserted after enactment. The seven Acts listed take a total of 3,632 pages in Tolleys Tax Handbook. Of course, not all the above sections and schedules apply to business profits, particularly in the income tax acts, which also apply to non-business matters. Further, a particular taxpayer will normally only be subject to either corporation tax or income tax, and so two of the above acts will not be directly applicable to that taxpayer. Nevertheless the total of 5,690 sections and 43 schedules is clearly indicative of an extremely long tax code that may be applicable to business. The definition of a business It is proposed that every activity undertaken by a company will be deemed part of a single business, save to the extent that the company is merely acting in a representative or trustee capacity, or acting as a director or other office holder. Following the introduction of the annual tax on enveloped dwellings ( ATED ) in 2013, any ATED related gain which is subject to cgt is also excluded from the tax on business profits described in this paper. A trade, profession or vocation, or most property business, or other commercial or profit making activity undertaken on a continuous basis by an individual or a partnership would also be taxed as a business. An 'adventure in the nature of a trade' is unlikely to have sufficient continuity to rank as a business, so that any profit or loss would be taxed or allowed in the tax category applicable to non-business activity. Following this approach profits and gains of individuals would therefore be taxed in three distinct categories - either as business profits, or earnings from employment, or as non-business profits. Further points concerning profit It has been argued in earlier papers published by the IFS, co-authored with Graeme Macdonald, that the 'one-bucket approach' should remove most distinctions between capital and revenue profits for tax purposes, (although some specific rules, such as roll-over relief for specified types of capital assets used for the production of goods and services, will still be required). Although in general the suggested approach should appeal to business, this point may not be so widely welcomed, because it implies that all business profits, whether income or capital, which are realised by individuals should be taxed at the same rate, and could also imply the withdrawal of the indexation allowance that is currently available for companies. Nevertheless, at a basic level, the concept of profit, be- 5

6 ing the amount that can be withdrawn from the business at the end of the year without leaving the business owner worse off than at the beginning of the year, seems to apply equally to capital as to revenue profits. Abolishing the distinction has for example been achieved for companies for intangible fixed assets, loan relationships and derivatives, and enables substantial rationalisation of tax law. There would be further substantial compensating benefits for both companies and individuals, however, in the pooling of income and capital receipts. For example capital losses could be pooled with revenue losses and utilised in the same way against all profits. (Of course, on the sale of the whole or part of a business by an individual a lower rate of tax given to entrepreneurs would still be appropriate. The distinction between the profit on a sale of a business and the profit realised by a business in the course of that business is already recognized in tax law.) With very few exceptions accounting profits determined in accordance with GAAP equate to realised profits under The Companies Acts. Profits realised in cash are therefore included, and the accrual of investment or other income is also normally included. A gain on capital assets should only normally be recognized for tax purposes on realisation, although in the case for example of financial assets it may sometimes be appropriate to recognise fair values for tax purposes, even if the asset has not been sold. Depreciation and impairment of an asset should be deducted as a cost, even though there is no realisation of the asset. It is proposed that, in accordance with the more accounts based approach, that the capital allowances system should be abolished in favour of giving tax relief for accounting depreciation see the discussion below under the Capital Allowances Act The annual investment allowance could still be retained to give immediate 100% tax depreciation for appropriate assets, upto an annual limit of expenditure, and indeed tax depreciation could also be granted at rates that differ from accounting depreciation on defined assets, (as is currently possible for intangible fixed assets), without undermining the basic approach. Accounting rules for impairment are given in IAS 36 and FRS 102, and seek to ensure that an entity's assets are not carried at more than their recoverable amount (i.e. the higher of fair value less costs of disposal and continued value in use). To introduce a general tax relief for impairment will be generous to the taxpayer compared to the current situation where a loss is only normally recognized in relation to a capital asset if there is a disposal of it, or a claim that it has become of negligible value. In some circumstances however giving tax relief for impairment may be too generous, for example in relation to debts due from a connected party, or shares issued by a connected company, (and sections O15 - O16 in the BT Act restrict relief accordingly.) Giving tax relief for depreciation or impairment produces an asymmetry for tax purposes, in that unrealised gains are not in general taxed whereas losses on as- 6

