Author Archives: Graeme Blair - Partner

About Graeme Blair - Partner

T +44 (0)20 7874 8835

Graeme helps guide businesses through the corporate tax world. He is particularly expert at issues that property companies and professional practices have to navigate and therefore often manages large and complex assignments, many of which have an international element.

As a client of Graeme's wrote "I am increasingly impressed that when I pick up the phone to Graeme I receive robust and appropriate advice."

Following on from my previous blog and the issue of alphabet shares discussed there, HMRC have revisited Entrepreneurs’ Relief and amendments were made to the Finance Bill as it made its way through Parliament. This softened the effects of the restrictions that were originally proposed in the Budget. The Finance Act received Royal Assent on 12 February 2019 and these revisions are now final.

Equity Holders

Under the new rules introduced by the Finance Act 2019 an individual would need to be an ‘equity holder’ to obtain Entrepreneurs’ Relief on their shares. An equity holder is a term which is rather wider than holders of ordinary share capital and includes holders of convertible loan notes, or debt securities with equity like characteristics. So a holder of ordinary share capital could have found their entitlement was diluted below the 5% threshold when other rights were taken into account. Additionally the rights of the ‘equity holder’ are not restricted to checking that they have at least 5% of the ordinary share capital which controlled at least 5% of the voting rights. The 5% test is extended to considering the individual’s entitlement to the distributable reserves of the company and assets on a winding up of that company.

Alphabet Shares

These changes cause difficulties when there were different classes of shares – alphabet shares – which are often used to declare dividends between different classes of shareholders at different rates. Entrepreneurs’ Relief would not have been available if these new rules had been introduced without change as the discretionary levels of dividend would have meant that shareholders would not have had a guaranteed entitlement to 5% of the company’s distributable reserves.

This proposed change was not withdrawn. Instead, an additional and alternative, 5% test has been introduced which softens the impact of the change. The legislation looks at a shareholder’s entitlement to the proceeds if the whole company were sold, including a liquidation as well as a sale. One important difference here is that this test is applied as a snapshot considered at the date of the sale/liquidation rather than throughout the whole share ownership period. So in the case of alphabet shares, it would be possible to vary entitlement to dividends throughout the holding period, but provided the shares rank equally on a sale/liquidation and the holder is entitled to 5% of the assets of the company on a winding up then Entrepreneurs Relief is available. This revision only considers ordinary share capital, so the rights of other ‘equity holders’ are disregarded when considering this.

The revision could be beneficial to management in situations where outside investors have a preferential right to proceeds in the event of a sale of the company. At the beginning of trading, when the company holds little value, the preferential rights would mean that an ordinary shareholder (i.e. management) may not be entitled to 5% of the sale proceeds. However, as the company increases in value, the ordinary shareholder’s entitlement increase. If the company is then sold, the two year qualifying holding period will begin on the date of the first acquisition of the shares, but the test as to whether it is his qualifying personal company would only be applied on the date of disposal when the 5% test will be satisfied.

Clients should still review their position as shareholder and their company Articles. to see if they satisfy this new test now that the rules have been finalised but this is a welcome relaxation of the original proposals.

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James Hallett’s excellent blog on preparation for a No Deal Brexit highlights some of the practical consequences which should be considered by 29 March. James highlighted practicalities for import/export and financial reporting.

Group structuring and group cash flows may also be impacted by a No Deal Brexit.

Group structuring

Some EU countries’ domestic legislation provides specific reliefs if the counter-party is in the EU. These reliefs may have been relied upon for past transactions and reorganisations. As the UK may no longer be classed as an EU counter-party this may result in clawback of a relief which has been relied upon. Sticking to this theme, there may well have been migration involving the UK which has relied on tax deferrals under the EU freedom of movement. The UK’s departure from Europe may put the availability of those deferrals at risk and generate unforeseen tax liabilities.

At a more esoteric level the existence of a UK subsidiary, which is no longer within the EU, within a European group may adversely affect treaty benefit claims under double tax treaties involving EU countries and the US. The reliance on such treaties and the consequence of the UK’s departure from the EU should be considered.

