Spring Budget 2023

There could be no doubting that in today's Budget, the Chancellor's sights were firmly set on economic growth and investment. The consistent themes running through today's key tax announcements were rewarding capital investment by businesses, boosting the workforce and creating further incentives for investment in the products and industries in which the UK aspires to lead the world in the future.

This effort was spearheaded by a few headline-grabbing tax measures, the most eye-catching of which is the move to annual expensing for businesses, allowing them to claim capital allowances for their full expenditure on qualifying assets in the year in which the expenditure is incurred. This change, designed to ease the concerns of business around the increase in corporation tax rates from 19% to 25% in April 2023, and the end of the "super deduction" for qualifying plant and machinery, is a significant upgrade to the existing capital allowances regime and will give the UK one of the most generous reliefs for capital expenditure in any advanced economy. This will come at a cost of £9bn per year, but OBR forecasts suggest that this is a price worth paying to increase investment in the UK by 3% per year.  To read more, click here.

The announcement of a bidding process to create twelve "Investment Zones" across the UK looks to be a further (and less generous) iteration of the "freeports" proposal, aimed at generating investment and employment in areas outside London and the South East. Businesses which establish themselves in these areas can expect to benefit from SDLT reliefs, enhanced capital allowances and relief from employer national insurance contributions.

Also leading the headlines will be the increase to the pensions annual allowance and the surprise abolition of the lifetime allowance (the threshold up to which workers can accumulate amounts in their pension fund without incurring additional tax). These changes are aimed at bringing more "experienced workers" (as the Chancellor coyly referred to them) over the age of 50 back into the workforce, with doctors given as a particular example of a group who have been disincentivised to work past that age as a result of the additional tax that they would pay on pension amounts above the lifetime allowance. You can find further details here.

Whilst these changes, and other important non-tax measures such as the extension of free childcare for children under three and investment in energy and green technologies will doubtless be the subject of most of the media discussion, there were also a raft of less visible measures designed to provide more targeted improvements in various areas. What is welcome is that many of these changes are the result of consultation and discussion with businesses and the wider tax community, showing that detailed technical consultation can lead to change and improvement to the law – a small victory for "tax geeks" everywhere.

For SMEs, there was a welcome change to the reliefs for research and development expenditure for certain businesses with intensive R&D activity. From 1 April, where an SME incurs R&D expenditure totalling 40% or more of its total expenditure in an accounting period, it will qualify for a cash tax credit equal to 14.5% of its qualifying R&D expenditure. This effectively reverses changes announced in the 2022 Autumn Statement, and is a response to a wider consultation on R&D reliefs in the early part of this year. More change may follow as a result of this consultation on merging the R&D regimes for large companies and SMEs.

In the real estate sector, some helpful changes were announced to the REIT regime, aimed at removing compliance burden and increasing the attractiveness of REITS to investors. Again, this change has its origins in technical consultations, in this case in relation to the Qualifying Asset Holding Company regime in 2020. The decision (following consultation) to maintain the current tax exemptions for investors with sovereign immunity is also likely to prove particularly welcome to investors in UK real estate.

Active and constructive discussion between the alternative asset management community and HMRC is also evident in the proposed changes to the "genuine diversity of ownership" condition, which is key to the ability of funds to access the qualifying asset holding company (QAHC), REIT and non-resident CGT regimes. This rule has posed a challenge where fund structures contain a number of separate entities, not all of which satisfy the condition, so the proposed revision of the rules to allow all entities which form part of a "multi vehicle arrangement" which meets the condition to qualify is a welcome development. Further changes to the QAHC regime have also been announced today, allowing for the holding of listed securities by QAHCs without prejudicing the availability of QAHC status, but at the cost of losing the exemption for tax on dividends.

In the world of incentives, the call for evidence on the Enterprise Management Incentive (EMI) scheme is unlikely to lead to a major overhaul of the scheme, but has resulted in some short term changes to the administrative requirements in relation to EMI options, which will help to avoid inadvertent errors which can prejudice the beneficial tax treatment of options. Changes to make the CSOP option scheme more generous have also been announced, with a view to helping companies incentivise their employees effectively as they grow larger and can no longer access the EMI regime.

The team at Travers Smith is proud to have contributed to many of the consultation processes that have led to these changes, representing our clients and a wide range of industry bodies. If you would like to know more about any of the Budget announcements and its impact on your business, please do get in touch.

The Chancellor announced major changes to pensions allowances with the aim of encouraging the over 50s to remain in, or return to, work.  This is particularly pertinent to high earning senior clinicians in the NHS.  In recent years, many high-earning NHS medics have retired early or reduced their hours in order (at least in part) to avoid incurring pensions tax charges in respect of their defined benefit pension accrual.  The changes are all, however, applicable generally.