7 sets can be allowed for tax purposes, even though no disposal has occurred. This point is often debated, and it is not the purpose of this paper to make a detailed contribution to this debate. It is simply noted that the purpose of depreciation is not to measure a fall in value of an asset, but to allocate the cost originally incurred on the asset to accounting periods as the asset is consumed in earning profit. It is not correct to regard depreciation, or even impairment, as simply the converse of an upwards revaluation. There are many other well-known arguments, such as tax capacity, volatility, and certainty of measurement, for taxing gains on capital assets on realisation - this is the current position of course, and also reflects the approach taken for trading stock. It is likely, in fact, that there is a wide measure of agreement concerning these proposed basic features of taxable profit, even though current tax law does not have any general rules permitting tax relief for depreciation or impairment of capital assets. It is not intended to underestimate the difficulties which have been experienced in deciding what should be the taxable profit following the introduction of International Financial Reporting Standards ('IFRS'), particularly in relation to financial and derivative instruments. There are serious concerns which go beyond the issue of taxation, illustrated for example where a company in financial difficulty can realise a profit by reducing the value of its own indebtedness, or by the Lloyds TSB case (heard in the Supreme Court in 2013) concerning whether an unrealised gain on acquisition should really be treated as a profit. It has been questioned whether IFRS can enable banks to overstate their profits - although of course the tax- man may benefit from this. Life would certainly be easier from the point of view of basing the tax computation on accounts and on realised profits if the historic cost method of accounting, based on transactions rather than valuations, had continued to be generally applied. Nevertheless the fact of IFRS has already been addressed in tax legislation. The adjustments necessary to recover realised profits from accounts which may show fair values for certain assets, such as 'available for sale' financial instruments (including equities) within IAS 39, or investment properties within IAS 40 are referred to below. Para 1 of Part D to the BT Act provides that fair value accounting does not apply to certain assets that are, under tax law, dealt with on an historic cost basis. The convergence between IAS and UK GAAP, particularly following the introduction of FRS 102 which will occur in January 2015, helps in this connection, because the starting point of accounting profit is more likely to be the same for different businesses undertaking similar transactions. FRS 102 is short (under 350 pages long), reflecting the simplified accounting requirements and substantially fewer disclosures that are relevant to its expected users - those not required to apply full IFRS. The UK GAAP rule-book was previously close to 3,000 pages. This paper has not addressed the impact that the separate accounting standard for smaller entities ('FRSSE') may have on tax liabilities under a more accounts based approach for companies that use it. The differences which might emerge between the tax position of smaller entities and other entities using the accounts based approach need to be identified and any problems resolved. It is nevertheless expected 7

8 that this issue can be resolved without undermining the approach as a whole. For very small businesses further relaxations from the strict requirements of GAAP would be appropriate, as is the case in some overseas jurisdictions - see below. It is also recognised that the concept of profit for accounting purposes may be subject to amendment and refinement as accounting rules are refined. At present tax law for trades is automatically linked to changes in accounting rules, and an amendment to tax law is required to opt out of what would otherwise be the tax consequences of an accounting change. This ad hoc approach seems to work satisfactorily in practice. But it is noted that both under current tax law and under the tax law which is proposed in this paper the effect of many accounting changes would already be eliminated. This is because, for example, there would be specific tax rules for calculating the taxable gain on shares, which would apply irrespective of IAS 39 or any changes in IAS 39. Impact on tax law This paper seeks to identify where tax law can be rationalised and improved using the 'one-bucket' approach. It is considered that these changes can be achieved without sacrificing other important policy objectives. It should be understood of course that the exercise carried out in this paper is only a 'first stab', and there will undoubtedly be errors and inconsistencies. Transitional rules would be a major issue, but have not been considered in this paper. Certain specialised businesses, such as insurance or oil businesses, are also outside the scope of this paper. The intention, however, is to set out (even though approximately) in the BT Act how tax law might appear if the approach embodied in this paper is pursued. It is considered that the revised law would be straightforward, coherent and comprehensible in a way that current legislation is not. The revised law would also be very much shorter. Compliance costs for business should be significantly reduced. Losses Current law generally permits the offset of revenue trading losses against other income on a current year basis, although there are some restrictions, such as the restriction against using miscellaneous losses, (which would have fallen within the old Case V1 of Schedule D), against other income. Losses carried forward, however, can only normally be set against profits derived from the same source. Capital losses can only be set against current or future capital gains. Under the 'one-bucket approach' all profits and losses are pooled. However it would seem appropriate to have some restriction on the utilisation of losses carried forward. This is because without restriction it would be possible for example to carry forward a loss attributable to a trading activity and set it against future investment 8

