2003 Pre-Budget Report

PN 5

10 December 2003

A COMPETITIVE AND MODERN BUSINESS TAX SYSTEM

A package of measures to strengthen the UK's competitive business tax regime, was announced by the Chancellor today. The measures, which promote investment, growth and fairness, will build a tax system that recognises the realities of the modern business world.

The Paymaster General, Dawn Primarolo, said:

    "The measures announced today will ensure that the UK has a fair and competitive tax system that recognises the challenges of today's business environment. They will advance the Government's vision of a modern and efficient tax system that supports commercial decisions and promotes economic efficiency and productivity while keeping pace with European and international developments."

The Government is considering the issues raised in response to the August 2003 consultation on corporation tax reform and looks forward to continuing the dialogue with business. Two measures have been identified as priorities for reform, and are announced today:

  • the extension of relief for the expense of managing investments to companies that do not qualify as investment companies, removing outdated and unnecessary restrictions that currently cause some companies to adopt uncommercial structures in order to obtain relief; and
  • reform of the transfer pricing and thin capitalisation rules and a package of measures to mitigate the impact of the extension of the current rules particularly for smaller businesses.

To promote investment and simplify the tax system, the Pre-Budget Report announces:

  • changes to the tax rules for offshore funds to enable a wider range of investments in offshore funds to meet the rules for "distributor" status;
  • measures to ensure that companies choosing to adopt International Accounting Standards (IAS) to draw up their accounts receive broadly equivalent tax treatment to companies that continue to use UK GAAP (UK Generally Accepted Accounting Practice);
  • publication of draft amendments to the legislation on the taxation of corporate debt to assist companies in administration, administrative receivership, and liquidation; and venture capital funds investing in close companies;
  • implementation of the Interest and Royalties Directive from 1 January 2004, removing source state taxation of payments made between associated companies in the EU and a consultation on introducing a definition of `UK source' for the purposes of deducting tax from payments of interest and royalties;
  • the introduction of an exploration expenditure supplement so that the full value of the 100 per cent exploration and appraisal allowance for new North Sea companies is maintained over time; and
  • changes to facilitate the introduction of the European Company Statute which comes into effect from 8 October 2004.

DETAILS

Corporation tax reform - relief for the expense of managing investments

The Government will extend corporation tax relief for the expenses of managing investments by lifting the requirement to qualify as an investment company from 1 April 2004. This measure was widely welcomed in the Corporation Tax Reform consultation. This will benefit companies by:

  • removing an outdated restriction that creates difficulties for some groups. Up to now, many groups have had to introduce extra companies in order to create investment companies that do not themselves have trades. This layer of complexity will be removed; and
  • facilitating group re-structurings, which may be desirable for commercial reasons and may help to reduce the administrative impact of the transfer pricing changes.

Corporation tax reform - transfer pricing and thin capitalisation

Transfer pricing and thin capitalisation rules exist to ensure a fair division of profits between related entities. The transfer pricing rules require transactions between related enterprises, such as companies within the same group, to be priced as if they had been between enterprises dealing at arm's length. If a transaction would not have taken place at all between unrelated enterprises, then it can be treated for tax purposes as if it had not occurred. The thin capitalisation rules deny a tax deduction for excessive interest payments between certain related parties.

The UK's transfer pricing and thin capitalisation legislation generally only apply where one party to a transaction is outside the UK. Some doubts have been expressed as to the interaction of these rules with European law. While the Government does not accept that there is any incompatibility, it recognises the importance for business of certainty in tax law. The measures announced today will remove any uncertainty by extending the scope of transfer pricing rules to transactions within the UK from 1 April 2004. The thin capitalisation legislation will be repealed, and the transfer pricing rules will be adapted to enable them to undertake the same role.