The key announced changes are as follows:

• The lifetime allowance (currently £1,073,100) will be abolished.
  
  
• The annual allowance will be raised from £40,000 to £60,000.
  
  
• The tapered annual allowance will be raised from £4,000 to £10,000, with the 'adjusted income' threshold increased from £240,000 to £260,000.
  
  
• The money purchase annual allowance will be raised from £4,000 to £10,000.  
  
  
• The maximum tax-free pension commencement lump sum (for those without protections for higher amounts), currently set at 25% of the lifetime allowance, will be retained and frozen at that level, which is £268,275.

These changes take effect for the 2023/24 tax year and thereafter.  Technically, it is only the lifetime allowance tax charge that will be abolished from April 2023, with the full lifetime allowance legislation to be repealed from April 2024.

We explain these allowances and comment on some technical implications of the changes in our Budget 2023 Pensions Tax Update briefing.

The Chancellor announced today a new enhanced R&D tax credit payable at 14.5% to loss making SME whose R&D expenditure makes up at least 40% of their total expenditure for an accounting period. This announcement will go some way to relieving SMEs following the reduction of the SME R&D tax credit to 10% in the Autumn statement. The Budget documents also confirm that the planned changes to R&D relief which would include expenditure on data licences and cloud computing within qualifying expenditure will go ahead as planned for expenditure incurred from 1 April 2023 but that the restrictions limiting R&D relief to UK expenditure will be postponed until 1 April 2024. The postponement is to give the government time to consider how this change could tie in to the proposed new single R&D regime which would apply both to SMEs and large companies and was consulted upon earlier this year.

We explain these changes and comment on some implications of the changes in our Budget 2023 R&D Relief briefing.

In today's Budget, the government has confirmed that it will make welcome amendments to the UK's rules for qualifying asset holding companies (QAHCs).  Several of the key reforms were announced on "L Day" last July, including proposals to improve access to the regime for corporate funds and where parallel and aggregator funds are used.  The substance of the L Day proposals has been retained, but following feedback from industry, the government has helpfully refined its plans for parallel and aggregator funds. 

Some further changes to the QAHC regime were also announced today, perhaps the most significant of which is an ability for potential QAHC's to, in effect, elect out of the "investment strategy condition", but at the cost of foregoing the tax exemption on dividends. 

For more detail, please read our Spring Budget: QAHC briefing.

The GDO condition is used in several of the UK's tax privileged regimes for investment fund vehicles.  Essentially, the GDO condition requires that a fund is sufficiently widely marketed before the relevant vehicle (which, depending on the regime, may be the fund itself or an entity owned by it) can access certain tax benefits.  

Under the current rules, the GDO condition is generally applied by reference to individual entities in a fund structure.  This can be problematic for investment structures which involve multiple legal entities which, in substance, form part of the same fund arrangement.  This is because one or more of the individual entities may not, looked at in isolation, satisfy the GDO even though the structure, looked at as a whole, would.

On L Day in July, the government announced proposals to address this issue in the context of access to the qualifying asset holding company (QAHC) regime for parallel and aggregator funds.  Since then, the government has been consulting on the application of the GDO more widely and, as a result of that process, has today announced that changes to the GDO condition will be made for the purposes of non-resident capital gains tax rules and the real estate investment trust (REIT) regime, as well as the QAHC regime.  The measures provide that, for the purposes of all three regimes, an entity can be treated as satisfying the GDO condition by reference to the  multi-vehicle arrangements of which it forms a part (even if it would not satisfy the GDO when considered in isolation).  The definition of multi-vehicle arrangements encompasses a group of entities which form part of a wider fund structure where an investor would reasonably regard their investment to be in the structure as a whole.

The government has today announced that the UK CGT rules will be amended for tax year 2022-23 onwards to allow individual fund managers to make an irrevocable election for their carried interest to be taxed on an accruals basis. 

The background to this is that, following a change in HMRC guidance, fund managers who are liable to tax on their carried interest in more than one jurisdiction are commonly unable to claim double tax relief either in the UK or abroad.  A particular problem can be that the carried interest may be recognised and charged to tax at different times in each jurisdiction.  The measure announced today will give fund managers an optional alternative to the current UK tax position that carried interest is recognised for CGT purposes when it arises. 

The proposals appear to be a "win-win" from HMRC's perspective, addressing a concern of the asset management industry whilst raising revenue (with the government's forecast predicting that the measure will generate £120m by 2027-28).

Today's announcement contains little detail (and no draft legislation), and there are likely to be a number of technical implications to work through.  We expect to know more next week when the Spring Finance Bill is due to be published. 

As part of the Government's ongoing review of UK fund structures, it has announced three changes to the rules relating to real estate investment trusts (REITs) to enhance their attractiveness and flexibility. First, as previously trailed as part of the Edinburgh Reforms in December last year, the requirement for a REIT to hold at least 3 properties will not apply if the REIT holds a single commercial property worth at least £20 million.

The general tax exemption for the sale of a property is turned off for a REIT who sells a property within 3 years of development work being undertaken. Currently, for the exemption to be disapplied the development work has to exceed 30% of the fair value of the property when it was acquired or when the company became a REIT. The second announced change, also previously trailed, is to amend the valuation date of the property for the purposes of these rules so the valuation "better reflects increases in property values". Taxpayers will await draft legislation to understand the significance of this change.

Thirdly, and unexpectedly, the Government has also announced a welcome change to the withholding tax treatment of property income distributions (PIDs) from REITs when they are paid to partnerships. Currently, all partners in a partnership must qualify for a tax exemption from PIDs for that partnership to be able to paid a PID without withholding. The announced change will enable the REIT to look through to the underlying partners in a REIT and withhold on the PID only to the extent the underlying partner would have had withholding had they invested directly. This will be increasingly important as, since 1 April 2022, it has been possible for widely-held funds to incorporate subsidiary "private REITs" that do not need to be listed on a stock exchange. Where those funds are themselves constituted as partnerships this change will ensure that the fund structure does not itself give rise to any UK tax leakage that would not have arisen had the ultimate investors invested in the real estate portfolio themselves.

In addition to the REIT-specific changes, the definition of "charity" for UK tax purposes will be amended to remove EU and other foreign charities, so that only UK charities will fall within that definition. Amongst its other effects this will have an impact on who can be counted as a "institutional investor" for the purposes of the REIT and the qualifying asset holding company (QAHC) rules, although there are saving provisions which exempt those who already hold shares in a REIT or QAHC on 15 March 2023.

The government has announced in the Spring Budget 2023 that it will not go ahead with plans to materially narrow the UK's sovereign immunity exemption.

Under the current sovereign immunity principle, heads of state, foreign governments and governmental bodies (for example, sovereign wealth funds and public pension schemes) are exempt from UK corporation tax, income tax and capital gains tax on all UK source income and gains.  In July 2022 the government launched a consultation to materially narrow the categories of sovereign immunity from UK taxation, proposing that the exemption would be restricted to UK source interest income.

These changes would have resulted in a much wider scope of income and gains coming within the charge to UK tax for sovereign immune persons, particularly impacting the attractiveness of investments in UK real estate by sovereign immune persons.  Real estate sector businesses will be relieved to learn that the sovereign immunity exemption will be maintained in its current form.

The Government has confirmed its intention to create twelve "Investment Zones" with "special tax sites". Local authorities and their local partners in the twelve regions which have been identified will be able pitch for particular geographical areas to be given these designations and have access to a range of tax reliefs and targeted funding designed to encourage investment and stimulate economic activity. This concept is an iteration of the freeports concept which was introduced in 2021 (for more information on which please see our briefing) and was trailed in the September 2022 Mini-Budget, although some of the proposed tax reliefs have been paired back since then. The accompanying legislation is yet to be drafted, but the proposed tax reliefs include:

• SDLT relief (subject to the relevant property being acquired for a qualifying purpose and utilised within three years);
  
  
• 100% capital allowance for plant and machinery;
  
  
• an enhanced structures and buildings allowance of 10% per year for 10 years for qualifying expenditure (down from 20% under the 2022 Mini-Budget); and
  
  
• and employer NICs relief in respect of the first £25,000 of earnings of new employees for up to three years (down from c. £50,000 under the 2022 Mini-Budget).

It has been some time since we've seen a Budget that references all the tax-advantaged share plans at the same time and the positive announcements in relation to Company Share Option Plans (CSOP), Enterprise Management Incentives (EMI),  Save-as-you-earn (SAYE) and Share Incentive Plans (SIP) were very welcome.

As announced at the Autumn Statement, after nearly 30 years without change, the limit on the value of shares an individual can hold under CSOP options at any one time will rise to £60,000 from 6 April.  The limit is calculated at the time of grant and the increase is very good news for employees that have reached the existing £30,000 threshold.  The other change announced last year is a relaxation of the rules that determine the class of share companies can grant CSOP options over.  Currently, companies with more than one class of ordinary share can only grant CSOP options over the class that either gives employees control of the company or is majority held by non-employees.  This restriction was designed to ensure that CSOP options were granted over shares that HMRC considered "worth having", but in fact it prevents many private companies from granting CSOP options altogether.  From 6 April, this rule will be removed meaning that companies will be able to grant CSOP options over any ordinary class of share for employees, including so called 'growth shares', should they wish to.  Both changes will take effect automatically (i.e. a company won't need to amend its plan rules to take advantage of them), however, HMRC warns that it will undertake increased compliance activity to ensure CSOP is being used properly. 

