Although there were limited major tax changes affecting the transaction environment, the principal driver of new transactions may well prove to be the improving sentiment towards the UK’s economic outlook.
Whilst this Budget may have lacked any significant changes compared to more recent statements, it did provide some encouraging signs for those involved with transactions. The indications are that the UK will narrowly avoid a technical recession in 2023. The Chancellor further announced that the Office for Budget Responsibility has forecast that inflation is expected to reduce significantly from current rates of 10.1% down to 2.9% by the end of 2023.
Given this backdrop, it will be interesting to see how these expectations of lower than anticipated inflation filter through to monetary policy in the UK, and the corresponding impact on financing costs in a leveraged buy-out context.
Tax changes directly impacting the transaction environment were limited. There were no significant proposed changes to the capital gains tax regime for shareholders, although a new elective accruals basis for carried interest may provide welcome additional flexibility to access overseas tax relief for some investment managers. There were no changes to the previously announced increase in the main corporation tax rate to 25%. However, within the Chancellor’s pro-enterprise agenda, there were some proposals included that may impact the timing of cash tax payments, which should be taken into account when undertaking tax modelling on future deals.
Where a business invests in fixed assets, full expensing, which replaces the super-deduction, will allow companies to fully expense new main rate assets for a period of three years starting from 1 April 2023. Given that the increase in the main rate of corporation tax to 25% takes effect from 1 April 2023, under this new regime businesses will obtain up front relief worth 25p on every £1 invested, accelerating cash tax benefit that would otherwise unwind on an 18% reducing balance basis over many years. Importantly, the proposed full expensing rules will be in place until 1 April 2026 only, notwithstanding that the Chancellor expressed a desire to make the measure permanent in the future. This establishes a set period of time to benefit from full expensing and consequently consideration should be given towards the timing and funding of significant capital expenditure projects by those already holding investments and those considering potential further acquisitions. For further commentary on the proposed introduction of full expensing, see `below.
There was also a further change to the Research and Development (R&D) regime for R&D intensive small and medium enterprises (SMEs) with an enhanced R&D credit. This is welcome news given the previously announced changes to the R&D scheme that negatively impacted SMEs. Again, the need to consider this as part of any due diligence exercise and cash flow modelling will be important and require specialist advice to confirm eligibility to receive the enhanced benefit. For further commentary on the proposed changes to the SME R&D regime, see below.
Finally, the Budget contained some limited updates to the qualifying asset holding company (QAHC) regime, intended to align access to the regime with the intended potential beneficiaries. Amongst other minor changes, the rules will clarify that a securitisation company cannot also be a QAHC; will provide for an election to treat listed investments as unlisted so that access to the regime is not prevented in relevant situations; and will ensure that the capital gains exemption operates as intended in the situation where a QAHC invests in a derivative with an underlying subject matter of shares. The fact that the Government continues to refine the scheme demonstrates its commitment to the regime, and the broader desire to ensure that the UK is a first choice holding location.
Given the Chancellor’s restricted scope for major tax changes, those provided affecting the transaction environment were always going to be limited. Whilst there are some technical changes, the principal driver of new transactions may well prove to be the improving sentiment towards the UK’s economic outlook.
New full 100% expensing regime for capital expenditure on qualifying assets
From 1 April 2023, companies will be able to claim 100% and 50% first year allowances for qualifying capital expenditure on new main rate and special rate plant and machinery expenditure, respectively.
The Spring Finance Bill 2023 will include measures allowing companies to fully expense capital expenditure on new main rate plant and machinery, for a period of three years starting from 1 April 2023. Under this regime, businesses will save 25p on every £1 invested, so a 25% cash tax saving. The 50% first-year allowance for expenditure on new special rate and long-life assets has also been extended.
Both measures will be in place until 31 March 2026, with the intention to make the measures permanent when fiscal conditions allow.
In addition, measures first announced in the Autumn Statement 2022 will be legislated by the Government. This extends the first-year allowance on electric vehicle charge points by two years to 31 March 2025 for corporation tax, and 5 April for income tax. It also extends the £1 million Annual Investment Allowance indefinitely.
The introduction of full 100% expensing for capital expenditure on qualifying plant and machinery will be welcomed by companies, particularly given the end of the current super deduction which coincides with the increase in the corporation tax main rate to 25% from 1 April 2023. The intention to make this a permanent feature will also be well received and provide businesses with some certainty in undertaking investment decisions.
It is disappointing the relief is only available to companies within the charge to corporation tax and excludes individuals and partnerships containing individuals.
This is potentially a missed opportunity to better align the capital allowances regime with the Government’s wider strategies, particularly as investment decisions made now will impact the UK’s ability to meet its net zero target by 2050.
Whether or not this type of blanket untargeted relief provides the best return for both the Government and taxpayers is also debatable. The Government had stated that the previously introduced super deduction was costly to operate, and it is difficult to see how the introduction of full expensing will provide much better value for money.
When will it apply?
From 1 April 2023.
Reforms to research and development tax reliefs
A new increased research and development (R&D) tax credit rate for highly innovative loss-making SMEs has been introduced. Previously announced restrictions to overseas expenditure will be delayed a year.
Major reforms have been announced to both R&D relief schemes previously. Most of these changes will take effect for accounting periods commencing on or after 1 April 2023.
