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.
Consultation continues with a view to:
The government has identified two issues as particular priorities for reform and intends to introduce legislation with effect from 1 April 2004:
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.
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.
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:
It is also intended that the Inland Revenue will publish guidance in support of the revised R&D definition.
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.
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.
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
|
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.
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 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:
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.
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:
The original proposals were to be introduced in April 2005 but implementation has been deferred to April 2006.
New measures have been announced to take effect from April 2005 as follows: