Individual Taxation

IMF report and selected issues paper looks at tax issues in China

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On 15 August 2017 the IMF issued a report and selected issues paper following consultations with China under Article IV of the IMF’s articles of agreement.

The report notes that China is continuing its transition to more sustainable growth with 6.7% growth in 2016 and the same level projected for 2017. Progress has been made in rebalancing the economy towards services and consumption. The firmer economic activity gives an opportunity to accelerate reforms in areas such as greater social spending; further reforms of state owned enterprises; and reduction of financial stability risk through further efforts on regulation and supervision. The report suggests that further improvements in policy frameworks are required to maintain medium term growth and stability and local government autonomy could be increased.

Central-local fiscal relations

The selected issues paper notes that China has the largest share of local government spending in the world, but there is limited revenue autonomy at the local level. The paper notes that decentralization of revenues permits a more satisfactory matching of the tax system to the local situation and preferences, as well as encouraging accountability of policy makers. However centralization of taxation has benefits in terms of economies of scale, risk-sharing, and dealing with the mobility of the tax base.

The paper suggests that the provinces could be permitted to impose a surcharge in addition to the national personal income tax (PIT). This would allow the provinces some tax autonomy within a limit specified by the centre, for example an upper limit of 5% or 10%. The revenue contribution of the PIT is currently low by international standards and this would also be a way of increasing that contribution.

In the case of value added tax (VAT) there would be difficulties in implementing any VAT at the provincial level owing to the difficulties in monitoring border flows between local jurisdictions. The national scope of the VAT should therefore be maintained but there could be a review of the revenue-sharing arrangements to reduce compliance costs for taxpayers with multiple business locations. This could be done by introducing simple allocation rules based on factors like population or aggregate consumption.

The paper considers that a recurrent market-value based property tax would be suitable for local governments in China. A property tax would be linked to public service delivery through property values and as it is based on property its base is immobile. The accountability of local officials is helped by the fact that the tax is visible to local residents on a recurring basis. High-income households also generally have higher property wealth and a local property tax could therefore be regarded as progressive. Local governments could set tax rates within bands set by the central government, applicable to a tax base that is defined according to national guidelines.

Reducing inequality

There is increasing income and wealth inequality in China but tax reforms could be used to increase inclusiveness. If the tax system could be restructured to rely more on personal income tax this could also improve redistribution, as the income tax can easily be given a progressive structure. The current personal allowance could be lowered and transformed into a tax credit. Tax brackets could be redesigned to ensure that those with greater ability to pay are contributing more to the national budget. The method of imputed minimum earnings for calculating social security contributions is regressive and should be abolished so that direct taxes would be more equitable and workers could have more incentive to join the formal sector.


UK: HMRC reveals details of employment remuneration tax avoidance schemes

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HMRC has published details of tax avoidance schemes that are being used by employers, agencies and other intermediaries to avoid payment of income tax and national insurance contributions. These and other types of tax avoidance scheme are published in HMRC’s Spotlights, notifications aiming to publicise avoidance schemes that are considered by HMRC not to work. HMRC believes these tax avoidance schemes could be successfully challenged in the Courts. HMRC summarises the schemes and sets out what users of the schemes should do to bring their tax affairs into order. The Spotlights are available online on the UK government website.

One of the main types of tax avoidance scheme for remuneration is the loan scheme. These schemes involve the employees being paid a small amount of remuneration but the main part of the remuneration is paid in the form of loans from third parties.

On 10 August 2017 the latest Spotlight on contractor avoidance, Spotlight 39, was published with the title Disguised remuneration: re-describing loans. This type of scheme involves the scheme users receiving sums from their disguised remuneration schemes under loan agreements; but they can claim that the money is only held by them in a fiduciary capacity. In the view of HMRC this is just a different name for the transaction that does not change the facts of what has happened, and they consider that re-describing the loans does not change the reality.

UK: HMRC to continue risk-based approach to PAYE filing penalties

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HMRC notes in the August 2017 issue of its Employer Bulletin that it has reviewed the use of the risk-based approach to PAYE penalties for late filing and has decided to continue the same approach in the tax year from 6 April 2017. Late filing penalties will therefore continue to be reviewed on a risk-assessed basis and will not be issued automatically.