The Chancellor announced today, however, that R&D intensive loss-making SMEs with qualifying R&D expenditure worth 40% or more of total expenditure for an accounting period will qualify for a higher tax credit of 14.5%. This will give qualifying loss-making companies a cash credit worth £27 for every £100 spent and negates the impact of the reduction in rates of relief for companies claiming under the existing SME scheme.
The Government also previously announced restrictions on the inclusion of overseas expenditure, but these measures have been delayed by a year, and will come into effect from 1 April 2024.
Other R&D tax reforms include:
- Categories of qualifying expenditure to include both cloud computing services and data licences
- The definition of R&D has been extended to encompass both pure mathematics and mathematical activities that contribute to R&D projects in other fields of science and technology
- Using new digital forms, companies will be required to both notify HMRC of the intention to make an R&D claim, if they had not made a claim before; and
- From August 2023 companies must provide additional information when making R&D claims, to assist HMRC with compliance checks
The Government is considering responses to the consultation on the form of a single R&D scheme to merge the SME and RDEC regimes, with draft legislation for a merged scheme expected to be released in Summer 2023 for technical consultation.
HMRC is also due to provide more accurate estimates of error and fraud to the Public Accounts Committee by summer 2023, along with a clear action plan to reduce error and fraud. Any further measures to combat this error and fraud will be announced thereafter.
We support the Government’s intention to combat error and fraud within the R&D regimes; however, it is our view that reforms announced in the Spring Budget 2023 will be ineffective in targeting fraudulent claims and in addressing the limitations with HMRC’s compliance processes.
While the enhanced relief for R&D intensive loss-making SMEs provides a welcome respite for those that meet the thresholds, it will result in a yet greater compliance burden for HMRC to ensure claimants are accurately meeting the 40% threshold.
We welcome the delay in implementing the restriction on claiming costs on overseas workers. While we support the intention to incentivise UK employment and activities, additional time is required to enable companies to prepare for this significant change and to enable the Government to further consider feedback from industry and advisors on this issue.
When will it apply?
The new regime for R&D intensive SMEs will come into effect on 1 April 2023.
The previously announced changes on R&D reform will take effect for accounting periods commencing on or after 1 April 2023, except the requirement to provide additional information which will apply to all claims made on or after 1 August 2023. Draft legislation is expected to be published summer 2023 on the merging of RDEC and SME regime with final measures currently planned to be implemented April 2024.
Changes to the genuine diversity of ownership condition for investment funds
Separate legal entities within investment fund structures will be able to meet the genuine diversity of ownership (GDO) condition providing that they form part of a GDO qualifying multi-vehicle arrangement, otherwise investors cannot benefit from certain tax benefits.
A number of tax regimes include a condition for GDO. Such regimes include:
- Qualifying asset holding companies (QAHC)
- Real estate investment trusts (REIT)
- Non-resident chargeable gains (NRCG)
The intention of the GDO condition is to prevent investment funds that are open only to a small number of predetermined investors from obtaining the tax benefits of these regimes.
The GDO condition as currently legislated requires each separate legal entity within a fund to be considered in isolation. This can mean that an entity within a wider fund arrangement does not qualify for one of the regimes above, although the wider arrangement could meet the GDO requirements when taken as a whole.
The Spring Finance Bill 2023 will amend the GDO condition to allow an individual entity to satisfy the condition where it forms part of a GDO qualifying multi-vehicle arrangement, which an investor would reasonably regard their investment to be in.
Fund structures can often involve a number of legal entities for a range of legal, regulatory, commercial and financial requirements. The relaxation of the strict GDO conditions is a positive move and supports the original intention of the policy while allowing funds a degree of flexibility in their choice of structure.
When will it apply?
From Royal Assent of the Spring Finance Bill 2023.
New elective accruals basis for taxation of carried interest
The Government will legislate to allow investment managers who receive carried interest to elect to be taxed on an accruals rather than receipts basis. This will assist with claims for credit for non-UK tax paid on the carried interest.
Individuals working in private equity are typically rewarded in part through ‘carried interest’, which is a capital entitlement due to them as a result of successful investments by the funds for which they provide investment management services.
In the UK, carried interest is chargeable to capital gains tax, albeit at the higher rates of 18% or 28%.
Carried interest is taxed in the UK when it arises to the individual, but often, where funds operate in multiple jurisdictions, individuals can be subject to tax in more than one country on their carried interest receipts. These different jurisdictions may apply tax on a different basis and at different times, which can create difficulties when claiming relief against the UK tax, even where a double tax treaty applies.
The Spring Finance Bill 2023 will contain provisions allowing individuals entitled to carried interest to elect to be taxed at an earlier point on their entitlement. This will allow them to align the UK and non-UK tax points, thereby ensuring they are eligible for double tax relief.
Carried interest often forms a large and important part of the reward package for those working for private equity funds, but the tax treatment of it can be complicated, with the complication compounded where there are inter-jurisdictional elements to consider.
This proposal directly addresses an issue that can often arise for those entitled to carried interest, so will be welcomed by those affected.
US citizens who are resident in the UK may benefit from these proposals, as the timing of carried interest is often earlier under US principles compared to UK. This may make it easier to claim double tax relief and avoid double taxation.
The Government will also hope that this helps the UK to remain an attractive jurisdiction from which to operate private equity funds.
When will it apply?
For tax years 2022/23 onwards.
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication.
Tax legislation is that prevailing at the time, is subject to change without notice and depends on individual circumstances. You should always seek appropriate tax advice before making decisions. HMRC Tax Year 2023/24.