This change would, if made in isolation, increase administrative burdens. Therefore the Government is implementing measures to mitigate the effect, including:

  • an exemption for small and medium sized businesses to ensure that over 95 per cent of businesses do not have to worry about transfer pricing when making a tax return;
  • to protect tax revenue, the rules will be retained for transactions with certain overseas territories and, for medium sized businesses, the Inland Revenue will retain a reserve power to apply the rules in exceptional cases justified by significant tax at risk;
  • a relaxation of the penalty regime for a transitional period of two years to give businesses time to adjust to the new rules;
  • steps to ensure that the new rules will not result in double taxation. Every adjustment to the taxable profits of one party to a transaction will be matched by a compensating adjustment for the other party, to ensure that both are taxed on a consistent basis. Special rules for loan guarantees and accrued interest will ensure that normal commercial lending arrangements will not be disturbed by the extension of the transfer pricing regime; and
  • new guidance on both the Inland Revenue's risk-assessment strategy and on documentation requirements, helping business to reduce the cost of tax compliance and the documentation that they need to keep to comply with transfer pricing rules.

Draft legislation and a summary of responses to the consultation on the management expenses and transfer pricing changes can be found on the Inland Revenue website.

Offshore Funds Reform

The Government intends to introduce changes in the 2004 Finance Bill to the taxation rules for offshore funds. These will amend the rules that determine whether investments in offshore funds can be treated as investments in "distributing" funds, so that UK resident investors in offshore funds will, in a wider range of circumstances, be charged to tax in the same way as an investor in an equivalent UK fund.

Tax and accounting (IAS and UK GAAP)

The Inland Revenue is continuing to work with consultative groups to look at the detail of IAS and of complementary changes to UK GAAP that will apply in 2005. As a result of work done so far 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;
  • ensure the R&D tax rules continue to allow the special reliefs and credits in the year in which expenditure is incurred, whatever the accounting treatment;
  • continue the current tax treatment of most hedging arrangements using derivative contracts and foreign currency liabilities; and
  • amend the corporate debt and derivative contracts legislation to reflect the changes made by IAS 39 and complementary revisions to UK Accounting Standards.

North Sea exploration

Budget 2003 launched a consultation to examine the reasons behind current low levels of oil and gas exploration, such as the concerns of some companies that they will not be able to gain access to infrastructure on appropriate terms and the need to continue to free up certain licensed acreage. To encourage exploration and

appraisal activity by companies new to the North Sea the Government will introduce an exploration expenditure supplement. The supplement will ensure that the full economic value of the current 100 per cent allowance is maintained over time Full details will be announced at Budget 2004.

European Company Statute

The European Company Statute is an EU Regulation which permits the setting up of a new kind of corporate entity, the European Company or Societas Europaea (SE). The SE is a legal vehicle for entities with a presence in more than one EU member state. Although the Regulation does not mention tax, some technical tax changes may be necessary to facilitate the formation of SEs and to make sure the UK is an attractive environment for SEs to set up.

The Inland Revenue is currently following in the steps of the DTI consultation on the UK company law changes required by the Regulation. The Government will publish draft clauses in the New Year to enable the European Company Statute to be accommodated within UK tax law, with a view to including the necessary legislation in Finance Bill 2004.

HM TREASURY PRESS OFFICE

Press enquiries: 020 7270 5238

Non-media enquiries: 020 7270 4558

INLAND REVENUE PRESS OFFICE

Press enquiries: 020 7438 6692 / 6706 / 7327

(out of hours: 07860 359544)

Non-media enquiries: 0845 300 3939

(office hours only)

HM CUSTOMS AND EXCISE PRESS OFFICE

Press enquiries: 020 7865 5095/5471 or 020 8929 4637

(out of hours:020 7620 1313)

GOVERNMENT DEPARTMENT INTERNET SITES

Further information and all published documents relating to the Pre-Budget Report may be found on the Internet at the following addresses:

HM Treasury www.hm-treasury.gov.uk/index.cfm

Inland Revenue www.inlandrevenue.gov.uk

HM Customs and Excise www.hmce.gov.uk

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