Group cash flows

At a more basic level dividend, interest and royalty flows may rely on the EU Parent Subsidiary Directive or the Interest and Royalty Directive to prevent the application of withholding taxes. With the UK leaving the EU the ability to apply the terms of these directives would be at risk.

Without the benefit of the directive it would be necessary to consider the double tax treaty which the UK has negotiated with the counter jurisdiction to determine the extent to which there is a reduced rate of withholding tax provided under the treaty. This is particularly of concern if debt has been obtained from elsewhere in the EU and the terms of the loans include a gross up clause for interest. If the treaty reduces the domestic rate of withholding tax then the process to obtain treaty benefit would have to be followed. There are varying processes and varying time frames required to access treaty benefits.

Election to tax the overseas dividend

A solution which is relevant for dividends received in the UK is the election to tax the dividend received from overseas. This might be beneficial as a small number of treaties require dividends to be taxed in the UK in order to qualify for reduced rates of withholding tax. Mathematical modelling could be undertaken to determine if it is more advantageous to pay 19%/17% on dividend income and have a reduced withholding tax or have the dividend exempt from UK tax but suffer the foreign withholding tax.

The above are a flavour of the myriad of direct tax consequences of a No Deal Brexit and show that there is no one size fits all solution for business. Each business should review its structure, past transactions and internal fund flows in order to determine the cost versus the benefit of No Deal planning.

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Entrepreneurs’ Relief is considered one of the most attractive tax reliefs but we’ve worked with a few business owners recently who have assumed they qualify only to find to their horror that they don’t.

In the most recent Budget there has been a relaxation to the conditions associated with the relief and two further restrictions on accessing the relief.

Relaxation of Entrepreneurs’ Relief

The relief applies where a shareholder owns at least 5% of a company’s share capital. The Government have been sympathetic to individuals who find that their interest is diluted below the 5% threshold due to capital funding rounds. The funding is for the benefit of the business as it provides capital to expand but is detrimental to the shareholder as they no longer meet the conditions for Entrepreneurs’ Relief.

Draft legislation has been issued which allows the shareholder to be treated as if they dispose of, and reacquire, their shares immediately before the dilution. This allows them to bank their Entrepreneurs’ Relief before they cease to meet the 5% threshold test. This is an election and therefore not mandatory on the shareholder. If a capital gain is treated as realised, then there is a second election which allows the individual to defer payment of the tax on the gain until the shares are subsequently sold. This prevents the Entrepreneurs’ Relief claim on the deemed disposal giving rise to a tax liability but without having the money to fund it.

Some practitioners are questioning how the shares can be valued at the time of dilution. Of course, if there is dilution then there would normally be a third-party acquiring share at a known value. If that third party is acquiring shares at a negotiated market value, then it gives an indication of the basis for the deemed disposal.

The disadvantage of deferring the gain until payment of the tax is the risk that tax rates rise, or Entrepreneurs’ Relief is abolished prior to the eventual share sale.

New restrictions on Entrepreneurs’ Relief

There have been two restrictions. The first is the qualifying holding period has been extended from one year to two for disposals on or after 6 April 2019. This suggests that some shareholders are looking to make a disposal before the end of the current tax year as they know that they will not meet the qualifying condition immediately on commencement of the next tax year.

The second restriction on Entrepreneurs’ Relief was brought in with immediate effect on 29 October 2018. Prior to this date the shareholder needed 5% of the company shares which represented 5% of voting rights. From 29 October 2018 the shares must also entitle the holder to 5% of the company’s distributable profits and 5% of the assets available to equity holders on a winding up. This change is to try to ensure that Entrepreneurs’ Relief is granted to individuals who have a genuine economic entitlement to 5% of the company. This defeats structures where classes of shares have been issued which are carefully structured to achieve Entrepreneurs’ Relief without genuine economic ownership.

