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Basis instinct

Having set the ball rolling with my initial look at the proposals for corporation tax reform, this week I will focus exclusively on an issue which could impact directly or indirectly on the attraction or otherwise of financial products. I will also look at the advice that may be given to companies in light of any tax changes that may emerge from the consultation.

First, it is worth reminding you – as if that were necessary – that awareness of change and explanation of its relevance to your clients can only be relationship enhancing. That has to be a good thing, doesn&#39t it?

Let&#39s consider the proposals that could have a direct impact on the attractiveness or otherwise of financial products. In my opinion, the key proposed changes in this context are:

•Proposed abolition of the indexation allowance.

•Proposed taxation of capital gains and losses on a year-by-year basis before realisation.

It is true to say that there are already a number of areas where corporate capital gains are in effect taxed on other than a deferred basis, for example, in respect of gains and losses on transactions in intangibles, corporate debt, derivatives and forex. All of these have, in effect, been taken out of the capital gains regime, with its opportunities for deferment, and placed in the income tax regime. So one can understand the view that errs towards all capital gains made by companies being taxed in the same way. Coherence is generally thought to be a good thing.

However, perhaps the greatest concern here is the Inland Revenue&#39s expressed dissatisfaction with the definition of profits for corporation tax purposes. We are reminded that the current tax code does not have a general definition of income or profits.

Particular concern is expressed that capital gains and losses are only crystallised on realisation or when they can be readily realised, in which case the assets are usually marked to market, that is, treated as if disposed of at market value on a year-by-year basis.

As a result, the Revenue feels that companies are encouraged to defer tax for as long as possible by holding on to assets and that tax payments are deferred which, of course, the Revenue generally considers to be a bad thing. After all, just as tax deferred is tax saved when looked at from a taxpayer&#39s perspective, tax deferred is tax lost when looked at from a tax gatherer&#39s perspective.

The Revenue also dislikes the fact that the investor (in this case, a company) has flexibility as to when to realise a gain or loss. A change in this position would obviously enhance significantly the tax-planning attraction of growth-oriented collectives.

This seemingly growing concern about tax deferral is a continuation of the trend expressed in the consultation document on offshore funds which I have covered in previous articles and is a worry.

The Government&#39s expressed solution is to tax gains on a mark-to-market basis, as has been suggested for non-disclosing offshore funds. Fortunately, it does accept the difficulty of doing this where there is no ready market in the asset. However, where there is, as is the case for collectives and quoted securities, taxation on a mark-to-market basis looks to be the favoured option.

One may ask why the Government appears to be considering adopting this principle for companies and not individuals. Why is a mark-to-market basis of taxation being proposed for adoption for capital gains and, possibly, offshore non-distributor funds but not non-personalised investment bonds underwritten by insurers?

Both are very important questions but ones which perhaps ought not to be asked too forcibly, if you know what I mean.

In chapter three of the consultation document, the taxation of capital assets is expressly dealt with. The Government starts with the statement that I referred to earlier that it has already started on the process of taking gains and losses out of the capital gains regime in respect of transactions in intangible assets, corporate debt, derivatives and forex. All these have effectively been placed into the income regime.

The opening to chapter three concludes that the Government now needs to consider how all other capital gains assets might be transferred into the income regime. Mention is made here of the need to give special consideration to life insurance companies and collective investment managers.

This is dealt with further in paragraphs 3.19 (life insurance) and 3.20 (collectives). The reassuring statements are: “The Government recognises that life insurance companies need special consideration” and “The position of collective investment schemes…would also need to be considered carefully.”

The main rationale for this “special consideration” is that a substantial proportion of the profits of life companies accrue for the benefit of policyholders. Because of this, treatment of gains that may be appropriate to a company only making gains for its shareholders might be inappropriate for life companies.

Of course, life companies are entitled to indexation relief (as other companies are) and a form of mark-to-market taxation already exists in respect of their investments in unit trusts.

A similarly reassuring and investor-focused rationale is applied when considering managers of collective investments such as Oeics, unit trusts and investment trusts. All gains made by these managers inside the collective wrapper are currently tax-free, with a capital gain only arising on disposal or part disposal of the collective by the investor. The Government states that: “New rules would be needed to continue the tax exemptions for capital gains made by these vehicles.”

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