The budget announcements included some interesting developments for the banking and finance sectors. In particular, a number of advisers focused on the changes to the taxation of hybrid capital instruments amid recent changes to capital adequacy requirements. It seems clear that the reforms were intended to stave off the threat of EU State aid proceedings. However, the changes are widely drawn and may affect a far broader reach of taxpayers and arrangements.
(For Practical Law commentary on these measures, see Legal update, Autumn 2018 Budget: key business tax measures: Hybrid capital instruments.)
Read the reaction to the Autumn 2018 Budget from industry leading tax practitioners:
David Harkness, Clifford Chance LLP
There has always been a measure of uncertainty as to the tax treatment of bank regulatory capital instruments. For many years the special regulatory capital needs of banks has been recognised either informally or formally in the UK tax system, since 2013 through explicit regulations. Doubt has been cast on these by recent EU Commission arguments that special tax regimes (such as the UK Regulations) for bank regulatory capital securities may be unlawful State aid. While the Commission’s arguments are not convincing, they have caused widespread concern.
The solution announced yesterday is to replace the existing regulations with new tax rules for all hybrid capital instruments, whether issued by a bank or any other type of business. In practice, it seems unlikely any or many UK taxpayers (other than banks) will wish to take advantage of this new tax freedom so the tax impact will be small. Probably for this reason, the Budget Red Book shows the measure has having negligible impact on the Exchequer over the next six years.
This announcement is very welcome, if not surprising. The UK government has sought to steer between the competing dangers of a full-blown State aid investigation, the market disruption that would follow withdrawal of the UK’s regulations and the need to preserve the UK tax base. It is unclear if the changes announced today will discourage the Commission from a state aid investigation, but they are a welcome indication that the UK government is committed post Brexit to a vibrant and fully functioning UK bank sector.
Mike Lane, Slaughter and May
For corporates, the 2018 budget was a bit of an old fashioned one. Unless you’re a search engine, social media or online marketplace provider targeted by the day’s intended headline grabbing Digital Services Tax or DST, it’s a case of going through the Red Book line by line to work out whether there is anything of particular import to you and your sector.
For banks and insurers worried about the tax treatment of regulatory capital in the form of debt since the State Aid challenge to the Dutch tax treatment of such instruments surfaced earlier in the year, the announcement that the Regulatory Capital Securities Regulations will be replaced with a non-sector specific Hybrid Capital Instruments regime broadly intended to ensure that tax deductibility for such instruments is maintained should be welcome. For others, the total withdrawal of 100 percent first year allowances on energy saving kit with effect from April, 2020 is likely to be a surprising blow, particularly given the green fingerprints elsewhere in the budget. Perhaps symptomatic of swapping carrot for stick in this area?.
There’s a continued feel of scrabbling down the back of the sofa for every last penny. In the era of SSE, groups don’t generally make material capital gains. And capital disposals tend, by their very nature, to be lumpy. So, the 50 percent restriction on using carry-forward capital losses against gains with effect from April, 2020 is likely to produce some arbitrary losers. Stamp duty has managed perfectly well without a deemed market value rule since at least 1891 but even that looks set to end now. Desperate times…
So, is there any good news? Well, the government has at last accepted that it is a bit rich to charge both diverted profits tax and corporation tax on the same profits and is going to legislate to remove the double charge ab initio!
Simon Letherman, Shearman and Sterling (London) LLP
The greatest relief arose when the stream of toilet gags in the Budget speech finally petered out. But still the Chancellor relentlessly pushed the new OBR forecasts that promise to make him flush.
Back at the budget, the proposed cap limiting the use of carried-forward capital losses by companies to 50 percent of capital gains each year has even greater potential, compared with the recent cap on revenue losses, to create significant trapped losses. Businesses may reasonably aspire to sustained revenue profitability in future. But they won’t be planning to realise their capital assets on a regular basis, all the more so where historic capital losses can no longer fully absorb a taxable gain. And how will the cap apply to property derivatives, where fluctuations in value each year may be taxed as capital gains and relieved as capital losses? There is obvious potential here for the cap to cause permanent mismatches.
The announcement of a new general regime for hybrid capital instruments from January 2019, previously only available for regulatory capital, is a response in part to revised Bank of England capital requirements but can apply more widely. That is presumably due to State aid concerns, although it remains questionable whether the position of businesses required to maintain loss-absorbing capital should really be comparable with those which are not. While the announcement is unlikely to be a surprise to the major financial institutions, others will need to study the new regime quickly and carefully once full details are available. Not all aspects of the current regime will be grandfathered, and in some cases—we seem to be going back to general principles.
Finally, the fix for intangible fixed asset de-grouping charges, giving access to SSE relief as has been the case for years in the capital gains world, is both very welcome and very long overdue.
Richard Sultman, Cleary Gottlieb Steen & Hamilton LLP
Even though deliberately applicable to all issuers of debt, the new regime for “hybrid capital instruments” will principally affect a relatively small body of taxpayers in the banking and insurance sectors. But its impact is significant and timely given the imminent introduction of internal minimum requirements for own funds and eligible liabilities (MREL). Helpfully, the new rules should extend reliefs (notably, interest deductibility) to a wider range of loss absorbing capital instruments than previously. The trade off, however, is the repeal of the existing regime for regulatory capital (AT1 and T2) securities. This will add complexity to the analysis for those instruments and result in the withdrawal (subject to transitional rules) of some automatic benefits (such as exemption from issuer income recognition on conversion or write down). By extending the regime to all sectors, the Government may be trying to side step the possibility of a State aid challenge against the preferential treatment of regulatory capital.
The Technical Note also addresses some general debt versus equity questions, reconfirming HMRC’s view that perpetual instruments can be debts so long as they are repayable on liquidation, and expressing a helpful view (in the context of the distributions code) that the terms of unlisted convertible instruments are reasonably comparable with those of listed securities if they would have been entered into by independent parties.
The other main changes that caught my eye are those proposed to the intangibles regime to allow some amortisation of acquired goodwill, and to address de-grouping charges on a share disposal that qualifies for the SSE. It seems the government has been listening to taxpayer representations – although we will have to wait another week to see the details.
Martin Walker, Deloitte LLP
A real cornucopia of tax measures was announced by the Chancellor on Monday, amid a smattering of slapstick gags and toilet humour. Possibly the most eye-catching was the announcement of a new digital services tax (DST) on digital economy businesses at 2 percent of revenues, above certain thresholds and subject to safe harbours, generated by UK users of search engines, social media platforms and online marketplaces. The tax will not be creditable against UK corporation tax but will constitute a deductible expense. The UK’s double tax treaties are not intended to apply to the new DST. While acknowledging that the UK would prefer to introduce a DST as part of a global consensus, will consult broadly on the detail and would indeed recalibrate the tax in the event of a comprehensive global solution, this go it alone approach would seem to be borne of frustration at the length of time being taken to reach agreement on a more multi-lateral basis. The Chancellor was nonetheless keen to note that the UK remains ‘open for business’.
Other measures had more of a feel of tinkering around the edges of existing tax rates and bases as well as exemptions and reliefs. Banking and insurance groups will need to assess whether their existing regulatory capital securities are impacted by the changes regarding hybrid capital instruments. The use of carried forward capital losses for corporation tax purposes will be (broadly) restricted to 50 percent of current year chargeable gains, following in the footsteps of the trading loss restriction rules.
The announcement of a deemed market value charge for stamp tax purposes, with immediate effect, on transfers of listed securities at an undervalue between connected parties is unlikely to have any material impact on commercial transactions. The proposal to align more generally the consideration rules of stamp duty and stamp duty reserve tax could be more impactful if some of the business-friendly quirks of the parallel stamp tax regime are lost by way of collateral damage during this simplification process.
Read more on the Autumn 2018 Budget
Further analysis on the key areas:
- Digital Services Tax
- Property, Energy and Environment
- IP, Media and R&D
- Employment
- Other business measures