Alphabet shares and family businesses

There has been debate within the profession about the impact of the new conditions on alphabet shares. Alphabet shares have often been issued in family companies to allow different shareholders the right to dividends without automatically requiring dividends to be paid to other shareholders at the same rate. These shares therefore allow individuals to receive dividends in sums which are tax efficient for themselves. Typically, the Articles of the company specifically state that the shareholder is not entitled to dividends in the company until such time as the Board declare dividends on their classes of share. This is to prevent the need for all classes to receive dividends at the same rate.

If the Articles state that a shareholder is not entitled to dividends, then some commentators have identified that alphabet shares may not be eligible to Entrepreneurs’ Relief as there is no entitlement to 5% of the dividends of a company in any 24-month period.

There are two schools of thought. The first is that HMRC did not intend the Entrepreneurs’ Relief changes to apply to alphabet shares and will confirm this in due course. The other school of thought is that HMRC were aware of the impact of the Entrepreneurs’ Relief changes to alphabet shares and they are leaving it to the shareholder to determine if they wish to keep the alphabet shares (and therefore have income tax efficiency) or to restructure (to generate capital gains tax efficiency after a further two years).

It is important that HMRC issue their views on Entrepreneurs’ Relief and alphabet shares as any restructure then has a two-year follow-on period before Entrepreneurs’ Relief is available on the shares which replace the alphabet shares.

Make sure you check your position against the new requirements.

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The Corporate Interest Restriction is one of two strands of the Governments modernisation of the UK tax system; with the other strand being the reform of corporation tax losses. My blog of 25 June made reference to the impact of the Corporate Interest Restriction (CIR) Regulations. Although it was mentioned in the context of both inward investment and property investment it is not restricted to those two arenas.

For many years the UK has been at the forefront of the Organisation for Economic Corporation and Development’s best practice, including measures against Base Erosion and Profit Shifting (BEPS). One of the strands of BEPS is prevention of excessive tax deductions for financing costs. Typically the financing would be intra-group with the lender being in a tax advantaged jurisdiction and therefore high levels of intra-group debt or higher interest rates would save the group tax.

CIR for groups with UK interest deduction over £2m

CIR came into force on 1 April 2017 and only has a fiscal consequence for groups whose UK interest deduction is more than £2m. £2m was taken by the UK Government as being a sum which excluded the vast majority of organisations from the legislation. If UK interest is more than £2m then there are formulaic calculations to determine the tax relief which can be claimed. Tax relief can be claimed on sums as great as 30% of EBITDA (as adjusted for tax). The Government acknowledges that this ceiling can be particularly restrictive for certain groups and therefore it is possible to apply a different ratio; one which is more dependent on external financing and UK profitability. However, this alternative strategy needs management and therefore the relevant election should not be made before medium term profit forecasts are developed.

When the interest restriction applies a group company should be appointed to notify HMRC of the group’s interest restriction and how the group wishes for that restriction to be allocated amongst the group companies. In the absence of the election HMRC can allocate the restriction pro-rata between the companies and HMRC’s allocation may not be appropriate for the group’s tax profile.

Corporation Tax Loss Relief

CIR was not the only new matter introduced on 1 April 2017. There was a revision to the fundamentals of corporation tax loss relief which became effective from the same date. Prior to 1 April 2017 unrelieved trading losses could only be carried forward and offset against future profits of the same trade. Other types of losses had their own specific restrictions.

From Spring 2017 there was a relaxation of the use of carried forward losses in a way to generate greater flexibility. However, conversely there was a restriction on the amount of the brought forward loss which could be offset in any one year. The relaxation applies to all corporates with the restriction only applying to larger, more profitable, companies. This mismatch is designed to assist the SME sector.

The relaxation allows losses to be carried forward against total profits of the same company and therefore makes them more flexible. Additionally losses can now be carried forward against subsequent profits of certain group companies, and not just the future profits of the loss making company. Before accessing this flexibility there are certain conditions to be met and those conditions cannot be assumed to be satisfied. They need to be checked.

The restriction occurs if losses exceed £5m. Prior to April 2017 brought forward losses could be offset against subsequent income without a ceiling. From 1 April 2017 the first £5m of brought forward losses can be used without restriction. However if profits of the later period are greater than £5m then only 50% of the profit above £5m can be offset by losses brought forward.

