Tax issues for UK businesses in 2021

Out-Law Analysis | 19 Jan 2021 | 2:25 pm | 10 min. read

With public sector debt at a record high and tax revenues down, the big question for 2021 is whether we will see any UK tax increases, one-off taxes or radical changes to the system.

Much turns on the extent to which the coronavirus vaccine roll out and new Trade and Cooperation Agreement (TCA) delivers an economic boost – and whether that comes quickly enough for the Budget on 3 March to be used for tax-raising.

‘Sovereign’ tax policy

The UK is now free of the shackles of the ‘fundamental freedoms’ and VAT directive so can set its tax policy as it sees fit, subject to observing its commitments to the Organisation for Economic Cooperation and Development (OECD) and wider community and its obligations under the TCA. The UK has committed in the TCA not to ‘weaken or reduce’ the level of protection in current legislation of OECD procedures and standards and entered into a Joint Political Declaration on Countering Harmful Tax Regimes – no doubt reflecting the EU’s concerns that the UK could become ‘Singapore-on-Thames’.

Climate

One of the most pressing business and social issues is countering climate change. The EU and UK have used the TCA to reaffirm their respective commitments to achieve net zero greenhouse gas emissions by 2050 and to meet their latest ‘carbon budget’ commitments for 2030. 

The UK government needs to think strategically about using the tax system to reduce carbon consumption.

The TCA also affirms the UK’s commitment to maintaining a system of ‘carbon pricing’ but is silent on methodology. The UK does not currently have a carbon tax but has been a member of the EU’s Emissions Trading Scheme (ETS), which through control of the supply of ‘carbon credits’ creates a market price for the right to emit. The UK has left the EU scheme and a UK ETS applies to UK emitters with effect for emission arising from 1 January 2021. Negotiations are ongoing as to whether credits from one system can be used in the other.

Press reports suggest that the UK may be proceeding with the ‘carbon emissions tax’ on which it consulted in the summer. Although a country generates revenues from auctioning credits in an ETS, it does not see any direct upside from a rise in the price of those credits due to market forces. The EU and UK ETSs also cover only 30-40% of those who actually emit and the £1bn the UK generates from auctions is relatively modest. Maybe the temptation to tax carbon more heavily will be too great to miss. Taxes designed to discourage activity should, if perfectly successful, lead to no increased tax take – but given how long it will take to turn the carbon super-tanker around, a carbon tax might only to be around for the amount of time it will take to pay off coronavirus debts.

More fundamentally, though, the government needs to think strategically about using the tax system to reduce carbon consumption.

DAC 6

On 1 January 2021, the UK left the EU regulations and directives dealing with administrative cooperation, information exchange and recovery of taxes and duties. It of course remains party to OECD information and cooperation schemes.

The UK is no longer bound by the EU Directive known as 'DAC 6'.  DAC 6 at its simplest creates a common reporting system under which, in the context of all taxes levied in the EU other than VAT, customs duties and excises duties, EU based intermediaries must report to their home state where they assist others to engage in cross-border arrangements which bear certain ‘hallmarks’. The home state is in turn obligated to share the report automatically with all member states affected by the arrangements.

UK legislation has been updated to continue to require UK intermediaries and taxpayers to follow Hallmark D of DAC 6, but not the remaining hallmarks. This is because DAC 6 was born out of the OECD’s BEPS Action 12, which recommended mandatory disclosure rules for cross-border tax schemes. DAC 6 was welcomed by the OECD but not designed by it. The only policy area for which the OECD has developed detailed ‘model’ rules is CRS avoidance and opaque structures – which marries up to Hallmark D of DAC 6.  So, to respect its obligation not to lessen any legislation which implements OECD rules, as a quick fix the UK has decided to continue to require Hallmark D reporting for now.

However, during 2021 the UK will consult on new legislation to remove all links to DAC 6 and to implement its own regime – as HMRC puts it, in order to move from ‘EU to international rules’.

