Budget 2016: business tax roadmap includes new withholding tax on royalties and restriction on carry forward losses

As part of its Budget the government has published a 'business tax road map’ setting out its plans for business taxes to 2020.

From April 2017 companies with profits in excess of £5 million will only be able to offset 50% of their profits against losses carried forward. Banks can already only offset 50% of their profits with pre-April 2015 carried-forward losses. The Chancellor announced that banks will be further restricted from 1 April 2016 so that they will only be able  only offset 25% of their profits against pre-April 2015 carried-forward losses.

At the same time the chancellor also announced that the loss system would be modified to make it more flexible. Under the current system losses carried forward can only be used by the company that incurred the loss, and not used in other companies in a group and some losses carried forward can only be set against profits from certain types of income, for example trading losses set against trading profits.

The government says this "can produce unfair outcomes and is out of step with the way businesses operate"  so for losses incurred on or after 1 April 2017, companies will be able to use carried forward losses against profits from other income streams or from other companies within a group.

Eloise Walker, a tax expert at Pinsent Masons, the law firm behind Out-law.com said "In 2014 HMRC restricted loss relief for the banks on the basis that the economic crisis was all their fault and no-one outside the banking industry really cared. Emboldened, they've now decided to have another go – but not just at banks this time. Whilst offering the carrot of added flexibility in loss utilisation they have ripped away the right to use the valid losses generated whilst times were hard. One can only wonder if industry as a whole will take this one lying down."

Since 2010 the government has cut the main rate of corporation tax from 28% to 20% and the  rate is due to reduce to 19% in April 2020. The rate was scheduled to reduce to 18% in April 2020, but the Chancellor announced that the rate would instead be reduced to 17% in 2020.

Heather Self, another tax expert at Pinsent Masons said "the reduction will be a welcome surprise to business, but does not take effect until 2020, by which time we will be almost at the next General Election".

The roadmap announces that the government is introducing a withholding tax on royalty payments, because it says that intragroup royalty payments to low tax jurisdictions can be used by multinational enterprises as a way to shift profits around the world. It is therefore extending the UK’s withholding tax rights so that payments for the use of intangible assets such as trademarks and brand names made to overseas connected persons will be subject to withholding tax. Tax will be withheld unless the withholding is prevented by a double tax treaty or by the EU Interest and Royalties Directive.

To prevent the withholding being avoided by payments being routed through a treaty country, the government will introduce a treaty abuse rule. This rule will mean that the UK will be able to withhold on a royalty payment if it is being routed through a treaty partner jurisdiction for "tax motivated and uncommercial reasons". The government will also apply withholding tax on royalty payments that are connected with the activities of UK permanent establishments of overseas companies.

Heather Self said: "This could give HMRC a new weapon to challenge the complex structures used by US groups in particular".

"While business generally supports the government's efforts to create a level playing field, and to clamp down on artificial and abusive structures, there is a risk that companies and HMRC will not agree on whether royalty payments are being routed through a particular country for 'uncommercial' reasons, leading to an increase in disputes and potential double taxation," she said.

As expected the roadmap contains an update on the UK's plans to implement the recommendations made by the Organisation for Economic Co-Operation and Development (OECD) to prevent tax avoidance by multinationals in reports published in October 2015 as part of its base erosion and profit shifting (BEPS) project.

The chancellor confirmed that the UK will be introducing a fixed ratio rule limiting corporation tax deductions for net interest expense to 30% of a group’s UK earnings before interest, tax, depreciation and amortisation (EBITDA) from April 2017. The UK will also be implementing a group ratio rule based on the net interest to EBITDA ratio for the worldwide group as recommended in the OECD report. There will be a de minimis group threshold of £2 million net of UK interest expense designed to "target the rules at large businesses where the greatest BEPS risks lie".

The roadmap confirms that the government also intends to introduce rules to ensure that the restriction does not impede the provision of private finance for certain public infrastructure in the UK where there are no material risks of BEPS.

The roadmap states that the worldwide debt cap will be repealed. However, rules with similar effect will be integrated into the new interest restriction rules, so that a group’s net UK interest deductions cannot exceed the global net third party expense of the group. The government says "This modified cap will strengthen the new rules and help counter BEPS in groups with low gearing."

The interest restriction was one of the OECD proposals . In October 2015 the Treasury launched a consultation on how the proposal could be implemented into UK law.

Eloise Walker said: "It's no surprise that the fixed ratio rule is going ahead. Nor will it surprise the cynical reader to learn the worldwide debt cap will be killed off only to be instantly resurrected within the new rules. The big disappointment – not unexpected for those who knew ahead of the Budget – is that we don't yet have any real detail, especially on the all-important public infrastructure exemption. If they want to legislate for April 2017 commencement, HMRC will need to get a move on."

A surprise announcement in the summer 2015 Budget was that dates for payment of instalments of corporation tax for companies with profits in excess of £20m would be brought forward. The new payment schedule had been due to apply from 2017, but the government announced that it has now deferred the measure by two years so that the new payment schedule will now apply to accounting periods starting on or after 1 April 2019.