Although the Government feel that setting a restriction above £5m will remove all SMEs from the legislation I do not believe this is the case. It is common for our property development clients to have phenomenal years as sites come up for sale. If there are brought forward losses (e.g. due to the cost of financing in the period of building) then our clients cannot guarantee that all the losses are available for offset against subsequent profits. We are having regular discussions with property clients about sales forecasts and the extent that sales may occur over a number of years. Although a spread of sales is more common for residential development it may also apply to commercial sites.

1 April 2017 was a watershed for corporation tax in the UK with the introduction of both CIR and the group loss relief rules. Undoubtedly there are groups who will benefit greatly from the new rules and also groups which will experience restrictions.

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With the Brexit deadline looming we are finding greater amounts of interest from overseas businesses wishing to set up in the UK. For some of these businesses (e.g. those based in the Republic of Ireland) the reasons for expanding into the UK are self-evident. Others come to the UK for more subtle reasons, such as benefiting from the relative weakness of Sterling.

Ease of company incorporation in the UK

Features of the UK landscape are the ease of company incorporation and the ability to have company directors who are all non-UK residents. When compared to the Republic of Ireland our 17% corporation tax rate is unattractive. However this does not appear to dampen the appetite for Irish businesses setting up subsidiaries in the UK.

Structuring for expansion into the UK

When considering expansion into the UK there are a number of decisions which have to be taken about structure. As identified in my blog on the development of the UK corporate tax landscape it is important to model the impact of financing on the UK results as well as modelling the quantum of any opening year losses.

Withholding taxes after Brexit

Typically Irish ownership would access the benefits of the EU Interest and Royalties Directive in order to avoid withholding taxes on intra-group interest payments. In advance of the UK withdrawal from the EU in 2019 the terms of the UK tax treaty may be more relevant and making it more important to register as a borrower under the treaty passport scheme.

As the UK does not have an outbound dividend withholding tax, our departure from the EU does not make dividend withholding taxes a concern. Although this may be efficient as a mechanism for the repatriation of profits out of the UK the impact of dividend income receipts in the home state would still need to be understood.

UK Boards and non-UK Directors

Many inward investment groups have non-UK directors on their UK Boards and this is a common mechanism to enable commercial control of the UK subsidiary by home state persons. Like many countries the UK has a concept of management of control for company tax residency and the impact of our domestic rules should be considered when determining directors numbers, residence and their powers.

Audit requirements

Even if the UK company may not be expected to be particularly large, one still has to consider consolidated accounts and their audit requirements in the home state. This may lead to obligations to audit the UK subsidiary and for the UK auditors to have tight reporting deadlines in order to fit in with group timetables. Typically our audit teams are required to audit the financial statements of the UK subsidiary which have been prepared under UK GAAP and provide GAAP adjustments for overseas parent consolidation. Although this is not necessarily relevant for investment from the Republic of Ireland it can be an important factor to timetable into UK work when reporting to other countries, such as the US.

Future visa requirements

No business is a success without the right people. Expansion into the UK regularly results in staff coming to the UK to manage the early development of the UK subsidiary. Nationals from EU countries have not had to consider visa issues. This may change in the future. The group parent should not assume that its employees can come to the UK without visas. For example an Irish parent company may second staff to the UK to manage the early stage of the UK subsidiary without considering that the staff are, say, Australians working in Dublin. Visa requirements for any secondments need to be explored.

Sending staff to the UK

The UK has tax breaks for movements of staff which may be of benefit. The extent to which the transfer is a temporary matter of a few months or a long term matter should be identified at the outset. This is to ensure that social security is paid to the right country and any relevant terms of bi-lateral social security agreements are applied. Even a short term transfer may result in PAYE obligations or reporting requirements which need to be managed.

Longer term staff transfers inevitably result in the individuals falling into the UK income tax net. Planning for salary equalisation is important when offering the individual a long term transfer. Also whilst developing their total remuneration package it is important that the impact of share options granted to secondees is understood in the UK and home state.