HMRC intends to impose the first penalties for the year commencing 6 April 2017 in September. The risk-based approach involves not charging penalties if Full Payment Submissions (FPSs) are filed late but within 3 days of the payment date, unless there is a pattern of persistent late filing. Employers must still file their submissions by each due payment date except in specified circumstances. Employers persistently filing after the statutory filing date but within three days may be contacted by HMRC and could be considered for a penalty.

In the case of late payment HMRC will also charge penalties on a risk-assessment basis and persistent late payers will be the main focus. The risk-based approach to PAYE penalties will continue to be reviewed beyond 5 April 2018 with a view to focusing on the employers who persistently fail to meet the due date for payment.


IMF report comments on economic position of Japan

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The IMF issued a report on Japan’s economic position on 31 July 2017 following the conclusion of discussions under Article IV of the IMF’s articles of association.

The report notes that Japan’s economy is growing above potential with positive private consumption growth and stronger private investment. There are however labor shortages, weak wage growth and persistently low inflation. The IMF expects the growth to continue through 2017 but to fall back in 2018 if the fiscal stimulus support decreases as currently planned.

The IMF directors consider that the current favorable environment provides an opportunity to go ahead with a comprehensive reform package to sustain growth, raise inflation and deal with the medium term challenges including fiscal consolidation and increasing potential growth.

A selected issues paper published at the same time as the report looks at tax policy challenges of an aging and declining population. This notes that the consumption tax should remain the main part of revenue reform but that the timing of rate increases is important. Other potential tax measures should also be examined.

Consumption tax

The consumption tax is an important policy owing to the size of the public debt and the need for more health and social security spending for the ageing population. Although expenditure reform is also required Japan will need additional revenue. The consumption tax rate is currently low relative to other industrialized countries and there is therefore room for raising the tax rate. Also the efficiency of collection of the consumption tax is high so more revenue can be raised with low collection costs. Raising the consumption tax rate is likely to be less detrimental to economic growth than other tax options. A gradual increase each year would reduce any volatility of the impact on growth. The IMF is therefore proposing gradual increases to the consumption tax as part of a broader fiscal adjustment package.

Other potential tax measures

Other taxes such as a tighter personal income tax, property tax, inheritance tax or asset and wealth tax could also be examined to supplement the revenue gains that can be earned from the consumption tax increase.

Personal income tax

Tightening the personal income tax would contribute to revenue growth. The top rate of personal income tax is currently one of the highest in the OECD but reforms could focus on addressing inequality and eliminating disincentives to work. The low collection level of the tax indicates that there are a large number of deductions and these enable the higher earners to obtain benefits. The deductions could be replaced with more progressive measures such as targeted tax credits.

This could be linked to other reforms such as eliminating disincentives to full-time or regular work resulting from the operation of the spousal tax deduction. Exemptions for pension income could be reduced and targeted tax credits for elderly workers could increase incentives for them to remain in the labor market.

Property tax

In Japan only 30% of local tax revenue is raised from recurrent property tax, compared with 100% in the UK and Australia, 90% in Canada and 75% in the US. Raising property taxes would provide a more stable revenue base for local governments and reduce the level of transfers from the center. This could encourage growth and raise revenue as property tax is the most efficient tax.

Asset or wealth tax

Only a few countries currently use wealth taxes and one important motivation for them has been as a temporary measure in a broader fiscal consolidation. Countries that scrapped their wealth taxes cited high administrative costs compared to revenue collected and problems of capital flight as reasons for its discontinuance. Generally a wealth tax is best structured with very few exemptions, a high threshold of liability and a flat marginal rate set at a low level.


UK: Changes to non-domiciled rules in Finance Bill (No 2) 2017

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Changes to the UK non-domiciled rules that were excluded from the Finance Bill 2017 are to be included in the Finance Bill (No 2) 2017. The Bill is to be published and considered by parliament in September 2017 following the summer recess. Updated draft legislation and explanations on the changes to rules on deemed domicile were published in July 2017, and when passed they will take effect from 1 April 2017.

