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Business and Corporation
Tax
Small companies
Hidden away in the detailed text of the
Pre-Budget Report is a rather worrying reference to the government’s plans
for small companies. The Report summarised all of the reasons why many
businesses have chosen to incorporate over the last 18 months or so. It then
went on to say ‘the government is concerned that the longstanding
differences in tax treatment between earned income and dividend income should
not distort business strategies, or enable reductions by tax planning of
individuals’ tax liability’. Consequently, measures are planned for
introduction in the spring 2004 Budget to ‘ensure that the right amount of
tax is paid by owner managers of small incorporated businesses on the profits
extracted from their company’. We are not able to add anything further at
this stage but the uncertainty a statement such as this creates is not helpful.
We will of course keep you informed as soon as we learn anything further.
Corporation tax reform
Consultation continues with a view to:
- bringing companies’ capital gains into
an income regime
- considering rationalising and simplifying
the headings (‘schedules’) under which a company’s income is
taxed
- reviewing the differences in tax treatment
between trading and investment companies.
The government has identified two issues as
particular priorities for reform and intends to introduce legislation with
effect from 1 April 2004:
- reform of the rules on transfer pricing and
thin capitalisation
- the extension of relief to companies for
the expenses of managing their investments.
Transfer pricing
Transfer pricing rules require the market
value of transactions between connected businesses to be recognised for tax
purposes. Thin capitalisation is the excessive use of debt finance rather than
equity finance between connected companies Currently these rules only apply to
cross-border transactions.
Decisions of the European Court of Justice
have created uncertainty about the application of these rules and therefore the
government intends to extend transfer pricing rules to domestic transactions as
well. The thin capitalisation rules will be abolished and transfer pricing
rules will apply instead in the relevant circumstances.
The government
will introduce an exemption for small and medium-sized businesses. Small
businesses are ones with fewer than 50 employees and either turnover or assets
of less than about £7 million. Medium-sized businesses are ones which
have fewer than 250 employees and either turnover of less than about £35
million or assets of less than about £30 million.
A small or
medium-sized business will benefit from the exemption in respect of
transactions with related businesses that are in the UK or in a country with
which the UK has a double tax treaty containing a suitable non-discrimination
article.
All small and medium-sized businesses will be able to make
their tax returns without applying transfer pricing rules to qualifying
transactions with related businesses.
For medium-sized businesses
only, the Inland Revenue will have a power to require transfer pricing
adjustments in exceptional cases. There will be no equivalent power in respect
of small businesses.
Extension of relief to companies for the
expenses of managing their investments
Corporation tax relief for the expenses of
managing investments will be extended by lifting the requirement to qualify as
an investment company. This removes a restriction that creates difficulties for
some groups (for example, where there are companies which carry on both trading
and investment activities and may therefore fail to qualify as investment
companies under current rules).
At the same time, the government is
taking the opportunity to state in the draft legislation that capital
expenditure is specifically excluded from deduction as a management expense.
This will ensure that relief for the expenses of managing investments is
aligned with relief for trading expenditure.
Research and development (R&D)
expenditure
In 2000, an R&D tax credit was introduced
for small and medium-sized companies (‘SME tax credit’). This enables
SMEs to claim tax relief on 150% of qualifying R&D costs. Alternatively,
for loss-making companies, the credit may be surrendered for a cash repayment
equal to 24% of the R&D expenditure.
The scheme was extended to a
‘large company tax credit’ in 2002 which enables large companies to
claim tax relief on 125% of qualifying R&D costs but with no cash repayment
option. There has been consultation on widening the definition of R&D and
the government now proposes a number of changes to the schemes. Draft
guidelines have been published which:
- replace the current requirements for
‘novelty’ and ‘innovation’ with the need to show an
‘advance in science and technology’
- propose a new category of qualifying costs
to replace the current ‘consumable stores’, to include materials,
water and fuel consumed during the R&D and software used directly and
actively in the R&D.
It is also intended that the Inland Revenue
will publish guidance in support of the revised R&D definition.
Tax and accounting
International Accounting Standards (IAS) will
apply to certain UK companies from 2005. The Inland Revenue is continuing to
look at the detail of IAS and the complementary changes to UK Generally
Accepted Accounting Practice (UK GAAP). Legislation will be introduced to
ensure that accounts prepared in accordance with either IAS or UK GAAP will be
an acceptable starting point for computing taxable profits.