For both secondees and UK employees the HR policies associated with UK employment need to be identified and where appropriate, group policies flexed to meet UK employment laws.

Plan for setting up in the UK

The decision to come to the UK is a relatively easy one for many overseas businesses faced with the uncertainty of Brexit. For our friends in the Republic of Ireland it is possibly an easier decision to make, especially given our close histories, legislative approach and common language. However that does not prevent the need for planning by any group considering coming to the UK at both the tax level and the employee level. We are finding that the most successful businesses are those which engage with us on these matters at an early stage.

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The UK hospitality sector is facing some significant challenges and opportunities at the moment, due to a number of different factors.

How Reorganisation can help

Reorganisations can help in a number of ways, including facilitation of financing, asset protection and performance improvement.

Reorganisation for Financing

Quality real estate is still well regarded by sophisticated investors such as pension funds. UK real estate continues to trade at historically high levels compared to bond yields making property both attractive as an investment class and a viable option for investment diversification.

Quality UK properties are attractive as the market is liquid, sterling is weak and the legal consequences of property ownership well understood. These factors have increased the demand for UK real estate amongst those seeking annuity incomes or higher yields, including international investors.

Hotel occupancy rates, particularly in the big cities, continue to be strong and meet expectations. This gives investor confidence about acquisition of hotels as an asset class.

This presents an opportunity for those looking to grow their hotel business.

Financing requires a reorganisation to offer the lender security on real estate assets. If monies are to be raised by sale of a real estate asset then separation of that asset from the trading activity can be beneficial.

Reorganisation for Asset Protection

The Brexit vote and the fall of sterling has reduced the pool from which the sector traditionally recruits, whilst margins are being squeezed due to the higher cost of imported raw materials.

For restaurants this is exacerbated by the impact of the delivery operators as well as punitive business rates. This has resulted in a number of high profile restaurants faltering.

The current number of high profile restaurant failures would suggest that company reorganisation for asset protection may be a positive strategy.

Reorganisations for asset protection can involve separation of properties from the trade so that if there is a failure of the trade it does not necessarily mean the property is at risk. Group structures can help. Alternatively, more formal measures such as demergers can facilitate this planning.

Reorganisation to focus on performance

Management theory dictates that individuals should be incentivised on matters which they can control.

Property rich activities such as the hotel and leisure sector can lead to increasing share values due to property price increases rather than improvements in the underlying trade. It is therefore possible that management interests grow in value due to property prices rising rather than underlying trading improvements.

Reorganisations such as demergers can create structures which provide vehicles for management to focus and be incentivised based solely on trading performance. If properly structured these can also attract approved tax treatments such as the EMI share option reliefs.

Conclusion

In conclusion, the different strands of the hotel and leisure sector face different challenges and carefully structuring for particular situations can help manage risk and provide management reward opportunities.

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The objective behind CIS

The current iteration of the Construction Industry Scheme (CIS) came into effect on 6 April 2007 but it has been refined in the years since its introduction.   All permutations have been created to try and overcome the belief that many payments in the construction industry were not reported for tax purposes.  CIS prevents this by operating a system which is not dissimilar to PAYE.  The payer has an obligation to consider the status of the party to whom payments are made and, in certain circumstances, withhold tax from the payments.  As the operation is similar to that of PAYE, it is the PAYE section of HMRC which administers CIS.

What is covered by CIS?

CIS applies to the labour element of a construction contract.  Construction contracts are defined in legislation and go beyond simply building structures.  Examples of construction operations include painting and decorating and preparative work such as site clearance and scaffolding.

Who is affected by CIS?

The legislation specifically excludes some operations from CIS.  Examples include the professional work of architects and surveyors, and security installation.  However, if any of those parties take part in the management of construction work then they are within CIS.

For CIS to apply,  operations must take place in the UK, including the UK territorial waters, and can include marine construction.  The residence of the parties is not relevant; it is the location of the works which are important. This can be overlooked by non-UK businesses seeking contracts in the UK.

Managing CIS

CIS applies to the labour component of construction.  If there is one contract that covers all construction operations then CIS considerations will be relevant to the entire contract.  This applies even if separate invoices are raised for separate parts of the contract.  It may be necessary to split the project into separate contracts so that there is a single contract for labour and CIS would only apply to that contract.

CIS responsibilities for contractors

CIS applies whenever there is a contractor and sub-contractor relationship.  The legislation defines both and gives an extensive list of those persons who are treated as contractors for its operation.  If CIS is relevant, then the contractor has an obligation to verify the status of the sub-contractor and apply the relevant regulations to payments made to them.  It is the impact of payments which is particularly important to understand.  This is due to the cashflow impact for the sub-contractor.

If the sub-contractor is not registered with CIS then the contractor must deduct tax at 30% from payments to the sub-contractor.  If the sub-contractor is registered then the deductions falls to 20% unless the sub-contractor is registered as a gross status party in which case no deduction is required.  The deduction is against the VAT exclusive payment and does not apply to the cost of materials of the sub-contractor.  If the sub-contractor does not confirm their cost of materials then the contractor should make a reasonable estimate.

There are regulations which define how the contractor must verify the status of the sub-contractor and the frequency of CIS Returns.  All of these administrative tasks must be done online.

If the sub-contractor is a company then tax deducted from payments received by it can be offset against its own PAYE and  National Insurance Contributions, deductions under CIS from payments made to its own sub-contractors and Corporation Tax on its profits.  If the sub-contractor is not a company then tax deducted is offset against its Income Tax liability and National Insurance Contributions.  The sub-contractor who is not a company will therefore claim relief for deductions at a later time than a corporate sub-contractor.

Registering for Gross Status

There are obvious advantages to registering for gross status and there are conditions which must be satisfied before gross status can be attained.  These include the method of operating in the UK, turnover thresholds, group structure and demonstrating a good compliance history with HMRC.  If the compliance history is damaged during construction operations then HMRC can revoke gross status which may have a catastrophic impact on cashflow.  Maintaining a good compliance history with HMRC is therefore paramount.

How we can help

We have considerable experience of CIS matters including split contracts, definitions of contractors and sub-contractors, the practical impact of professionals providing project management services and preventing loss of gross status.  All of these ensure that the cashflow impact of CIS is minimised.

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The report on employee ownership, “The Ownership Dividend” has been published.  It has been compiled following over a year of independent review and having heard evidence from more than 100 employee-owned businesses and advisers . A copy can be found at www.theownershipeffect.co.uk.

Benefits of employee ownership

The conclusion is that employee-owned businesses have advantages to both the employee and their employer; including higher employee engagement, motivation and wellbeing. The employer experiences increased productivity and efficiency. At a time when employee engagement levels are dropping, morale is felt to be low and UK productivity is lagging behind our global competitors, the benefits of employee ownership are more pronounced.

There are well known examples of employee ownership, with probably the best known being the John Lewis partnership, Arup and PA Consulting. Despite this there are relatively few employee owned businesses compared to the numbers of businesses in which employees have equity participation, but not overall control.

Tax reliefs of employee ownership

It is acknowledged that the numbers of entrepreneurs who gift ownership of their business to employees is limited. To promote employee ownership there is an exemption from capital gains tax for an entrepreneur who transfers a controlling interest to employees and exemptions for the employee on receipt of benefit connected with the shares. Despite these tax reliefs, far greater numbers of entrepreneurs retain control of their business and allow staff some equity interest in it. I believe that the 10% rate of capital gains tax makes it more attractive for the entrepreneur to retain control of the business and have the business grow to a point where it can then be sold. This exit becomes the fruits of the entrepreneurs’ labour and can represent life changing amounts.

Tax legislation provides incentives when offering shares (but not control) to employees. Tax advantaged share schemes can be categorised as either those which are “all-employee” or those which can benefit specific employees, or groups of employees. Typically, the latter schemes are only offered to directors and senior managers. There are other niche schemes for specific circumstances, such as university spin outs.