9 income, even if the trade had by then ceased. Where a company has realised a trading loss, and the trade ceases, the company might then acquire some safe investment so as to receive the income from the investment tax free by reason of the brought forward losses. It is therefore suggested that with the introduction of the 'one-bucket approach' losses should cease to be available for carry forward if there is a major change in the nature or conduct of the business, even if there is no change in ownership of the business. There is justification however for current year offset of losses from one business activity against profits of another business activity, because the losses may put the profitable activities at commercial risk. Anti - Avoidance If there is a comprehensive tax base, under which all receipts are brought into the charge to tax, without distinguishing between income and capital receipts, it is possible radically to simplify anti-avoidance tax legislation. Because the starting point is simply to tax all profit, avoidance will normally either be the diversion of profit to some person or entity that is taxed at a lower rate (such as a non-resident), or the exploitation of a relief in a way which would not have been intended by Parliament (and many rules for giving a tax relief already include a bona fide commercial test). But the manipulation of a taxpayer s affairs to exploit the complex web of rules connecting the various elements of the tax base would no longer take place. The 'one-bucket' approach promotes neutrality, since a profit is more likely to be taxed in the same way no matter how it is realised. Further, the doctrine of substance over form is well established in GAAP, whereas from the time of the Duke of Westminster case, tax law has struggled with this concept. At present complex anti-avoidance rules have been supplemented by a lengthy general anti-avoidance rule (a GAAR'). But a very much simpler GAAR might be appropriate following implementation of the suggested approach. It might simply counteract any steps taken to reduce a tax liability in any accounting period wholly or mainly for tax reasons, where it would constitute an abuse of the tax system to permit the taxpayer to succeed in his objective. A suggestion for such a GAAR is included at the beginning of Part P in the BT Act. It would be similar in many respects to the general anti-avoidance rules currently applicable to certain accounts based provisions separately drafted for loan relationships, derivatives and intangible fixed assets. It might be objected that such a simple general rule would be uncertain in its application. It is certainly true that it would take the courts time to work out which schemes constitute an abuse and which do not. But the one-bucket approach based on taxing accounting profit should help reduce the circumstances in which 9

10 the GAAR might need to be applied, and help the courts identify where tax has been underpaid - whether by reason of inadequate accounts or an abuse of tax law. It is submitted that this would result in an improvement on the current situation, where taxpayers search for ways to circumvent lengthy and detailed avoidance rules, and indeed they are almost encouraged to do so by the nature of these detailed rules. The purpose of the rules can be obscured by their complexity. And the large number of detailed rules does not sit comfortably with the general antiavoidance rule that has now been added. It has become clear with the introduction of codes of practice for banks, naming and shaming for taxpayers etc that the tackling of avoidance through complex legislation has not succeeded. But we should try hard to recover a straightforward legal basis for dealing with avoidance. Small businesses This paper and the BT Act being published today are intended to demonstrate that business tax law could be very simple for small businesses. It would of course be a necessary prerequisite that accounts are prepared for the business. Although accounts for most small businesses would be very straightforward the relaxation of strict accounting requirements would still be appropriate. For example the existing practice of allowing three line accounts for most small businesses would be continued, and be expressly sanctioned in the legislation. A business which is not involved in complicated financial products, or does not indulge in artificial tax avoidance, or have overseas sources of income or is not owned within a group of companies, need only concern itself with a small part of the revised code - namely Parts A-E of the BT Act (which could perhaps be published separately for the use of small or 'straightforward' businesses). Even if one of the more complicated issues might apply to the business, it should be much easier to find and apply the relevant provisions in a reformed code than under existing tax law. A key advantage with this approach would be that, as small businesses became larger, they would not become subject to a different code, it is just that more provisions might apply to them. Complexity in tax law cannot of course be eliminated, but it is appropriate to separate out the more complex law to subsequent Parts of the BT Act, so that only larger and more sophisticated businesses, which can cope more easily with such law, need to be concerned with it. Following reports by the Office for Tax Simplification a small business may now be taxed on a cash basis rather than an earnings basis, should the business make an appropriate election. A number of supplementary rules are still necessary for tax purposes where the cash basis is used. Moreover accounts prepared on a cash basis may need adjustment for other non-tax purposes, such as a claim for benefits, or an application for a loan from a bank. It is also likely that a decision whether to make an election may often be made on financial grounds rather than on grounds of simplified taxation. And it is not clear that this change has really produced simplification. 10

