UK's Postponed Budget Legislation Badly Flawed, Says Tax Body

by Jason Gorringe, Tax-News.com, London

17 May 2005

Now that the UK's Labour government has been safely re-elected, the Treasury will return to its postponed Budget legislation; but the Chartered Institute of Taxation has a lot to say on this subject, and not much of it is complimentary.

Generally, the CIOT thinks that the Government should consider the overall effect of all of its anti-avoidance legislation on the competitiveness of the UK as a home for companies. The new legislation includes the arbitrage rules, which contain a mini- General Anti-Avoidance Rule (GAAR), the rules restricting double taxation relief, which also contain mini-GAARs, and the reliance on guidance rather than legislation to avoid interest allocation.

The overall effect, says the CIOT, is to make the UK one of the worst countries in the EU in which to locate a group holding company, and undoes much effort to encourage the siting of such companies in the UK, eg the substantial shareholding relief.

The CIOT says it has the impression is that HMRC are taking on the role of policing other tax systems as well as the UK’s, which will undermine the competitiveness of the UK and in some cases will help other countries maintain uncompetitive and inappropriate rules.

The CIOT is concerned that rules may be used to restrict relief for private equity financing already in place, and to increase costs and complexity going forward. This is likely to have an adverse effect on the attraction of the UK as a place to site private equity houses to the benefit of our European competitors, says the CIOT.

Regarding the proposal to tax preference share dividends as interest, the CIOT says that it amounts to a fundamental change in the tax system by assimilating preference shares into the loan relationships rules, and by doing so asymmetrically as between the investor and the company. It is not clear, says the CIOT, how the legislation as drafted would interact with the CFC legislation. This needs to be made clear in any new legislation.

The CIOT does however have a welcome for changes that will increase certainty for Islamic financing, and which may lead to an expansion in the supply of, and demand for, Sharia-compliant financing for the UK’s increasing number of Muslim citizens. 'However,' says the CIOT, 'there are a number of areas where the legislation could be improved, reflecting the lack of scrutiny before FA 2005 was enacted. Section 46 limits the scope of the legislation to ‘financial institutions’ as defined. The definition is, however, unduly restrictive. For example, an equity capitalised company set up to provide Islamic finance but not licensed to take deposits would fail to meet the definition of a financial institution. There seems to be no policy reason to restrict the legislation in this manner, given the extensive protection for the Exchequer contained in TA 1988 Sch 28AA and the further protection enacted in s52. If the rules are intended to be mandatory for subsidiaries of banks, then it seems odd to use language like ‘wholly owned’ as it effectively allows banks to pick and choose whether to have a subsidiary within these rules.'

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