Share incentive plans and share option schemes

Share incentive plans and savings related share option schemes are all-employee schemes which, if operated correctly, provide tax breaks to the employees who receive shares. These schemes have limits on the tax advantages and generally result in large numbers of employees owning small numbers of shares.

Company Share Ownership Plans  and Enterprise Management Incentives

Company Share Ownership Plans (CSOP) and Enterprise Management Incentives (EMI) can be issued on a selective basis to key employees. CSOP has tax advantages but subject to a ceiling of £30,000 of shares per employee. The limit of £30,000 is sometimes felt to be an impediment to use of CSOP for incentivising senior executives.

EMI is by far the most popular approved share incentive plan in the UK. Smaller trading companies can issue options worth up to £250,000 per employee with the scheme being selective and therefore able to restrict ownership to senior executives. There are no costs to the employee of receiving options and growth in the company during the ownership of the option can be tax free for the employee. This is on top of generous tax reliefs for the employer. EMI can be structured to make it highly beneficial for the employee to grow the value of the business, especially if the option can be exercised immediately prior to a company sale. The tax reliefs available on company sale mean it is possible for the senior executives to receive a percentage of the sales value at a 10% rate of tax. For many this is a compelling reason to use EMI to incentivise senior people to grow the business and participate, together with the controlling entrepreneur, on its sale.

In conclusion

In summary, the benefits of share ownership as set out in The Ownership Dividend are valid. However, employee ownership is relatively rare, especially when compared to the numbers of businesses in which employees have a non-controlling interest. I believe that the tax breaks associated with approved share schemes are a factor in this differential. EMI has generous tax breaks for both the employee and employer. Statistics suggest that it is by far the most common share scheme and my considerable experience of share scheme structuring makes me feel that the statistics are accurate.

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Why the VAT Reverse Charge is being introduced

In 2017 the Government floated the idea of a change to the VAT treatment of certain elements of the construction industry supply chain. They believe that criminal gangs were offering specific supplies in order to perpetrate “missing trader” or “carousel” fraud. A Government paper indicated that this was losing the Exchequer an estimated £100m a year.

The Government believes that this fraud typically occurs when sub-contractors are set up to provide workers. The sub-contractor charges their customer for the supply of people and legislation requires this cost to have VAT added to it. However the cost to the sub-contractor is the payment of wages which does not have any VAT liability. The sub-contractor collects VAT from their customer and then disappears without paying it to HMRC. As the sub-contractor might have been set up for a single site this makes it difficult for HMRC to track the perpetrators.

Consultation with the construction sector

The Government consulted the construction industry on the impact of a reverse charge mechanism to prevent this fraud. A reverse charge was suggested as it has been used to prevent other forms of missing trader/carousel fraud.

The Government estimate that there are 300,000 business at different points in the supply chain and therefore the impact of a reverse charge would be more widespread than its other applications.

When will the Reverse Charge apply?

It has now been confirmed that the reverse charge will come into effect from 1 October 2019. HMRC feel that they have listened to UK businesses requests that they are given a considerable lead time to review and amend their systems in advance of this change.

Who will be affected by the Reverse Charge?

The reverse charge mechanism will only apply to construction services and HMRC will use the existing definition of construction services from the Construction Industry Scheme (CIS). This use of a pre-existing tax definition is welcomed as it would be illogical for there to possibly be one definition of labour for CIS purposes and a different definition for VAT purposes.

The reverse charge process would vary the billing profile of a sub-contractor as they would no longer charge for construction services with VAT. Instead they would issue an invoice requiring their customer (the main contractor) to self account for the VAT that would otherwise be due. One would not normally expect this to put either the sub-contractor or the main contractor in a worse position.

Winners and Losers

However, when one looks at cashflow there may be winners and losers. Using the example of a construction service with a value of £1m then presently the sub-contractor would charge their customer £1.2m (£1m plus VAT). That sub-contractor would account for the £200k to HMRC. Depending on payment terms and commercial agreement it is possible that some sub-contractors would receive the £200k VAT before having to pay it to HMRC and others would need to finance the £200k whilst they wait for payment of their invoice. Applying a reverse charge would have a negative cash flow impact on the former whilst a positive impact on the latter.

