The 2018 budget was highly anticipated in light of Brexit. There was a lot of speculation as to what stance the Government would take to prepare the UK (economically) for life outside of the EU. Below we discuss the 5 measures most likely to be of interest to social impact businesses in start-up and scaling mode.
Digital Service Tax
Against the backdrop of international debate around the taxation of the digital economy, the Government has decided to go it alone with a new digital services tax (DST).
From April 2020, the proposed DST anticipates a 2% tax on the revenues of large, established social media platforms, search engines and online marketplaces. These are business models which the Government considers derive significant value from the participation of their users without requiring a physical presence in the UK. The DST applies to the revenues of these in-scope business models where they are linked to UK users, which means that the location of the user is significant and not the location of the business.
At first glance the DST could raise concerns for tech start-ups. Many new business models in the digital services sector have generated significant profits from consumers in jurisdictions in which they do not have a physical presence.
Fortunately, the digital services tax, as currently envisaged, should not have an immediate direct impact on most technology start-ups and (it is hoped) is therefore unlikely to hinder innovation. The main reasons for this are:
- that small businesses will be outside the scope of the tax as it will only apply to businesses with revenue in excess of £500m and even then only to in-scope UK revenues in excess of £25 million; and
- the Government will be consulting on the design of a safe harbour to ensure this tax does not impact upon loss making or very low margin operations in a disproportionate manner.
However, the DST is just the first stage of a wider UK and international response to taxing the digital economy and therefore the importance of this development and the impact it may have on business models, scaling considerations and the wider tech industry going forward should not be overlooked.
For further information regarding the DST and the Budget more generally, please refer to the firm's tax briefing here.
Plastic Packaging Tax
The Government announced that there will be a plastics tax implemented in 2022 which will apply to businesses that produce or import plastic packaging that does not contain at least 30% recycled material.
The Government remains committed to tackling plastic waste and have allocated funding to tackle the issue of plastic waste. The funding (which includes R&D funding) is aimed at helping businesses transition to more eco-friendly materials.
On 29 October 2018 the Government published a plastics fact sheet (link here) which highlighted that this tax would provide a "clear economic incentive" for businesses to use recycled material. The fact sheet also states that a consultation will take place in the coming months, however a specific date has not yet been given.
The tax and funding both provide opportunities for start-ups to find and develop innovative solutions to the issue of plastic waste.
Annual Investment Allowance
The Annual Investment Allowance allows a company to deduct the cost of investment into equipment from their taxable profits and receive 100% tax relief.
Currently, the annual maximum expenditure a company could deduct from their taxable profits was £200,000. This has now been increased temporarily by 500% to £1 million for the two year period from 1 January 2019 to 31 December 2020. This is potentially a huge benefit to start-ups and smaller companies in scaling mode who may be incurring significant expenditure on computer equipment, office fit-outs and other business equipment.
Announced changes to taxation of workers with self-employed status (IR35)
The tax rules distinguish in a number of important manners between employees, on the one hand, and self-employed workers, on the other hand. The latter are generally exposed to lower national insurance charges (NICS), and are not subject to payroll deductions (PAYE).
Many businesses, particularly in the IT and constructions industries will engage workers via a personal service company (PSC) and under the current rules the PSC is responsible for determining the employment status of the worker and operating PAYE and NICs – thus protecting the business. The effect of the changes coming into effect from April 2020 is to place the burden of establishing employment status on the business (and not the PSC).
These changes have the potential to be onerous on affected businesses. Many start-ups and businesses in scaling mode will typically engage self-employed workers initially to lessen their tax and financial burden (until they reach a stage where they are able to hire employees).
Fortunately for such start-ups, the IR35 changes will only apply to "large and medium-sized businesses." Whilst it is not yet clear exactly what will constitute a "large and medium-sized businesses" it is hoped the majority of business in start-up and scaling mode will be spared this additional administrative complexity.
Further consultation and guidance to help taxpayers determine employment status have been promised.
For additional information regarding the IR35 changes please refer to the firm's tax briefing here.
Restrictions on R&D tax relief
SMEs that carry out qualifying R&D can receive a significant tax advantage and can even receive money by way of tax credits. The Government has announced that from April 2020 there will be a cap on the amount of payable credit that can be made to a loss-making business claiming R&D relief; this is part of an effort to prevent abuse of R&D relief. This cap will be three times the company's total PAYE and NICs liability for that year.
This measure may have adverse consequences for start-ups who invest heavily into R&D but also have low PAYE and NICs liability relative to this spend. The Government has recognised this concern and has said that it will consult on how the cap will be applied to minimise any impact to genuine UK businesses.
Overall, the 2018 budget was broadly sensitive to the requirements of start-ups, with some helpful developments such as an increase in the annual investment allowance and opportunities to innovate with the new plastics tax. Furthermore, exemptions from the DST and IR35 changes are likely to be available to the majority of social impact businesses in start-up or scaling mode, retaining flexibility for such businesses.
The contents of this publication are for reference purposes only and may not be current as at the date of accessing this publication. They do not constitute legal advice and should not be relied upon as such. Specific legal advice about your specific circumstances should always be sought separately before taking any action based on this publication.
© Herbert Smith Freehills 2022