The provisions relating to non-domiciled individuals include the following measures:

Deemed domicile

New deemed domicile rules provide that a non-domiciled individual will be treated as domiciled in the UK for all tax purposes in a tax year if that individual has been resident in the UK for at least 15 of the last 20 years.

The new rules will also provide that a non-domiciled individual who was born in the UK with a UK domicile of origin is to be treated as domiciled in the UK for income and capital gains tax purposes in any tax year in which that individual is UK resident; and the individual will also be treated as domiciled in the UK for inheritance tax purposes after one year of UK residence.

Rebasing relief

Individuals who are deemed domiciled from 6 April 2017 because they have been resident in the UK for 15 of the last 20 years can rebase their foreign located capital assets to market value on 5 April 2017 for purposes of capital gains tax. Consequently on a future sale of a foreign asset only the gain from 6 April 2017 to the date of sale would be liable to capital gains tax. This will apply automatically unless the taxpayer elects for the provision not to apply.

Segregation of mixed funds

Any non-domiciled individual who has been taxed under the remittance basis prior to 2017/18 will be able to rearrange mixed funds held in non-UK bank accounts and segregate them into their constituent parts. This is a transitional arrangement for the 2017/18 and 2018.19 tax years and applies only to nominated transfers of money from a mixed account to another account.

This is a useful measure because income and capital gains taxable under the remittance basis are treated by the law as remitted before non-taxable income. So if there is income taxable under the remittance basis and also non-taxable capital in a bank account any remittance from that account will be treated as a remittance of taxable income or gains rather than of the non-taxable element. By separating out the non-taxable element into a separate account the taxpayer can arrange to remit that non-taxable capital without a tax charge.

Inheritance tax on residential property interests

From 6 April 2017 inheritance tax is to apply to UK residential property interests held indirectly by non-UK domiciled individuals, for example through a non-UK company, and any debt used to finance the property will be subject to inheritance tax in the hands of the lender.

This means for example that any shares in non-UK close companies or interests in overseas partnerships the value of which is derived from UK residential property will come within the scope of inheritance tax. This will apply whether the individual is UK resident or non-resident.

Any debt used to finance the purchase, maintenance or repair of UK residential property will be treated as an asset within the scope of inheritance tax in the hands of the lender. If the lender is a non-UK close company or a partnership then look-through provisions will apply. Any security or collateral for the debt will also be within the scope of inheritance tax as part of the estate of the person providing the security.


UK: Draft guidance on corporate tax loss relief rules

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On 31 July 2017 HMRC issued for public consultation draft guidance in relation to the reform to corporate tax loss relief rules. An amended draft of the relevant legislation on corporation tax loss relief was published on 13 July 2017 and this is to be included in the Finance Bill (No 2) 2017 to be published after the summer recess. The draft guidance is an initial tranche focusing on the core rules and on areas where guidance has been specifically requested. HMRC intends to issue further draft guidance in due course. Comments on the current draft guidance are invited by 25 September 2017.

The reform of corporation tax loss relief aims to restrict the loss relief available to business with substantial profits, while also allowing more flexibility on how carried forward losses may be offset against the total taxable profits of a company and a group rather than only being offset against particular types of profits. The rules apply to companies and unincorporated associations that pay UK corporation tax and have losses carried forward. The revised rules are intended to apply from 1 April 2017.

The guidance emphasizes that the relief given for losses carried back from a later period and relief for losses in the year (such as group relief) is not affected by the new rules. The restriction on offset of losses and the greater flexibility on offset against profits will both apply to trade losses carried forward; non-trading loan relationship deficits carried forward; non-trading losses on intangible fixed assets (NTLIFAs) carried forward; management expenses carried forward; and UK property business losses carried forward.

Restriction on offset of losses carried forward

From 1 April 2017 companies with profits exceeding the deduction allowance (which will be a maximum of GBP 5 million) will not be able to reduce their profits to nil using losses carried forward. The profits (after the deductions allowance and after deduction of losses of the same year such as group relief) can only be reduced by up to 50% by losses carried forward.