In March 2021, the Government launched a Call for Evidence on Enterprise Management Incentives as part of its review into whether the plan was reaching the right companies and meeting its aims.  Following that review, the Government has concluded that EMI is working well and does not require any fundamental changes.  However, as noted in the Summary of Responses published with the Budget, FINAL_-_M5048_-_Enterprise_Management_Incentives_Call_for_Evidence_Summary_of_Responses.pdf (publishing.service.gov.uk) the Government accepts that there are a number of areas where improvements can be made to the process for granting EMI options.  To relieve the administrative burden on companies when granting EMI options, the Government has announced three key reforms:

• Removing the requirement to set out share restrictions in option agreements

The EMI legislation currently requires details of any restrictions attaching to option shares to be set out in the EMI option agreement itself.  There has been a lack of clarity as to how this requirement can be met creating uncertainty as to whether some options qualify as EMI.  To ease this burden, from 6 April, the requirement to expressly set out any restrictions attaching to the shares in the EMI option agreement will be removed.  This change will apply to existing (but not yet exercised) EMI options as well as those granted on or after 6 April.  We await further HMRC guidance on whether restrictions will still need to be notified to EMI participants (and by what means).

• Requirement for a signed working time declaration to be removed

Another aspect of the EMI grant process that can cause difficulties is evidencing that a signed working time declaration has been obtained from the relevant employees.  Under current rules, employees must sign a declaration confirming that they work for their employing company for at least 25 hours a week or, if less, 75% of their working time.  If the employee fails to sign this declaration, the award granted to them is technically not an EMI option even if, as a matter of practice, they work the required hours.  Recognising that this can lead to some harsh consequences, from 6 April the requirement for an employee to sign a working time declaration will be removed. Again, this will apply to existing but unexercised options as well as those granted on or after 6 April.  It is important to note, however, that the working time requirement itself will remain and companies will still need to satisfy themselves that it is met and keep a record of this.

• Date for notification of EMI option grant to be extended

The final announcement relates to the date by which companies must notify the grant of an EMI option and will not take effect until the 2024/25 tax year.  Currently, an EMI option has to be electronically notified to HMRC within 92 days of grant.  This 92-day notification requirement does not apply to any other tax-advantaged share options.  From 6 April 2024, the deadline will be extended to 6 July following the end of the tax year of grant to bring EMI notifications in line with the annual return deadlines for EMI and all other employee share plans.  We understand that the legislation to implement this will be introduced at a later date.

These changes are welcome news for all companies operating an EMI plan and should ease the administrative burden on companies when granting EMI options as well as reducing the uncertainty of how to treat the exercise of EMI options.

Having already reviewed the two discretionary tax advantaged employee share plans, the Government has announced that it will now turn its attention to the all-employee plans; SAYE and SIP.  The Budget contains a statement that it will be launching a Call for Evidence to consider opportunities to simplify and improve the schemes. It is likely that the Government will be asked to consider increasing the financial limits on individual participation and perhaps reducing the vesting/holding periods for tax relief to be available.

The Chancellor had some headroom to play with in the Spring Budget 2023, in part due to the impact of substantial fiscal drag.

What is "fiscal drag"?

"Fiscal drag" is the term given to the process where average income tax receipts increase as a consequence of tax rate thresholds and allowances not rising in line with wage growth. By freezing thresholds and allowances, tax revenue should generally be increased as a result of a greater proportion of wages being "dragged" into higher tax bands.

The freezing of thresholds and allowances is often referred to in the media as a "stealth tax", because the average amount of tax being paid by each individual as a proportion of their income will be increased as a result of the freezes.

Fiscal drag is not a new phenomenon, but the effect is expected to be particularly pronounced in near term because:

• inflation is high, which means that wage growth is generally expected to be high (even if it falls below inflation) in the short term with employers under pressure to increase wages; and
• thresholds and allowances for individuals are generally being either frozen or reduced in the coming years (following the announcements at the 2022 Autumn Statement).

How much tax does fiscal drag raise?

To illustrate the substantial impact of fiscal drag, in March 2023 the OBR estimated that the effect of extending the freezes on the income tax personal allowance and higher rate (40%) threshold for a further two years (to April 2028), as announced at the 2022 Autumn Statement, would amount to an additional £24.7 billion a year by 2027/28 relative to thresholds being increased in line with CPI inflation. This figure increases to an eye-watering £29.3 billion a year by 2027/28 if the effect of the corresponding NICs freeze (in particular, employer NICs thresholds) is also factored-in.

The government has recently consulted on the VAT treatment of fund management services.  There was speculation that we may see the results of this announced in today's Budget.  However, instead, the government has confirmed that is considering the feedback and continuing to discuss the proposals with interested stakeholders, and will publish its response in the coming months.