Autumn Budget 2017 – what does it mean for franchising?
On 22 November 2017, the UK Chancellor of the Exchequer, Philip Hammond, delivered the Autumn 2017 Budget, the first Budget in the new annual tax policy-making cycle.
For interested observers of politics in the UK, this budget was hotly anticipated, partly because the Chancellor's personal political reputation was at stake following a botched Spring budget but also because the UK Government's credibility was under the spotlight, following a string of damaging events, economic headwinds and infighting over the handling of Brexit.
The gloomy economic growth forecast grabbed the headlines, but the consensus seems to be that the Chancellor and the UK Government managed to navigate a safe course through these choppy waters. There were no big radical changes in policy, but there are areas, particularly around tax and business rates, that will affect the businesses sector in the UK, including franchise businesses.
1. Tax treatment of royalties
New liability for income tax
Unsurprisingly in the wake of the publication of the "Paradise Papers", the Government reasserted its commitment to tackling tax evasion and avoidance, including those seeking to do so by the use of offshore structures, by announcing a number of measures aimed at companies seeking to minimise their tax bill. One such measure is the publication, on 1 December 2017, of a consultation on expanding the circumstances in which a royalty payment to persons not resident in the UK has a liability to Income Tax.
Expansion of withholding tax to royalties
The Government plans to extend withholding tax to royalty payments, and payments for certain other rights, made to low or no tax jurisdictions in connection with sales to UK customers, regardless of where the payer is located. Whilst the Budget itself contains very little detail of the Government's proposals, it is likely they will significantly widen the scope of the withholding obligation. Under current rules, deduction of UK tax at source (currently, at the basic rate of 20%) applies to royalty payments in respect of intellectual property where the person entitled to the payments usually resides outside the UK and the obligation on non-UK persons applies only where that person carries on business through a UK permanent establishment. The Government intends to introduce draft legislation setting out the details of its proposals in the 2018-19 Finance Act and for the changes to come into effect from April 2019.
Why is this relevant to franchising?
Franchisees often pay an ongoing percentage of their turnover to their franchisor. Whilst these payments may be described in a variety of ways, such a management fee, services fee or royalty, in reality at least some portion of that payment relates to the ongoing right to use intellectual property relating to the franchise business.
For UK franchisees paying "royalties" to foreign franchisors located in low or no tax jurisdictions, these changes may impact on the commercial model. The same applies at an intra-company level - a typical structure for a franchising business will separate the franchisor from the IP holding company and consequently, a franchisor may pay part or the revenue they receive from franchisees as a royalty back to its IP holding company. For large domestic franchise systems or multinational franchise systems, the IP holding company may be located in low or no tax jurisdictions.
2. Corporate tax and the digital economy
In response to increasingly wide-spread perception that multi-nationals do not pay a fair amount of tax, the Government published a position paper alongside the Budget setting out its proposals for ensuring that the UK corporation tax paid by the tech sector is proportionate with the value it generates from the UK market; specifically from the participation of UK users. The Government is of the view that changes should be made mainly at an international level and has put forward some broad proposals, which it would like considered (along with some suggested unilateral actions) in the OECD's interim report on the digital economy to be delivered in mid-2018.
Why is this relevant to franchising?
For UK franchise systems which are competing with tech/online multinationals, such as in the retail and food & beverage sectors, this announcement is welcome news as it signals that the UK Government understands that there may be an uneven playing field which currently disadvantages UK companies. If this does translate into effective policy, a levelling of the playing field may also have the indirect effect of boosting the use of the franchising model within sections of the so called gig economy.
3. Environmental tax
Reducing single-use plastics waste
The Government has announced that it will be seeking views next year on how the tax system or charges could reduce the amount of single-use plastics waste. This proposal is intended to build on the success of the existing 5p plastic carrier bag charge, which has reduced the use of plastic bags by 80% in the last two years. It also follows the launch in October of an enquiry into on regulatory or voluntary measures to reduce littering and improve the recycling of drinks containers.
Why is this relevant to franchising?
This particular review is likely to have a significant effect on businesses in the retail and food and beverage sectors, many of which use the franchise model. The UK government will seek views on reducing single-use plastics waste through the tax system and charges. Disposable plastics like coffee cups and polystyrene takeaway boxes damage the environment and are an example of increasing regulatory costs to businesses which will need to be factored into business plans/consumer pricing.
4. Business rates
A planned cut to business rate rises in England has been brought forward by two years and will take effect from April 2018. In addition, the Government has announced that business rates in England will rise by the Consumer Price Index (CPI). Business rates currently rise by the Retail Price Index (RPI), a different way of measuring inflation which tends to be higher than the CPI. Furthermore, business rates revaluations will take place every 3 years, rather than every 5 years, starting after the next revaluation, currently due in 2022.
Why is this relevant to franchising?
This is good news for premises based franchised businesses, following the steep increases in business rates which took effect earlier in the year, although some have complained that it is merely another short-term relief measure that will do little more that add complexity to an already complex system and is likely to lead to higher rates in the long term as revaluations will happen every three years rather than every five.
5. VAT
The Government has announced that it will not change the VAT registration and deregistration thresholds for two years from 1 April 2018 while it consults on the design of the VAT registration threshold. Since 1 April 2017 the registration threshold has been set at a taxable turnover of £85,000 and the deregistration threshold at £83,000.
Why is this relevant to franchising?
For low entry level franchise systems which typically generate franchisee revenue under the VAT threshold, this announcement will provide some short term certainty. Nevertheless, franchisees which operate at or close to the VAT threshold, they and their franchisors will need to pay close attention to these developments as a tip in the balance could easily make the difference between an economically viable franchisee as a loss making franchisee.
If you would like more information on these developments, please contact Gordon Drakes at gordon.drakes@fieldfisher.com