The deductions allowance of GBP 5 million would be shared between the members of a group in the manner the group decides. A company will be nominated by the group to allocate the deductions allowance among the group. If the profits are below the level of the deductions allowance there is no restriction on offset of losses brought forward.

Although the restriction is effective from 1 April 2017 it applies to all losses carried forward including those brought forward from before 1 April 2017.

Flexibility of offset of losses

The greater flexibility to offset losses brought forward against total profits rather than a particular type of profits applies from 1 April 2017 to trading losses; non-trading loan relationship deficits (NTLRDs); non-trading losses on intangible fixed assets; management expenses; and UK property business losses.

From 1 April 2017 generally trading losses and NTLRDs may be carried forward and offset against total profits of the company, or surrendered as group relief, but in some situations the company will continue to be more restricted in loss offset. Trading losses for periods before 1 April 2017 will still only be available for offset against profits of the same trade. This also applies to losses of periods after 1 April 2017 in certain situations, for example where the trade has become small or negligible. Also NTLRDs of periods before 1 April 2017 are still only available for offset against non-trading profits, and for periods after 1 April 2017 in cases where the investment business has become small or negligible NLRTDs will still only be offset against non-trading profits.

Management expenses, UK property business losses and NTLIFAs will continue to be available for offset against total profits of the company. From 1 April 2017 they may also be available for group relief for carried forward losses. Carried forward management expenses will no longer need to be deducted in priority to other deductions from total profits.

New claims procedures will allow a company to choose which carried forward trading losses, NLTRDs, management expenses and UK property business losses are relieved in an accounting period.


UK: Updated draft guidance on corporate interest restriction

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On 4 August 2017 HMRC issued for public consultation updated draft guidance in relation to the corporate interest restriction rules to be included in the Finance Bill (No 2) 2017. The latest draft guidance amends and updates the initial draft guidance that was issued on 31 March 2017 and takes into account technical changes made and included in amended clauses published on 13 July 2017. Comments on the updated draft guidance are invited by 31 October 2017.

The corporate interest restriction generally follows the recommendations of the report on action 4 of the OECD project on base erosion and profit shifting (BEPS). The rules aim to restrict tax deductions made by a group in relation to interest expense and other financing costs. The deductible amount will be restricted to an amount commensurate with the group’s taxable activities in the UK. To arrive at that amount the rules take into account the amount the group borrows from third parties. The rules are to apply for periods beginning on or after 1 April 2017.

The rules apply to all groups within the charge to UK corporation tax but the restriction will not apply to groups with less than GBP 2 million of net interest expense and other financing costs per annum. Those groups will not be subject to any reporting requirements but should perform appropriate calculations to ensure the restriction does not apply to them.

For all other groups tax deductions for interest expense will be restricted to the group’s net third party interest expense, or the part of that expense that is proportionate to the taxable earnings before interest, tax, depreciation and amortisation (tax-EBITDA) in the UK. The rules will be applied after transfer pricing adjustments and adjustments for anti-hybrid rules but before the loss restriction rules are applied.

The default method for calculating the restriction is the fixed-ratio method. This applies two main limits on the interest deduction for tax purposes. The first restriction is by reference to a fixed ratio of 30% of the tax-EBITDA of companies within the group that are within the charge to UK corporation tax. The tax-EBITDA and the interest would be computed by reference to the amounts taken into account for UK corporation tax.

The second restriction is a debt cap that limits the net interest deduction to a measure of the worldwide group’s net external interest or economically similar expenses.

An alternative method for calculating the interest restriction called the group ratio method may be applied. Under this method the net tax deduction for interest is restricted by applying the group ratio to the tax-EBITDA. The group ratio is effectively the ratio of group interest to group EBITDA, measured on the basis of the consolidated accounts of the group. Under this method there is also a debt cap applicable based on the measure of the group interest expense used in calculating the group ratio.

Interest that exceeds the limit and is therefore disallowed in a particular year can be carried forward indefinitely. This interest can be used in a subsequent period if there is sufficient interest allowance available. Unused interest allowance may be carried forward for up to five years.

Optional alternative rules apply to the application of the restriction to public infrastructure assets. There are also some special provisions in relation to certain types of company and types of transaction.