11 Perhaps the key question is, what is the taxpayer who elects for the cash basis electing out of? The basic tax regime for business needs to be settled first. As a first step it seems logical to consider how the basic tax regime for business might be reformed, and simplified. The outcome would appear to be a system in which there is no need to elect out of it for the sake of having simpler tax affairs. The cash basis is not reproduced in the BT Act. Dividends Broadly individuals are liable to tax on distributions received, but have the benefit of an associated tax credit, and broadly (although very complex rules have recently been introduced) companies are usually not taxed on distributions received. UK companies do not obtain tax relief for the payment of dividends, as dividend payments are seen as an appropriation of profit, rather than an expense incurred to earn profit. This is in contrast to the tax treatment of interest, which is tax deductible for the payer and taxable on the recipient. The rules for the taxation of dividends could be very substantially rationalized and simplified if the tax treatment of dividends were more closely aligned with the tax treatment of interest. There are commercial reasons for such an approach. The tax advantages of debt over equity are widely understood, as is also the fact that this has encouraged companies, and banks in particular, to be too thinly capitalised. But proposals to level the playing field by disallowing tax relief for interest (as eg per the Hall/Rabushka flat tax) do not look sound for a sophisticated economy like the UK. Why, for example, should businesses be obliged to rent assets rather than borrow to purchase assets for tax reasons? But the problem could be approached from a different direction - by giving tax relief for paying dividends as well as for paying interest, and taxing everyone on dividends received. Dividends would be paid subject to withholding tax of 20%, in the same way as normally applies to interest. As the rate of corporation tax comes down to 20% it turns out that this produces an elegant tax solution to many issues, such as the double taxation of company profits, and taxing businesses in a similar way whether or not they are incorporated. It is noted that the overall tax payable would not be changed under this proposal in relation to dividends that flow through companies to individuals and to other companies, unless some of the persons concerned are realising losses on other transactions. 11

12 Of course some detailed questions arise - should pension funds be able to reclaim all the withholding tax on dividends, or should there be a minimum non-refundable element of the withholding tax to protect Treasury receipts? The EU parent/subsidiary directive would need to be amended (in the same way that it has been for Greece and Germany). But would other overseas controlling shareholders have their UK tax burden reduced too much under existing UK tax treaties? But the degree of simplification of existing tax rules, attempting to distinguish and police the boundary between interest and other forms of distribution, would be very great. For the time being however the BT Act merely reproduces the law as it is. Part G and Schedule G of the BT Act reflect the current tax code for dividends and other distributions, even though these very complex rules extend to approx. 15% of the BT Act. The difference in tax treatment for dividends received is the only substantive difference remaining between individuals and companies under the suggested approach in this paper. Drafting points It can often be difficult to see the wood for the trees in tax law as currently drafted. In the Business Tax Act detailed material, or material that is likely to be less often referred to, is therefore presented in schedules. While it is true that a short clause is not necessarily easier to comprehend than a long clause, it often appears that a tax rule can be more economically expressed without loss of intelligibility. Indeed the tax law re-write project has in places much expanded the drafting - for example sections CTA replace just one section, section 780, in ICTA 1988, without commensurately aiding comprehension. And it is not necessarily true, as a general proposition, that more words will reduce ambiguity, since most words are ambiguous to some extent, and the process of trying to eliminate ambiguity with more words can therefore be never ending. A compromise must often be made, and in this paper it is often considered that a shorter statutory provision is in practice better than a longer one. Very often small changes have been made to conform with this approach when it has not seemed necessary to make express reference to the change in the commentary. Clauses which provide overviews or rules for priorities have not generally been reflected in the BT Act, because they may not reflect the way that tax law is actually used - those wanting to check a point will normally seek the relevant section, and hope to find all relevant cross references there. A separate exercise would be required to review current regulations, and their possible application under the new approach. There is no cross reference given to Regulations in the current version of the BT Act. Because the tax code has developed piecemeal over a long period it contains a large number of inconsistencies. For example there is a rule for what to do where 12

