Business Tax and Investment Incentives

Corporation Tax

Capital allowances for small businesses

The rate of first year allowance for capital expenditure by small businesses on plant and machinery is increased from 40% to 50% for the period of one year from 1 April 2006 for companies and from 6 April 2006 for businesses subject to income tax.

Research and development (R&D) tax credits

Two changes are proposed to the existing rules relating to R&D tax relief and vaccines research relief:

• the period for claiming an enhanced deduction for R&D expenditure is to be aligned to the time limit for R&D tax credits and becomes the first anniversary of the filing date for the company’s corporation tax return. Transitional rules will apply to enhanced deduction claims for accounting periods ended before 31 March 2006. These claims will need to be made by the earlier of the current time limit for claims (six years after the end of accounting period in which the claim is made) and 31 March 2008;
  
  
• the definition of R&D qualifying expenditure is to be extended to include payments made to clinical trial volunteers. This will apply to expenditure by large companies from 1 April 2006 and for SMEs from when state aid approval has been received by the Government from the European Commission (EC).

The Government also intends to provide additional support to firms with between 250 and 500 employees through the R&D tax credits system. Details of the proposals will be published later in the year following state aid discussions with the EC.

Venture capital schemes

The Chancellor has announced significant changes to the Enterprise Investment Scheme (EIS), the Corporate Venturing Scheme (CVS) and the Venture Capital Trust Scheme (VCT). For EIS investors, the annual investment limit for income tax purposes is doubled to £400,000. Investors in VCTs will now only benefit from income tax relief at 30% (currently 40%). Another change is the reduction in the maximum size of companies able to raise money under the EIS, VCT and CVS schemes; this is reduced to £7 million before the investment and £8 million afterwards (‘the gross assets test’). This is a major reduction from the previous limits of £15 million before and £16 million afterwards.

However, the Chancellor has increased the minimum holding period for VCT investments from three to five years. All of the above changes take effect from 6 April 2006 except that the new gross assets test will not apply in relation to sums raised by VCTs prior to 6 April 2006 nor to EIS or CVS shares subscribed for before 22 March 2006.

The meaning of ‘investment’ under the VCT legislation has been changed in that with effect from 6 April 2007, a VCT must have 70% by value of its investments represented by qualifying holdings and no more than 15% of that total investment in any single company. This will mean that any money held by a VCT after 6 April 2007 will be treated as an investment.

Film tax relief

The Chancellor has chosen this year to reform film tax relief rather than extend the previous relief which will continue to apply to those films which commenced principal photography on or before 31 March 2006, provided the film is completed before 1 January 2007. The existing relief will also continue to apply to films acquired before 1 October 2007.

The new relief will apply from 1 April 2006 to UK film producing companies (FPCs) incurring expenditure on the production of British films. Each film will be treated as a separate trade for tax purposes. The new rules will provide a deduction on a maximum of 80% of total UK qualifying expenditure (which must in turn be at least 25% of total production expenditure). An additional deduction of 100% will be due for films with total qualifying production expenditure (QPE) of £20 million or less, 80% otherwise. Where this results in a loss, this can be surrendered for a tax credit, payable at 25% for films with up to £20 million of QPE and 20% for all other qualifying films.

Group relief

Following the European Court of Justice decision in the case of Marks and Spencer plc v Halsey in December 2005, the Government is to legislate to bring the group relief legislation into line with EC law. The new relief will apply from 1 April 2006 where a UK parent company has a foreign subsidiary (including an indirectly held subsidiary) which has incurred a foreign tax loss that is unrelievable in the home state (or elsewhere) and where that subsidiary is either resident in the EEA or has incurred the losses in a permanent establishment in the EEA.

The foreign losses will be relievable against UK profits only where all possibilities of relief have been exhausted and future relief is unavailable in the country where incurred or in any other country.

The foreign tax loss will need to be recomputed under UK tax principles. The UK claimant company will need to be able to demonstrate that the losses meet all the relevant conditions of the legislation.

Anti-avoidance rules have already been pre-announced to apply from 20 February 2006 to prevent loss relief where arrangements are made either to prevent foreign losses being made unrelievable outside the UK, where they otherwise would have been relievable or where foreign losses are generated that would not have existed but for the availability of relief in the UK and where the main purpose or one of the main purposes of those arrangements was to obtain UK tax relief.

Corporate capital losses

As announced in the 2005 Pre-Budget Report, anti-avoidance legislation effective from 5 December 2005 is being introduced to prevent schemes or arrangements aimed at gaining a tax advantage from capital losses. This legislation is aimed at preventing:

• the contrived creation of corporate capital losses
• the buying of capital gains and losses; and
• the conversion of income streams into capital gains and the creation of a capital gain matched by an income deduction, where the gains are then wholly or partly covered by capital losses.

Charities

The existing legislation only exempted charities from tax if the trade was carried on as a primary purpose of the charity or it was carried on by the charity’s beneficiaries. In many cases however, the trade of a charity became mixed with a non-exempt trade so that the tax exemption would become ‘tainted’ and leave the charity potentially exposed to tax on the trade as a whole. This problem has now been overcome by introducing a new measure which allows a trade to be split and the profits apportioned between the exempt and taxable activities. Up until now HM Revenue & Customs has usually agreed to split the activities into separate trades but this approach was not strictly supported by case law and always left charities potentially exposed. The new measure which takes effect for chargeable periods commencing on or after 22 March 2006 will remove the previous uncertainty.

This Budget has also tried to address the misuse of charitable funds and reliefs both by individuals and companies. The anti-avoidance provisions announced on Budget Day will tackle these abuses in three ways. The first will be to restrict the dealings that a charity can have with its substantial donors who are defined as those giving £25,000 or more in a single twelve month period or £100,000 or more over a six year period. ‘Dealings’ has a fairly wide meaning and involves the majority of commercial transactions, payment, exchanges, remuneration and investments. A breach of the rules may involve withdrawal of tax relief from the charity.

The second anti-avoidance measure is to introduce a direct link between non-charitable expenditure incurred by a charity and a loss of tax relief on a pound for pound basis. Lastly the present legislation restricts the benefits which individuals and close companies can receive as a result of making a gift to a charity. A new anti-avoidance provision will apply the same restrictions to gifts made by non- close companies. These anti-avoidance measures take affect on or after 22 March 2006 except for the third measure which will affect donations to charities made on or after 1 April 2006.

Taxation of leased plant and machinery

Legislation is to be introduced, applicable from 1 April 2006, to align the tax treatment of plant and machinery which is leased or acquired with other forms of finance. The legislation will apply to leases to be known as ‘long funding leases’. It will not apply to leases of less than five years’ duration and to leases of between five and seven years, where certain conditions are met.

The new tax treatment applying to long funding leases will be:

• the lessor will be taxed on the proportion of the rental income that reflects the financing charges and will not be able to claim capital allowances;
• the lessee will be able to claim capital allowances and receive a deduction for that part of the rentals relating to the finance element.

The proposed legislation will include provisions for certain transitional arrangements, companies within tonnage tax and for elections by lessors to apply the legislation to leases not exceeding £10 million in value.

Miscellaneous and anti-avoidance

The Treasury has been watching the activity of leasing companies for some time and has been aware that these companies are commonly set up within a wider group context so that capital allowances can be used to mitigate other group companies tax liabilities. A new measure has therefore been introduced to crystallise this deferred tax by recovering the full benefit of the capital allowances claimed when the leasing company is sold. The sale will trigger the end of an accounting period and the tax will crystallise. In compensation, the company will be given an equal amount of tax relief in the next accounting period. This applies where changes in economic ownership of lessor companies occur on or after 5 December 2005.

Where a subsidiary company of a UK company became non-resident in the UK for tax purposes before 1 April 2002 as a result of the operation of a double tax treaty, with effect from 22 March 2006 that company will be brought within the controlled foreign company legislation under certain circumstances.