France Telecom: lessons for UK employers following 'institutional harassment' ruling
Out-Law Legal Update | 27 Mar 2017 | 4:47 pm | 7 min. read
Move from income tax to corporation tax
Non-UK resident companies currently pay corporation tax (CT) if they are trading in the UK through a UK permanent establishment. However, if they are deriving income from UK property investments, or if they are trading in the UK other than through a UK permanent establishment, they pay income tax at the basic rate.
The government is considering whether to make non-UK resident companies subject to CT in respect of income from UK property. It has published a consultation document asking for views on its proposals. It is not proposing to change the treatment of companies that trade in the UK other than through a permanent establishment. Non-resident companies that are dealing in or developing UK land will already be within the scope of CT.
The government is also considering whether to make non-UK resident companies subject to CT rather than non-resident capital gains tax (NRCGT) on capital gains from UK residential property. In April 2015, gains in respect of the disposal of UK residential property interests by certain non-residents, including closely-held non-resident companies, became chargeable to NRCGT.
The government is considering the change because it wants non-resident companies with property income to be subject to the new rules restricting tax relief for interest payments and changing the loss relief rules. It considers that the easiest way to do this is to move income from UK real property into the CT regime.
A new 'fixed ratio' rule is being introduced into the CT rules from 1 April 2017 to limit the tax relief available for companies in respect of interest payments. Tax relief for interest will be limited to 30% of profits chargeable to CT, excluding interest, capital allowances, tax amortisation and relief for losses. There will be a de minimis allowance for groups of £2 million a year.
Changes to the rules on the use of CT losses also apply from April. Carried forward losses arising from 1 April 2017 will be available to set off against the total taxable profits of a company and its group members but this is coupled with a restriction on the use of carried forward losses. All carried forward losses will only be available to set off against up to 50% of a company's (or their group's) profits above £5m.
Calculation of profits and use of losses
If the profits of a UK property business of a non-resident company are brought within the charge to CT, it is intended that general CT principles would apply to calculate the profits.
If a non-resident company with a UK property business is not already within the CT regime, its first CT accounting period would begin on 6 April of the year the changes come into force. There would be a deemed cessation of the UK property business at 5 April for the purposes of the charge to income tax. The government is considering how capital allowances would be dealt with, but its current thinking is to avoid the creation of balancing allowances or charges.
The basic rate of income tax is 20% but the rate of CT is 19% from 1 April 2017 and is due to reduce to 17% in 2020, so the change will mean a lower rate of tax for non-resident companies.
The CT computational rules differ from the income tax rules. Under the income tax regime, relief for interest accrued in the tax year is given as a deduction in calculating the net chargeable income. However, for CT, the profits of a property business are calculated without regard to interest. Credits or debits of loan relationships and derivative contracts are dealt with in separate provisions and any deficit calculated under the loan relationship and derivative contract regimes would then be deducted.
The loss relief rules also differ. Under CT, a UK property business loss (excluding a loss from a furnished holiday lettings business) can be offset against other CT profits of the company, for example if it also carried on trading activities in the UK through a permanent establishment. It can also be carried forward to set against total profits of future accounting periods, provided the UK property business continues.
Under the income tax rules the loss can be offset against other income only in limited circumstances and it can be carried forward to set only against profits from the same property rental business.
Bringing the property rental business of a non-resident company within CT would therefore allow losses to be set against other income of the non-resident company that is within CT for the current year or future years. However, most property business will be carried out through a special purpose vehicle which is unlikely to have trading income, so this advantage may be of little practical benefit.
If the changes go ahead, a non-resident company could also surrender its brought forward CT losses, (excluding those from furnished holiday lettings) and its non-trade loan relationship deficits as group relief to a related UK resident group company.
Although the change would technically bring added flexibility in the use of losses, the CT loss reform rules would mean that carry forward losses could only be set against 50% of the profits of a future accounting period, meaning that it may take longer to offset the losses against profits. In particular, if a property rental business commences after the CT rules begin, any pre-commencement costs may create a loss in year one, which could then trigger the more restrictive CT offset loss rules. There will be an annual allowance per group of £5 million profits which can be relieved in full, so this restriction would only impact on non-resident companies with significant losses from a property rental business.
Any unused losses from the UK property business at the deemed cessation of 5 April would have been computed under income tax principles. However, the government is not proposing that these losses be recalculated on CT principles. They would be carried forward against profits of the UK property business but would not be available to be surrendered as group relief or set against other CT profits of the non-resident company. The new 50% loss restriction rule would not apply to these losses. If the UK property business activity was to cease the income tax property losses would be immediately extinguished.
Bringing the property rental business of a non-resident company within the scope of CT will mean that they will become subject to the new interest deduction restrictions, which will limit deductions to 30% of EBITDA. The proposed rules provide for a de-minimis exemption of £2 million net interest. This limit is shared by the worldwide group, but a non-resident company with no group associates would be entitled to access the £2 million exemption in its entirety.
The new rules also provide an exemption for public infrastructure. To qualify, a company’s income and assets must be referable to activities related to 'public infrastructure assets' and the company must make an election. The company must also be fully taxable in the UK which means that every activity it carries on must be within the charge to corporation tax. Any building may be a 'qualifying infrastructure asset' if it is part of a UK property business and intended to be let on a 'short-term basis' to persons who are not related parties. 'Short-term basis' means having an effective duration of less than 50 years and not being considered a structured finance arrangement. There are further detailed conditions which must be fulfilled, which include that the creditor must not be a third party and its recourse must be limited to the income assets, shares or debt issued by a qualifying infrastructure company. Financial guarantees provided by parent companies or other group companies can prevent the exemption being available.
The government is keen to ensure that concerned that non-resident company will not be able to claim tax deductions for management expense which relates to non-UK investments. It therefore proposes limiting the deductibility of management expenses to those amounts which have been wholly expended for the purpose of managing the part of the investment property business which have a UK source and are within the charge to CT.
It proposes that if a non-resident company ceased to carry on a UK property business any unused property losses from the UK property business would not be carried forward as management expenses but would be extinguished – although they could be resurrected if the non-resident company later commenced a subsequent UK property business.
Non-resident landlord scheme
The government has said that it has no plans to alter the non-resident landlord scheme which requires tax to be deducted at the basic rate of income tax unless the landlord has obtained consent from HMRC for their UK property income to be paid gross. The government is not proposing to change the rate of deduction to the CT rate which will be less than the basic rate because it says that double tax treaties mean that most non-residents pay at a lower rate.
A response to the consultation will be published in the Autumn. If the government decides to go ahead with the changes it is not clear when they will come into force. The consultation is open until 9 June.
Most non-resident companies investing in UK property are unlikely to be significantly affected if the proposals are introduced. At a high level, the taxable profits of a property investment company are likely to be broadly similar under a corporation tax computation as on income tax principles. Although the loss relief rules in relation to corporation tax are more restrictive, property investment will generally not generate income losses unless the tenant in default. A more material issue for larger investors will be the application of the corporation tax loan relationship rules including the BEPS corporate interest restriction and hybrid provisions which could restrict interest deductions to a greater extent than under income tax principles.
John Christian is a real estate tax expert at Pinsent Masons, the law firm behind Out-Law.com
France Telecom: lessons for UK employers following 'institutional harassment' ruling