13 accounts are not GAAP compliant for intangible fixed assets, a separate one for loan relationships and another one for derivative contracts, but no general rule applying to trades or to property businesses. The rules for changes to accounting basis appear needlessly different for trades and property businesses. There are very many examples of this issue, and in the BT Act the various different wordings have been merged. Transitional Provisions If the suggested approach were to be found attractive the hugely important issue of transitional provisions would still need to be addressed to determine whether implementation would be worthwhile and practicable. This paper does not address this question. One would need to decide the extent to which transitional provisions should ensure a complete reconciliation of taxable profit moving from the old regime through to the new regime, or the extent to which the new regime should be regarded as a new tax, starting with a clean break from the old regime. In practice a compromise between these two approaches would be likely. For example, it is likely that existing capital allowances pools should be dispensed with, and ordinary depreciation used for future tax purposes, without attempting to join up the tax written down value of an asset under the old regime with its depreciated carrying value under the new regime, unless the asset has tax carrying value of nil because of the annual investment allowance. The new law should not for example result in a company being deemed to dispose of a capital asset acquired from another group company simply because the first company is deemed to leave the group under any revised definition of group. A key issue would be the treatment of losses brought forward - some restriction is likely to be appropriate in future as briefly discussed above (and addressed in more detail below). It may also be necessary for example to restrict the utilisation of capital losses brought forward under the old tax law to set only against future capital gains, and perhaps the carry forward of such losses should cease after a transitional period. Further work would clearly be needed on this issue, but there would be much to be said for a short transitional period that left some scope for taxpayers and HMRC to agree minor points on a just and reasonable basis, which would have to be resolved if necessary by the tribunal in the absence of agreement. TAXATION OF CHARGEABLE GAINS ACT 1992 An analysis of the TCGA 1992 in relation to a more accounts based approach to business tax for companies was first published in British Tax Review in 2005 (coauthors Graeme Macdonald and David Martin). 13

14 The analysis in that article is used below in a review of the Taxation of Chargeable Gains Act 1992 to see how in the light of a more accounts based approach it might be simplified and rationalised for businesses generally. Although, as has been argued in that article, accounts do not reflect the tax distinction between 'capital' profits and 'revenue' profits, and the tax distinction should in general no longer be made, some issues arise in connection with the taxation of capital assets that have particular importance with a more accounts based approach. A 'capital' transaction is perhaps more likely to be a 'one-off' transaction, opening the possibility of the taxpayer choosing an accounting treatment or policy with that specific transaction in mind so as to minimise tax. Gains or losses may be more substantial than those that arise on trading assets. Nevertheless, as mentioned above, a more accounts based approach has been introduced in relation to loan relationships, derivatives and intangible fixed assets, which ignores the distinction between capital and revenue, and which has been broadly successful. This has demonstrated that one does not need most of the numerous separate rules contained in the Taxation of Chargeable Gains Act 1992 in order to tax these assets. The code for intangible fixed assets, first introduced in Schedule 29 to the Finance Act 2002, is perhaps the most comprehensive of the three. This can be used as a basis for taxing capital assets in general where it would apply in an appropriate way, and any provision in the Taxation of Chargeable Gains Act 1992 can be dispensed with. Thus, for example, profits are in general charged on a realisation, and, In line with the intangible fixed asset rules, upwards revaluations of assets in the accounts should not be subject to tax unless they reverse depreciation for which tax relief has previously been given. Broadly maintaining the position that gains are normally taxed on a realisation basis is particularly important in relation to accounts prepared under International Accounting Standards, which has more assets subject to revaluation than was the case under earlier standards. Thus in the analysis that follows some of the rules set out for intangible fixed assets are applied to all 'capital' assets, with savings and additions for certain assets or situations that need to be separately addressed, such as share reorganisations, value shifting, etc. The intangible fixed asset rules at present apply only to companies, but under the suggested approach the same tax rules for obtaining taxable business profits would normally apply to both companies and individuals. There are also many sections in the Taxation of Chargeable Gains Act 1992 which appear more appropriate for individuals in a non-business context. These provisions can be omitted. Section 1 Section 1(1) provides that tax is to be charged on chargeable gains computed in accordance with this Act accruing on the disposal of assets. 14