Professional fees and subscriptions
The government is consulting on what changes
can be made to the tax relief available for professional fees and
subscriptions, to support the provision of training and development across the
workforce and act as an incentive for professional bodies to expand their
commitment to skills.
In addition, it is suggested that the relief
should be targeted at those where business failures are most significant and
that a limit be placed on the overall relief.
Small and medium-sized company
thresholds
It is expected that the increased thresholds
will come into force in January 2004. The new thresholds will apply for
accounting periods ending on or after the date the regulations come into
force.
The thresholds are used to determine which businesses are
entitled to 40% first year allowances (FYA) on plant but no statement has been
made as to when the new thresholds will apply for FYAs.
|
Current small
company limits |
New small
company
limits |
| Turnover not more than |
£2.8m
|
£5.6m
|
| Balance sheet total not more than |
£1.4m
|
£2.8m
|
| Number of employees not more than |
50 |
50 |
|
Current medium-sized
company limits |
New medium-sized
company limits |
| Turnover not more than |
£11.2m
|
£22.8m
|
| Balance sheet total not more than |
£5.6m
|
£11.4m
|
| Number of employees not more than |
250 |
250 |
Capital allowances in Enterprise Areas
The government plans to introduce a 100%
capital allowance for the capital costs of renovating business premises in the
2,000 Enterprise Areas. The allowance, which is subject to state aid approval,
will apply to premises that have been vacant for a year and will take effect in
2005.
Venture Capital Trusts (VCTs) and the
Enterprise Investment Scheme (EIS)
The government is seeking to amend some of the
tax incentives in VCTs and the EIS in order to help commercial investors
provide access to growth capital for small businesses.
VCTs
VCTs invest in the shares of unquoted trading
companies. An investor in the shares of a VCT is currently exempt from tax on
dividends (although the tax credits are not repayable) and on any capital gains
arising from disposal of the shares. Income tax relief at 20% is available on
subscriptions for VCT shares, up to £100,000 per tax year, if the shares
are held for at least three years. Capital gains (up to £100,000 per tax
year) can be deferred into VCT investments.
The government is mindful
of the recent relative weakness in the VCT market and is in favour of providing
a less cyclically sensitive set of incentives for investors. It is therefore
considering:
- providing an additional temporary
improvement to income tax relief for a period of two years from 6 April 2004.
Its favoured option is to increase the effective rate of income tax relief from
20% to 40%, with the additional relief paid directly into the VCT for
investment in companies seeking finance
- increasing the upper limit for eligibility
for income tax relief from £100,000 to £200,000 in any single tax
year
- withdrawing, from 6 April 2004, the ability
to defer liability for capital gains tax (CGT) by investing in VCT shares
- in the long term, offsetting the effect of
withdrawing CGT relief by an enhancement, of equivalent value, to the level of
income tax relief for new subscriptions to VCT shares.
EIS
The EIS allows new equity investment of up to
£150,000 in any tax year in qualifying unquoted trading companies
(including AIM). Income tax relief at 20% is available on the investment and
capital gains tax exemption is given for shares held for at least three
years.
Furthermore unlimited capital gains may be deferred by
reinvestment in EIS shares. An added benefit is that after two years of
ownership EIS shares will qualify for business property relief for inheritance
tax purposes.
In line with the proposed increase in the upper
investment limit for VCTs, the government proposes to increase the upper limit
for eligibility for 20% income tax relief through EIS from £150,000 to
£200,000 in any single tax year, with effect from 6 April 2004.
Construction Industry Scheme (CIS)
reform
Special arrangements have been in place under
the CIS since 1972. Although the rules were revised in 1999 the government
considers that there is too much tax avoidance and non-compliance. The main
proposals were announced in the 2003 Budget and are to:
- replace Registration Cards and Gross
Payment Certificates with a verification service
- introduce an employment status declaration
- replace vouchers with periodic returns.
The original proposals were to be introduced
in April 2005 but implementation has been deferred to April 2006.
Childcare costs
New measures have been announced to take
effect from April 2005 as follows:
- extending the current workplace nurseries
tax exemption
- removing the requirement for the employer
to have management responsibility for the childcare provision
- a new matching tax exemption for childcare
vouchers
- a rule that where schemes operate they
should be open to all employees.
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