2008 Budget Overview

The Chancellor of the Exchequer, Alistair Darling, delivered his first budget on Wednesday 12 March 2008.

As expected, most of the announcements merely confirm changes which had previously been outlined by the controversial 2007 Pre-Budget Report (which have already been extensively reported in the press). In addition and as widely anticipated, many of the changes announced in Budget Press Releases are intended to close tax loopholes that have been brought to the attention of HM Revenue & Customs ("HMRC") through the disclosure of specific tax avoidance schemes.

In the wake of a slow in the housing market and the rising cost of living, coupled with the threat of recession and increasing public debt, it is perhaps unsurprising that the Budget contained very little that we did not already know about, and indeed included a number of changes to the proposed reforms that had been previously announced.

It is also, perhaps, unsurprising (if disappointing) that, despite widespread lobbying, there was no backtracking (or grandfathering) in respect of possibly the most controversial change to the tax regime in recent years, namely the abolition of taper relief and the introduction of a flat rate of 18% capital gains tax ("CGT"), announced in the Pre-Budget Report.

The detailed HMRC Press Releases in respect of the 2008 Budget can be found at http://www.hmrc.gov.uk/budget2008/index.htm. However, we have set out below a brief summary of some of the key headline changes that were announced.

Residence and Domicile

The rules in general

The Chancellor has provided some additional information and details, and has announced some further changes, to the new rules designed to expand the scope of income and gains subject to UK taxation for UK resident, non-UK domiciliaries. The proposals for these new rules were announced in the Pre-Budget Report and released in draft form on 18 January 2008 (for further details, please click here to read our Note).

Following widespread public condemnation of the proposed scope and extent of the proposed new rules as announced in the Pre-Budget Report, and the apparent haste with which they had been compiled, the Chancellor has effectively back-tracked on many of the proposals relating to the future taxation of non-domiciled residents in the UK.

The principle changes to the proposed regime as announced in the Pre-Budget Report and outlined in the January release appear to be that:

non-UK resident trustees will be able to elect to rebase the value of the trust assets at 6 April 2008. If this election is made, it will have the effect of cancelling out any pre-6 April 2008 "gain" from being taxed on the non-domiciled beneficiaries of such trusts;
capital gains realised by non-UK resident trustees pre-6 April 2008 will not be taxable on non UK domiciled beneficiaries who receive capital payments after 5 April 2008;
income and gains realised by offshore trusts will only be taxed when remitted to the UK, even if they derive from UK situated assets;
where a non-domiciled individual elects to be taxed on a remittance basis and pays the £30,000 annual charge, there will be a credit against foreign tax for that £30,000;
art work brought to the UK for public display or repair will not be treated as taxable remittances;
there will be exemptions from the taxation on a remittance basis of money, property and services derived from foreign income;
more limited scope for an individual being charged on a remittance where others benefit from the individual's foreign income and gains (this is now limited to the individual's "immediate family" - effectively spouses, civil partners, individuals living together as spouses or civil partners and their children or grandchildren under 18);
non-UK domiciled individuals with less than £2,000 unremitted offshore income and gains within a particular tax year (it was originally £1,000) will be exempt from the £30,000 annual charge and can retain their personal allowances;
art work sold by offshore trusts in the UK will only be taxable if the trust remits the gain to the UK.
Whilst these changes seem positive and are certainly to be welcomed, the real implications will only be known once the detail of the draft legislation has been considered, and as this has not yet been published, some uncertainty remains. Notwithstanding this, the Chancellor confirmed that the new rules shall have effect from 6 April 2008.

The Residence Test and Day Counting Rules

It was widely anticipated that the Budget would confirm changes to the way days are counted for the purposes of the UK residence test and it has now been confirmed that, from 6 April 2008, any day where an individual is present in the UK at midnight will be counted as a day of presence in the UK for residence test purposes. In other words, it will now be necessary to count the nights spent in the UK for these purposes.

This change tightens up the previous rule whereby an individual would not be required to count any days of arrival into and departure from the UK for the purposes of the day test. However, the new rule (which applies regardless of whether the nights counted are in respect of days of arrival and departure) is slightly more generous than indicated by the pre-Budget Report, which indicated that all such days of arrival and departure would count for these purposes.

From 6 April 2008, there will also be an additional exemption for days spent in the UK by passengers who are in transit between two places outside the UK. Such days will not be counted for the purposes of the residence test (even if they involve being in the UK at midnight) so long as, during transit, the individual does not engage in activities that are to a substantial extent unrelated to their passage through the UK. This is designed to prevent individuals abusing the system by carrying out business activities in the UK during a day of transit here (although how this aspect is to be monitored in practice is beyond the author's comprehension).

New Offshore Funds Tax Regime

New legislation will allow regulations to be made dealing with the taxation of investors in offshore funds and the rules for allowing certain funds to be classed as "reporting funds". A reporting fund is, broadly, a type of offshore fund which allows favourable (capital as opposed to income) tax treatment for its interest holders.
The current offshore funds rules provide that the relevant fund must be assessed annually in order to be classified as a "reporting fund" and impose various restrictions upon their operation. It is expected that the new regulations will relax some of these restrictions and remove the annual assessment obligation.

We await the publication of these new regulations.

Entrepreneurs' Relief

In accordance with the draft legislation issued by HMRC on 28 February 2008 a new "entrepreneurs' relief" was confirmed by the Chancellor with effect from 6 April 2008.

Entrepreneurs' relief will, broadly, be available in respect of gains made by individuals on the disposal of shares or assets of a company in respect of a business carried on by the individual (either alone or in partnership). It will apply where the individual has held such shares or assets throughout a period of one year ending with the date of the disposal, and during such time:

the individual has owned at least 5 per cent of the ordinary share capital of the relevant company and be able to exercise at least 5 per cent of the voting rights in such company;
the individual has been an officer or employee of the company; and
the company has been a trading company.

An individual will be able to make claims for relief on more than one occasion, up to a lifetime total of £1 million of gains qualifying for relief. These qualifying gains will be subject to CGT at an effective rate of 10% (with gains in excess of £1 million being charged to CGT at the new flat rate of 18%).

The Chancellor's announcement in respect of entrepreneurs' relief contained no surprises and merely provides an explanation as to the operation of draft legislation, which has already been published.

Restrictions on Trade Loss Relief for Individuals

Individuals carrying on a trade can, subject to certain restrictions, set off their trading losses against other income and gains. This is commonly known as "sideways loss relief".

Last year, HMRC announced that sideways loss relief would be widely restricted in the context of partnerships, primarily to target participants in what HMRC considered to be film partnership tax avoidance schemes. However, in HMRC's view this restriction prompted the exploitation of various new tax avoidance schemes involving individuals acting other than in partnership, which were a variation of the partnership structures.

As a result of the disclosure to HMRC of these new so called "sole trader" schemes, legislation will now be introduced in the Finance Bill 2008 to extend the restriction that already applies to partnerships, to individuals.

Under the new provisions, the amount of sideways loss relief that can be claimed by an individual carrying on a trade in a "non-active capacity" will be restricted to an annual limit of £25,000 in respect of the trade carried on by that individual. Moreover, where a loss arises to an individual carrying on a trade in a non-active capacity as a result of tax avoidance arrangements no sideways loss relief at all will be available for that loss.

For these purposes, an individual carries on a trade in a non-active capacity where such individual spends an average of less than 10 hours per week engaged in the activities of the relevant trade.

These changes have effect on and after 12 March 2008.

Enterprise Management Incentives ("EMI")

New rules are being introduced in respect of the conditions which must be satisfied by companies wishing to offer EMI share options to their employees.

Currently, in order to qualify for EMI status, a company must, broadly, be independent, have only subsidiaries which are 51% owned, and have gross assets of no more than £30 million.

However, to ensure compliance with EU State Aid guidelines, only companies with fewer than 250 employees will now be able to grant qualifying EMI options to their employees. This change will have effect in respect of options granted on or after the date upon which the Finance Bill 2008 receives royal assent.

In addition to the above change, regulations will also be made to increase the individual employee limit on grants of qualifying options. Currently, an individual employee may not hold qualifying EMI options over shares with a total market value of more than £100,000 (taking into account for these purposes Company Share Option Plan options also granted to them). This threshold will be increased to £120,000 in respect of options granted on or after 6 April 2008.

This increase in the qualifying options threshold is welcomed, and whilst it does not compensate for the fact that one of the key tax advantages of EMI options has been reduced with the abolition of taper relief and introduction of a flat rate of 18% CGT, EMI options will remain an attractive way of incentivising employees, as any gains made in respect of the underlying shares will still be within the charge to CGT rather than income tax, and (broadly speaking) will only brought into charge upon the sale of the underlying shares rather than on exercise of the option.

Employment related securities

Employees with shares who are UK resident, but not ordinarily resident for tax purposes will from 6 April 2008 be treated in the same was as UK resident, UK ordinarily resident individuals.

Enterprise Investment Scheme ("EIS")

The limit on the amount which can be invested in an EIS qualifying company by an investor in any given tax year is being increased from £400,000 to £500,000.

This change is subject to state aid approval by the European Commission, but is intended to have effect on or after 6 April 2008.

Stamp Duty: Changes to loan capital exemption

Transfers of loan capital are currently exempt from stamp duty unless the right to interest on such loan capital is determined to any extent by the results of a business or value of any property.

New legislation is being introduced which will provide that, even where the right to interest on such loan capital is determined by the results of a business or value of any property, it will, nevertheless qualify for the exemption from stamp duty if it is also subject to a capital market arrangement on limited recourse terms.

Harbottle & Lewis LLP
12 March 2008

This note and is intended as general guidance only and does not constitute legal advice. It should not be relied upon in the absence of specific advice relevant to your particular circumstances and/or tax profile.