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March 9, 2011

The last few months have been significant in the world of Corporate Tax with the introduction of measures intended to make the UK’s system of taxation fairer, flatter, simpler and more competitive on the international stage under the snappily titled, “Corporate Tax Reform; delivery of a more competitive system” (the DNA of which goes back to a large extent to the 2005 Forsyth Tax Reform Commission).

A number of major policy proposals designed to benefit businesses with operations in the UK underpin the commitment (along with some counter measures that should also be considered):

  • An annual commitment, commencing in April 2011, to reduce the headline rate of corporation tax from its current level of 28 per cent to 24 per cent by April 2014 – giving the UK the lowest rate in the G7. Whilst a lower rate does not necessarily mean lower effective taxation (the move to a flatter system – e.g., by reducing allowances – will negate, to some extent and for certain taxpayers, the benefit of lower rates), there is plenty of evidence that the headline rate can be a compelling factor in the decision of where to invest. There is also evidence (see the experiences of Ireland, Australia and New Zealand – albeit, at different times) that reducing rates does not necessarily reduce tax revenues and can cause an increase. The fact, however, that the Government did not feel completely confident, politically or economically, in this hypothesis is borne out by the fact that it didn't drop the rate immediately to 25 per cent as had been set out in its manifesto.
  • To help pay for the cuts, the rate of the main annual capital allowances (tax depreciation) on capital spending will be reduced from its current level of 20 per cent to 18 per cent in the spring of 2012. This reflects the view that specific reliefs, which only benefit certain taxpayers, should be reduced and that moving to a “flatter” tax system is preferred (all businesses should benefit from the corporate tax rate cuts).
  • The UK Controlled Foreign Companies (“CFC”) regime (seen by many as “gold plated”) has long been regarded as a significant disincentive to international groups choosing the UK as a holding company jurisdiction (despite the other benefits of the UK, such as the weather) and the main reason why a number of high profile companies have left the UK in recent years. The new proposals (essentially to “territorialise” the taxability of earnings – also to be adopted in relation to the taxation of foreign branches – and to streamline the CFC compliance procedure) are designed to counteract the exodus. Consultation is now underway on the proposals with a view to the publication of draft rules in spring of 2011 and legislation in autumn of 2011. Provided the spirit of the proposals survive the ingrained HMRC / Treasury concern about avoidance, this could be one of the most significant developments in UK corporate tax for many years to come.
  • With a similar rationale to the CFC proposals is the announcement, with effect from spring of 2013, of a 10 per cent “Patent Box” regime for UK Intellectual Property (“IP”). In addition, there will be provisions in the new CFC rules that would essentially result in only profits from IP, which were “artificially” diverted from the UK, from being taxed in the UK.  The true significance of this is likely to depend on how the concept of “artificiality” is ultimately defined in the legislation but it could, again, provide a serious fillip to the maintenance and establishment of businesses in the UK.
  • A commitment has been made providing stability for corporate taxpayers in relation to new tax legislation. New tax law will, in the future, be put forward only (except where loopholes need to be closed quickly) following proper consultation and scrutiny.
  • Finally, despite considerable speculation, the Government has decided not to extend the concept of territoriality to the UK’s very generous interest deduction regime and has decided to maintain (and probably enhance) research and development tax credits. Both decisions again reinforce the Government’s stated intention to make the UK the obvious home for major corporates. A sigh of relief will have been heard in boardrooms across the country – particularly, in relation to interest relief.

In summary, there is firm commitment to improve the UK corporate tax regime. However, the decision to locate operations in the UK is also swayed by personal tax factors; whether flagged changes to the “non-domiciled” regime, coupled with the 50 per cent income tax for higher rate taxpayers and significantly increased capital gains tax, will derail this corporate tax initiative remains, however, to be seen. Interestingly, the US has recently issued proposals to reduce its headline rate and move to a more territorial based system, so we may well soon be able to compare and contrast the fortunes of the two jurisdictions.

Footnote
Stephen Machin was the Commissioner primarily responsible for business taxation.

Author:
Stephen Machin
Managing Director
London
Telephone: (+44) 207.663.0762

Marcus Nicolaou
Director
London
Telephone: (+44) 207.715.5222
 

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