Corporation tax controversies

HMRC’s ‘tax under consideration’ for large businesses has risen by 16% to £34.8bn in the year to 31 March 2020, from £29.9bn the year before. Within this, transfer pricing (TP) and thin capitalisation under consideration has jumped 74% to £10.4bn from £6bn.

TP/Residence/Profit Attribution

HMRC launched the Profit Diversion Compliance Facility (PDCF) in January 2019 and, after a short break as a result of the pandemic, has now resumed sending ‘nudge’ letters to businesses, prompting them to reconsider their TP, residence and profit attribution arrangements and offering them the opportunity to disclose all irregularities under the PDCF and pay any tax owing, in order to avoid an HMRC investigation and a possible exposure to diverted profits tax. Use of the PDCF is not a panacea, and we are already seeing HMRC rejecting the conclusions drawn by some users of the PDCF and launching its own checks.

Businesses may also need to revisit their TP arrangements if the way they conduct business has changed as a result of the pandemic. One of HMRC’s areas of concern is that businesses are pricing internal transactions based on internal contracts or other documented positions which do not reflect the reality on the ground.

Businesses may need to revisit their transfer pricing arrangements if the way they conduct business has changed as a result of the pandemic.

HMRC has disclosed that it has started a number of fraud investigations, centred on whether knowing misrepresentations have been made during HMRC’s enquires into TP, residence and profit attribution arrangements. This serves as a warning for Heads of Tax to be sure of their facts before making any submissions to HMRC – because if the facts are later found to differ from those presented, HMRC will want to know whether that was purely accidental, careless or knowing. Even if the corporate can show that the misrepresentation wasn’t deliberate, carelessness will provide grounds for HMRC to impose penalties.

Notification of uncertain tax positions

Many large businesses expressed relief that HMRC has deferred proposals for requiring large businesses to notify HMRC of uncertain tax positions until April 2022. From public domain comments made by a senior HMRC official, it sounds as if HMRC is (rightly) rethinking one of the most controversial aspects of the proposal, which is the fact that businesses would have to decide whether the position they have taken is one with which HMRC may not agree. We may find out in the Budget what is proposed instead.

State aid

In April 2019, the European Commission concluded that the full and partial exemption for non-trading finance profits in the UK’s CFC rules was incompatible with EU state aid rules to the extent that the profits are generated from UK activities and required the UK to recover the unlawful state aid, with interest, from groups which benefited.

The UK has challenged the decision before the EU courts but is still obliged to recover the state aid notwithstanding this litigation. As the alleged aid is an amount absolved under UK tax legislation, recovery falls outside the usual tax assessment system. To avoid having to rely on costly and protracted civil proceedings to recover the aid, HMRC has been given new powers to recover the alleged aid using a process of issuing charging notices, using a ‘pay now argue later’ system similar to that used for diverted profits tax and advance payment notices. We can expect to see many of these notices issued during 2021.

Taxing rights and 'cake-carving'

The pandemic has accelerated the exploitation of the digital economy and made changes to country taxing rights to deal with digitisation and consumer-facing brands even more pressing. The OECD had aimed to have agreement to a new rule book by the end of 2020. However, this was not possible: partly as a result of intransigence of the US, which sees the measures as unfairly targeting US owned technology companies; and partly as a result of the pandemic. Meanwhile countries which are major markets for the technology giants continue to take more aggressive stances under current rules on ‘digital PEs’ and withholding taxes – or, like France and the UK, press ahead with temporary unilateral digital services taxes. 

If international agreement cannot be reached on new taxing rights in early 2021 we are likely to see even more unilateral digital services taxes, including the mothballed EU wide proposal. The need to collect taxes to pay off coronavirus-related borrowing is only likely to add to the pressure.

Employment tax

The pandemic-delayed changes to the so-called IR35 off-payroll working rules will come into force on 6 April 2021. The rules essentially shift the responsibility for ‘observing’ the rules to the engager (if a medium or large business), as happened first for public sector engagers. Although many businesses have already changed practices and taken some roles directly on to payroll, we still expect to see some businesses struggle with compliance where roles continue to be sourced through intermediary working.

