UK Budget delivers measured optimism

Although many of the Budget statements merely confirmed previously announced measures, there were also some significant new developments. The changes to pension tax allowances in particular will be welcomed by many, although whether this produces the return to work that the government anticipates remains to be seen.

We note a number of the most interesting business tax developments below.

Corporation tax

While the planned increase in the corporation tax rate to 25% will still go ahead with effect from 1 April 2023, the blow has been somewhat softened by the introduction of “full expensing”. Broadly, this means 100% first year allowances for main rate expenditure on plant and machinery from the same date. There is also a 50% first year allowance on special rate assets. Each allowance is introduced for a period three years. However, the government hopes to extend these thereafter.

The life sciences sector also did better than some might have anticipated. Although previously announced curbs to R&D allowances will generally be implemented, a new R&D tax relief will be made available for loss-making R&D intensive SMEs. It is worth noting that the government also confirmed that discussions about the shape and possible merger of R&D allowances are still continuing. These will need to factor in the impact of the Pillar Two rules to ensure that any reforms continue to incentivise investment in the UK in the manner that is intended.

Reforms to sovereign immunity shelved

For sovereign wealth funds and similar investors, there was a very welcome announcement that the government would not be proceeding with its proposed reforms to sovereign immunity from taxation.

The government first announced that it was considering reform in July 2022. It came rather out-of-the-blue, in particular because sovereign immunity from tax has been very valuable in encouraging inward investment; there was therefore considerable concern about the design and implications of the proposals. We are pleased that the government has taken on board industry and investor engagement on this.

The effect of the Budget announcement is that the status quo (based on common law) will remain, so that taxpayers benefitting from sovereign immunity will continue to be exempt from UK direct taxes on income and gains. It also means that eligible taxpayers will continue to be treated for the purposes of the real estate investment trust (REIT) and qualifying asset holding company (QAHC) regimes as “Qualifying Investors” and as “Qualifying Institutional Investors” for the purposes of the substantial shareholding exemption from capital gains tax.

Investment and funds

The government has announced an amendment to the rules on carried interest to allow individuals to elect for carried interest to be taxed in the UK on an accruals basis. The change is intended to allow fund managers to access double tax treaty relief more easily.

There are also helpful changes to the genuine diversity of ownership condition, which (very broadly) seek to look at parallel funds on a holistic basis, which will be useful to investors in the context of the QAHCs and REITs regimes.

However, those waiting for the outcome of the consultation on the reform of the VAT treatment of fund management will have to wait a little longer, although the government promises its response shortly. (A response to the consultation on the VAT treatment of financial services is also expected.)

Investment Zones

The government has resurrected its Investment Zones idea (previously announced as part of Kwasi Kwarteng’s ill-fated mini-Budget). This comprises the creation of 12 new investment zones which will attract grant funding and enhanced tax reliefs in the context of stamp duty land tax (SDLT), capital allowances and Class 1 national insurance contributions (NICs). We expect increased interest in these areas once the Investment Zones have been identified.

Environmental tax measures and commitment to clean energy

Many of the tax announcements relate to environmental issues as the fiscal policy focus of the government’s commitment to net zero continues to grow.

Specifically, there is confirmation in the context of the Energy Profits Levy (EPL) of a decarbonisation allowance, which will introduce a more generous allowance of 80% (instead of the normal 29% EPL allowance) from 1 January 2023 for qualifying expenditure on decarbonising upstream oil and gas production. There is also confirmation of the temporary Electricity Generator Levy of 45%, which will also have effect from 1 January 2023 and will be charged on exceptional receipts realised from the production of wholesale electricity by nuclear, renewable, biomass and energy from waste sources.

The announcements also include a commitment to introduce incentives for Carbon Capture, Usage and Storage (CCUS) and an increase in Climate Change Levy (CCL) rates for gas and solid fuels as well as extending a reduction for those meeting energy efficiency targets. A call for evidence on options to reform VAT relief for the installation of energy saving materials is also anticipated.

This is an evolving area for tax, and one which is becoming increasingly topical. We expect to be focusing more on this area as it develops.

Going forwards … and more Pillar Two

More detail on many of the Budget announcements is expected in the Finance Bill 2023 (to be published on 23 March 2023) and, as ever, the specifics and mechanics of the drafting will be key. We are also promised further announcements at a Tax Administration and Maintenance Day later in the year.

In particular, we expect the Finance Bill 2023 to include a further iteration of the draft legislation implementing the multinational top-up tax (the UK’s implementation of the OECD Pillar Two proposals). The government has announced certain policy refinements since the first draft of the legislation (in particular in relation to the qualified domestic minimum top-up tax) so any redrafting will warrant close review.

Please get in touch with your usual Allen & Overy contact if there is anything you would like to discuss.