Similarly, the main contractor could sometimes be in a position to make an input tax claim on a VAT return before having to pay the sub-contractor or vice versa. As can be seen, either party could win or lose.

A significant complication is that not all construction services will be caught by the new provisions. Only standard and reduced rated supplies will be effected, which makes sense. There can be no tax loss to missing trader fraud where the supply doesn’t have any VAT on it in the first place. Further, certain related party transactions will be excluded as will supplies to end users such as developers. The new rules only apply to contractors supplying to other contractors. This will require contractors to seek confirmation of status from their customer before engaging to ensure that the correct VAT treatment is applied.

Contractors and Sub-Contractors

Contractors will need to consider the definition of labour more carefully than they have to date. It is reasonable to assume that larger contractors use sub-contractors who are gross status payers for CIS. This means that larger contractors have not had to worry about the definition of labour.

Invoices received from sub-contractors may have components with VAT charged on some services but not others. This will lead to complexity for the contractor especially when approving payment of an invoice. The concern for the contractor is that if they are charged VAT incorrectly then they cannot recover it even if they have inadvertently paid the invoice and their supplier has accounted for that VAT to HMRC. The only mechanism to overcome this error would be to renegotiate with the sub-contractor. However if the sub-contractor is an overseas entity or is created for a single development then they may not be in continued contact with their customer.

Make sure you’re ready in time

In summary there is a considerable shift in VAT compliance from October 2019 which has an impact for both contractors and sub-contractors down to the entire construction supply chain. Businesses should use the period to October 2019 to review contracts, update systems and understand the definition of labour for this purpose.

Our property and construction team would be pleased to talk to you about how this will affect you.

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In the past corporate non-resident landlords have experienced a beneficial tax profile for UK property profits. Rental profits are taxed a flat 20% rate of income tax, capital gains were exempt from UK tax and there were no inheritance tax consequences for the company owner.

Over time these advantages have been eroded. For example, non-resident corporate landlords are now subject to UK capital gains on gains made on residential properties. In 2017 the Government announced that non-residents would be liable to capital gains tax on disposals of commercial sites from April 2019. This brings all disposals into UK tax. The advantage that rental profits are taxed to the flat 20% rate remains.

Tax changes coming

From April 2020 there will be a transition by non-resident corporate landlords from income tax to corporation tax. Many will find this attractive as the flat rate of corporation tax will be 17%. The Government’s intention is to make this technical transition seamless and therefore capital allowances are expected to transfer between the taxes at tax written down value and any rental losses should be available to carry forward into the new environment.

Currently there is uncertainty about the compliance process. Income tax is calculated to 5 April annually whilst corporation tax is determined with reference to the company’s year-end. If the company does not have a 5 April year-end then in 2020 there is likely to be some element of time apportionment between income tax and corporation tax. The filing deadlines for these taxes differ. In addition, the dates of payment of corporation tax differ from those of income tax. Depending on the company’s profile this may accelerate or defer payment of tax on rental profits.

It seems slightly perverse that non-resident corporate landlords are subject to capital gains tax on all sales from April 2019 and subject to a shift in tax treatment from April 2020. Logic would suggest that these two changes should happen simultaneously.

Beware the potential sting in the tail

Although the move from a 20% tax regime to a 17% regime appears attractive there can be a sting in the tail for leveraged property acquisitions. For the non-resident corporate income tax does not have any restriction for interest deductions. From 2020 non-resident corporate landlords will be subject to the Corporate Interest Restriction (CIR) Regulations. These can restrict the interest deduction which a company can claim if its annual interest charge is more than £2m. In group situations the £2m is spread across the group. Larger property acquisition can easily result in interest payments in excess of £2m and therefore companies and groups may find that a move to corporation tax increases annual tax burdens. This is despite the reduced headline rate of tax.

Be prepared

Businesses should be using the period to the change to consider their strategies for a revised compliance environment and model their tax burden based on the corporation tax rules, including the impact of the corporate interest restriction.

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