15 There is no general definition of the word 'disposal' in the legislation, although there are some specific rules, for example that a transfer by way of security is not a disposal. There are also some rules for deemed disposals, which occur for example on the receipt of a capital sum derived from an asset, or when a person becomes absolutely entitled to settled property. In general however 'disposal' is taken to have its ordinary dictionary meaning of 'transferring' or 'alienating' or 'getting rid' of something. Although the basic meaning of 'disposal' seems to deny the possibility of anything between owning an asset and not owning it, a part disposal may occur if part of the asset ceases to be owned, and (by section 21 - see below) there is a part disposal where an interest in or right over the asset is created by the disposal. In the modern commercial world there is a spectrum of possibilities for the ownership and for dealings in an asset. An asset may, as a legal matter, be owned by a financier, but the risk and reward in the asset falls on a different person who is using the asset. Finance leasing and hire purchase contracts are treated quite differently under existing capital gains law, even though their financial effects may be very similar. Sales with rights or obligations to repurchase, limited recourse financings, sales where the seller retains some risk in the value of the asset, effective sales achieved through the making of a derivative contract rather than a disposal of the asset itself etc. also need to be addressed in the tax code. In the face of these possibilities, which are widely debated in the accounting context, the tax concept of 'disposal' in capital gains legislation can appear somewhat crude. The corresponding accounting question, addressed by FRS 102, is whether an asset should be 'derecognized'; a 'disposal' therefore occurs for accounting purposes when the asset is derecognized. FRS 102 confirms that the entire asset should cease to be recognized when all significant benefits and risks relating to the asset have been transferred. An example illustrates how the accounting analysis works. If a company sells an asset and agrees to compensate the purchaser for any subsequent loss in value up to 2% of the purchase price it is necessary to decide whether the risk retained is significant in the context of the total realistic risk that existed in the first place. If the asset is a volatile one, with big fluctuations in value likely, the seller would have disposed of the significant risk in the asset, whereas if the asset is likely to retain its value, holding it was not particularly risky in the first place, and so most of the risk will not have been removed. It will be noted that this result, although logical, is not necessarily what is expected since it is more likely that the obligation will be called on in the example of the volatile asset. In this latter case however the seller would simply provide for any expected loss under the guarantee in measuring the profit on the sale. Although this is a large subject and a full discussion is not possible in this paper, it is relevant to note that since the profits of sale of trading assets are already determined by GAAP the FRS rules are already applied for tax purposes. They apply in relation to consignment stock for example. They are also applied in relation to in- 15

16 tangible fixed assets by virtue of section 734 CTA 2009, which provides that a realisation occurs for tax purposes of such an asset when as the result of a transaction, and in accordance with GAAP, the asset either ceases to be recognized in the balance sheet or its carrying value in the balance sheet is reduced. The accountants analysis of when an asset is to be derecognized is therefore more sophisticated than the tax concept of disposal. HMRC would have cause to be worried if adopting the accounts concept generally would lead to widespread manipulation, such that a sale is not recorded (so that no profit is realised) by means of the artificial retention of some risk or benefit in the asset. This issue may perhaps be of less concern to the extent that IAS concepts allowing or requiring partial derecognition will apply in future. The basic point, however, is that there seems no need, conceptually, to determine a charge to tax by reference to whether an amount received is capital or revenue in nature, or whether the amount received is for a disposal (or deemed disposal) of an asset. It seems more appropriate merely to ask whether a profit has been earned, and to take GAAP as the test for this, for 'capital' as well as 'revenue' items. It is suggested therefore that section 1 is inappropriate for the revised tax code for business tax, and it does not appear in the BT Act. Section 2 This section defines the persons and gains subject to capital gains tax, and sets out the basic rule for allowing losses. This section is not required in the BT Act, which applies to all businesses, and which (in general) pools all gains and losses (whether capital or revenue) together for tax purposes. Section 2A Repealed Sections 2B- 2F The Finance Act 2013 introduced a new charge, the annual tax on enveloped dwellings ( ATED ), which applies to a non-natural person (typically a company) that owns a single dwelling valued at more than 2m. On a disposal of a property which has been subject to ATED, some or all of the gains or losses will be ATED-related. The fraction of the gain that is ATED-related will normally be the number of days which were chargeable days for ATED purposes as a fraction of the total period of ownership. This gain is subject to cgt at the rate of 28%. 16

17 Sections 2B 2F, together with section 57A and Schedule 4ZZA(see below), define the person chargeable and the amount of the gain chargeable. It is considered that ATED is a charge that should fall outside the business tax code in the BT Act, and that accordingly the ATED related gain that is subject to the special cgt charge, (which would apply in the case of companies instead of the usual charge to corporation tax), should also fall outside this code. Section D8 in the BT Act reflects this proposal. Section 3 This section provides for an annual exempt amount for cgt purposes, and Schedule 1 applies the section to trustees. The section and the schedule are not required for the BT Act, since no separate annual exemption would be appropriate for capital gains. Section 3A This section provides relief from the obligation to report small gains in a given year of assessment. This is not appropriate for the purposes of the BT Act - the accounts will reflect all transactions that have occurred, and it would be a complication rather than a simplification to extract small transactions. Sections 4, 4A and 4B These sections set out the rates of cgt, and the rules for deducting losses from gains subject to tax at different rates. They would not required under the suggested approach, where the same rate of tax would apply to all profits and gains. Sections 5-7 Repealed. Section 8 17