VAT

The domestic reverse charge for the construction sector to counter organised VAT fraud is another of those measures which seem to have been talked about for a while and keep getting deferred. Its introduction was initially delayed from 1 October 2019 to 1 October 2020, because there were concerns that many businesses were unprepared for the changes. Then coronavirus delayed it until 1 March 2021. It is still doubtful whether businesses are prepared for the change and it remains to be seen whether it will have to be delayed even further.

 

In the midst of the pandemic, HMRC published a surprise change in practice in relation to VAT and contract terminations in its Revenue & Customs Brief 12 (2020), which it claimed would have retrospective effect and would potentially affect all compensation payments in relation to contracts. This resulted, in particular, in confusion as to how the brief applied to real estate, including dilapidation payments under leases. We understand that HMRC is backing down on making the change retrospective and intends to issue a further brief this month, which should clarify its new position.

Now that the Brexit transition period has come to an end and the UK is fully out of the EU, 2021 may be the year when we begin to see the UK moving away from EU VAT law in some areas – or at least signalling where it intends to do so in the future.

The call for evidence into the VAT group rules launched in the autumn suggests that this could be an area where the government is looking to make changes. Points being considered include making it so that only UK businesses and the UK establishments of non-UK businesses would be able to be VAT grouped; making grouping compulsory rather than elective; allowing limited partnerships and Scottish limited partnerships to join VAT groups – an area which definitely needs to be clarified. Although it may be ambitious to expect changes to the regime to happen in 2021, we should at least hear more about the likely direction of travel.

Another call for evidence published in December suggests that the government is looking at possible changes in relation to digital platforms in the ‘sharing economy’. The platforms typically maintain that legally and for VAT purposes they provide information technology and agency services only, and that the underlying service (such as a rental) is a supply by the service provider, who is often under the VAT registration threshold, to the customer. The call for evidence suggests the government may accept defeat on the legal analysis, but change the rules to make the platform the supplier for VAT purposes. The call for evidence closes on 3 March 2021, which means we will have to wait to see if this is likely to turn into a full-blown change in tax policy.

Tax dispute procedure

The government has appointed a panel of experts to look at the case for reform of the judicial review process. Separately, the government is also looking at making it harder to obtain permission to appeal from the Upper Tribunal to the Court of Appeal. Changes in either area could have deep-seated implications for disputes with HMRC and we should hear more about what the government proposes to do during 2021.

In relation to VAT and other parts of the tax system which constitute ‘retained EU law’, the tax tribunals and the courts will have to begin to use new rules to interpret that legislation. UK courts and tribunals will not be bound by decisions of the Court of Justice of the European Union (CJEU) made after 31 December 2020 and the Supreme Court will be able to depart from CJEU decisions made before that time in the same way as they are able to depart from their own decisions. The government has extended this power to depart from CJEU decisions to the Court of Appeal and its equivalents. It seems unlikely, though, that these new rules will have a major impact in 2021. They are more likely to lead to disputes as UK VAT moves away from the EU system.

Tax investigations

HMRC is likely to continue to deploy significant resources to audit and investigate non-compliance with furlough and the other government coronavirus support schemes. Those who have claimed the support need to continue to remain vigilant to ensure that they are complying with the rules and to make sure that they are aware of what has been happening on the ground. There are sure to be many cases where, unbeknown to senior management, employees have been working whilst on furlough, whether as a result of an instruction from their line manager or because they think they are helping their employer. As these cases come to light, it will be important that employers make a full disclosure to HMRC and repay any amounts overclaimed as soon as possible.

HMRC raids in relation to the strict liability facilitation of tax evasion offences, also known as the corporate criminal offence (CCO) began at the end of 2018. It is possible that charges will be brought in relation to some of these cases in 2021. HMRC raid activity has, naturally, been hampered by the lockdown restrictions so we expect to see an uptick in raid activity as and when such restrictions are lifted. 

This is based on an article by Jason Collins and Catherine Robins, tax experts at Pinsent Masons, the law firm behind Out-Law, which was published in Tax Journal on 8 January 2021.