18 Chargeable gains are computed for companies for an accounting period after deduction of allowable losses arising in that period or brought forward from earlier accounting periods. In the paper, 'Tax and Accounting: a Response to the 2003 Consultation Document on Corporation Tax Reform', (Macdonald and Martin), it was suggested that the full pooling of capital losses with revenue losses is to be preferred to the segregation of capital losses. There may be natural concerns that this would be expensive for the Revenue to concede, but it would appear to be fair as between taxpayers. It will be noted that this result already obtains for example for intangible fixed assets held for the purposes of a trade. A particular concern for the Revenue would be that a taxpayer would have a tax incentive to realise losses on assets in respect of which a loss has accrued but to retain other assets in respect of which a gain has accrued. Avoidance legislation might be appropriate to address this possibility, which could take many forms. A loss might therefore be disallowed or postponed if the sole or main reason for a disposal was the realisation of a loss for tax purposes, or there might even be a form of compulsory 'rollover' of a loss to prevent the realisation of a loss if a replacement asset were purchased within a defined period of time. But it should also be noted that if depreciation and impairment were normally allowed for tax purposes, there might be less need for anti-avoidance measures, since the loss would be allowable irrespective of realisation. This section does not therefore appear in the BT Act. Further consideration should however be given to anti-avoidance measures. Section 9 Repealed. Sections 10, 10A, 10AAand 10B These sections define residence and the scope of the charge to tax on capital gains for non-residents. No separate rules would be needed for capital gains under the suggested approach, and the sections are therefore amalgamated with section 6 ITTOIA 2005 and section 5 CTA 2009, all these sections being modified to refer to a business being conducted in the UK rather than a trade. 18

19 Section 10 applies to individuals trading in the UK through a branch or agency, while section 10A refers to a company trading in the UK through a permanent establishment. Section 6 ITTOIA refers only to a trade carried on in the UK, and section 5 CTA 2009 refers to a trade carried on through a permanent establishment. These variations should be eliminated, and it is suggested that the requirement for a permanent establishment should be adopted. A very important issue arises in connection with taxing gains realised by nonresidents on the sale of property held in the UK. The Treasury has recently completed a consultation on this. It is noted that the leasing of a UK property should not of itself constitute a business conducted in the UK through a permanent establishment under the OECD treaty definition. This means that special law would be required to tax a gain on a property accruing to a non resident, whether under current law or under the suggested approach. Overseas jurisdictions commonly tax non-residents on the sale of land located within their jurisdiction, and there seems ample justification for the UK doing so as well. But since this topic is currently being debated, (and it may be that widely held property funds would escape any charge), no special changes are proposed in the BT Act at this time. [Merged with section 6 ITTOIA 2005, section 5 CTA 2009.] BT Act - section M2. Section 11 This section applies specifically to visiting forces and official agents. It is not needed for the revised code of business tax. Section 12 This section applies to non- domiciled individuals to whom the remittance basis applies. The rules for the remittance basis for charging capital gains of a business would be merged with the rules for charging income of a business in the relevant sections of Chapter A1 Part 14 ITA These rules do not however serve to determine the profits of the business which are charged to tax, but the liability to tax on those profits for certain non-domiciled individuals. It is suggested that all rules for charging tax on individuals should be located in one place, which should not be in the code for business tax. Section 12 is not therefore reproduced in the BT Act. 19

20 Section 13 A proportion of a gain accruing to a non resident company (which would be close if it were UK resident) is attributed to a UK resident (including a company) that is a participator in the overseas company, the proportion corresponding to the extent of the participator s interest in the overseas company. The charge does not apply unless more than one quarter of the gain is apportioned to the participator (and persons connected with him). There are certain other exemptions, including where the gain is on the disposal of an asset used for the purposes of a trade outside the UK. It will be noted that this provision confers a substantial advantage on a UK resident open company that has an overseas subsidiary that realises a capital gain compared with a UK resident close company that similarly has an overseas subsidiary which realises a capital gain. This is because the CFC legislation does not apply to capital gains realised by overseas subsidiaries. This paper argues that 'capital gains' should not be distinguished in principle from 'income gains', since they are each just profit. If the CFC rules were extended to capital gains then the CFC gateways would apply in a similar way for all overseas profits, which would appear reasonable. This is a big subject, but the above analysis suggests that serious consideration should be given to abolishing section 13 and including capital gains in the scope of the CFC legislation. The section does not appear in the BT Act. Sections 14-14A These sections elaborate on how section 13 operates for non-resident groups of companies and for non-uk domiciled individuals. Given the comments made above concerning section 13, these sections have not been included in the BT Act. Section 15 Only chargeable gains (and not all gains) are charged to tax. 20

21 This point is addressed in detail in relation to those sections that define certain gains not to be chargeable gains. Examples are betting winnings (section 51(1)), compensation for personal or professional injury (section 51(2), interests in settled property (section 76), gilt-edged securities and qualifying corporate bonds (section 115(1)), savings certificates (section 121(2)(a)), certain contractual savings schemes (sections 151 and 231(4)), policies of insurance (sections 204(1), 210(1)-(2)), certain pension and annuity rights and annual payments (section 237), woodlands (section 250), debts (section 251), gifts for public benefit (section 258), chattels (section 262), passenger vehicles (section 263), and decorations for valour (section 268), This section is there for drafting purposes, since it would have been possible merely to provide for the exemption in the separate sections. If a separate capital gains code were abolished for companies this section would no longer be required, particularly in circumstances where the number of exemptions had been reduced. Each separate section that provides for each exemption is all that is required. Section 15 is not reproduced in the BT Act. Section 16 Similarly only allowable losses (normally losses arising in such circumstances where a gain would have been a chargeable gain) are deductible for tax purposes. Again, this point is discussed in detail in relation to the sections concerned. Again, this section would cease to be necessary if the separate capital gains code were abolished for companies. The section does not appear in the BT Act. Sections 16ZA, 16ZB, 16ZC, 16ZC These sections provide for an election to be made to enable foreign capital losses of non-uk domiciled individuals who are liable to tax on a remittance basis to be allowable losses. In view of the comments made in relation to section 12 above these sections are not included in the BT Act. Section 16A This is an anti-avoidance section that denies relief for a loss realised in connection with arrangements entered into to secure a tax advantage. 21

22 This section can be amalgamated with other similar sections in the tax code, and is not required separately to deal with capital losses. [Merged with sections , , 864, , 1248 CTA 2009.] BT Act - section P1. Sections An acquisition or disposal of an asset is deemed to be made for a consideration equal to market value in specified circumstances where the transaction is not a bargain at arm s length, or made for a consideration that cannot be valued or in connection with an employment. By section 18, a transaction between connected persons is deemed not to be a bargain arm s length for this purpose. It is relevant to consider how this section compares with Part 4 to the Taxation (International and Other Provisions) Act 2010 (which are the general provisions for transfer pricing)) or Chapter 13 Part 8 CTA 2009 (which are the provisions for deeming market value consideration in relation to transfers of intangible fixed assets). Part 4 provides a code for removing a tax advantage from a provision in a transaction between parties having a defined connection that differs from the arm s length provision that would have been made between independent enterprises. However small or medium-sized enterprises are normally exempted from these rules. Chapter 13 provides that, on the transfer of an intangible fixed asset from a company or to a company from a related party, the transfer is deemed to be for a consideration equal to market value for tax purposes. A person is 'related' if (broadly) that person controls the company or has a major interest in the company, or if the company controls or has a major interest in the person, or if a third party controls both the person and the company. 'Major interest' and 'control' are defined in a similar way as for Part 4. Chapter 13 does not apply, however, if the consideration for the transfer falls to be adjusted under Part 4, or falls within the scope of that schedule even if no adjustment is required under that Part. Chapter 13 does not apply either to override any specific provision in the intangible fixed asset legislation which deems a transfer to be for a tax neutral consideration. There is no market value substitution in either Part 4 or in Chapter 13 in relation to disposals to an employee. Suppose, for example that a company has a capital asset with a base cost of 100, but which is worth 1,000 when it is transferred to its employee. The employee is taxed on 1,000. It is submitted that the employer should be in the same tax position as if it had sold the asset for 1,000 (realising a 900 profit) and then paid the employee 1,000 (obtaining a tax deduction of 1,000), i.e. a net tax deduction of 100. This would appear to be the result without any deeming provisions since the accounts should reflect a net 100 charge in P&L. If the dis- 22