On 2 July 2021, the Supreme Court delivered its judgment in R (on the application of Haworth) v HMRC [2021] UKSC 25, finding unanimously in favour of the taxpayer and upholding the Court of Appeal’s decision to quash the follower notice issued to him.
What it Means for Taxpayers
The Supreme Court held that HMRC can only issue a follower notice where they consider that there is “no scope for a reasonable person to disagree” that an earlier judicial decision would deny the taxpayer the advantage claimed. This test is both (i) more precise and (ii) imposes a higher threshold than the Court of Appeal’s formulation that required HMRC to only have “a substantial degree of confidence in the outcome”. This reformulation of the test is apt considering the severe consequences which such measures can have for taxpayers.
The Court’s decision is likely to be of primary relevance to cases with less uniform fact patterns or where the issues involved are fact sensitive. Tax avoidance schemes which are mass marketed are likely to be harder to distinguish from those addressed in earlier decisions and thus remain more susceptible to follower notices. Nevertheless, taxpayers may still be able to point to differences in the legal arguments raised, so a thorough assessment of such arguments would be sensible.
The Court also confirmed that follower notices are not automatically invalidated by defects. Taxpayers should therefore be wary of ignoring such notices simply because they consider them to be non-compliant, particularly on formal or technical grounds.
The Follower Notice Regime
The follower notice regime is contained in Part 4 of the Finance Act 2014 (“FA 2014”). It applies where HMRC contend that an advantage claimed by a taxpayer depends on a particular interpretation of a taxing statute which a court has already decided is wrong.
Where HMRC issue a follower notice, the taxpayer has two options: they can either (i) accept HMRC’s interpretation, concede the advantage and pay tax on that basis, or (ii) refuse to do so and maintain the claim. If they do the latter and HMRC are ultimately proven to be correct, the taxpayer may be liable not only for the tax owed but also an additional and substantial penalty calculated by reference to the value of the claimed advantage.
Furthermore, the existence of a follower notice forms one of the bases on which HMRC can issue an accelerated payment notice, which requires the taxpayer to pay the disputed tax to HMRC on account, in advance of the substantive issues being determined.
Background to the Case
The taxpayer sought to make use of what is commonly referred to as a ‘round the world’ scheme to avoid the payment of UK capital gains tax on the disposal of shares by a trust of which he was the settlor. It aimed to do this by taking advantage of provisions in the Taxation of Chargeable Gains Act 1992 and the UK/Mauritius double tax convention to ensure that Mauritius (which did not charge capital gains tax) had the sole taxing rights.
HMRC issued the taxpayer with a follower notice on the basis that the scheme was materially the same as the one which had been held to be ineffective by the Court of Appeal in the prior case of Smallwood v HMRC [2010] EWCA Civ 778 (“Smallwood”).
The taxpayer’s challenge by judicial review was initially rejected by the High Court but upheld by the Court of Appeal, which quashed the follower notice. The case then came to the Supreme Court to finally resolve the issue.
The UK Supreme Court’s Judgment
The main issue
Before HMRC can issue a follower notice, they must be of the opinion that “the principles laid down, or reasoning given, in the [earlier] ruling would, if applied to the chosen [tax] arrangements, deny the asserted advantage or part of that advantage” (emphasis added) (sections 204(4) and 205(3)(b) FA 2014).
The main issue before the UKSC concerned the degree of certainty that this test requires from HMRC as to the application of the prior ruling. The UKSC held that it is not sufficient for HMRC to opine that the earlier ruling is likely to deny the taxpayer’s advantage; instead, they must consider that there is “no scope for a reasonable person to disagree” that it would. Since this threshold was not met, the follower notice was quashed.
The Court’s decision was based, in part, on the fact that the follower notice regime restricts taxpayers’ constitutional rights to have their case determined by a court by imposing the risk of a significant financial penalty. As such, the provisions had to be interpreted narrowly to reduce the interference with those rights to the minimum extent necessary, whilst still being consistent with the aim that Parliament wanted to achieve by enacting the regime, namely to reduce the resources needed to deal with unmeritorious claims. It was therefore appropriate to give full weight to Parliament’s use of the word “would” in the legislation.
Having set out the relevant test, the Court identified four factors that it said would be relevant to whether HMRC can reasonably form the opinion that the earlier ruling would deny the claimed tax advantage. These were: (i) how fact sensitive the application of the previous decision is (i.e. whether a small difference in the taxpayer’s facts as compared with those of the earlier decision would prevent it from applying); (ii) HMRC’s view of the truthfulness (or otherwise) of the taxpayer’s evidence; (iii) whether the taxpayer raised any legal arguments not considered in the earlier decision; and (iv) the precedential value of the earlier decision (e.g. whether the taxpayer was legally represented and the reasoning in the decision was clear).
The remaining issues
The Court also determined three other issues, holding that:
The full text of the Supreme Court’s judgment is available here.
The Fidelity case concerned claims brough by three undertakings for collective investment in transferable securities (UCITS) for the repayment of Danish withholding tax on dividends received from companies resident in Denmark between 2000 and 2009. The Supreme Court rejected the claims on the grounds that the Fidelity UCITS did not fulfil the conditions for the exemption provided by Danish law.
Background
Danish law allowed UCITS resident in Denmark to apply for an exemption from withholding tax on dividends received from Danish companies. The granting of the exemption turned on two conditions being met: (1) the UCIT must be resident in Denmark; and (2) the UCIT must have Article 16 C fund status. The first condition (UCITS is resident in Denmark) had been held to be contrary to the free movement of capital in 2018 (see ECJ decision here). The second condition (Article 16 C fund status) was met if the UCITS undertook to make a minimum distribution and to withheld from that distribution the tax payable by its members or, after June 2005, if the UCITS calculated a minimum distribution which was taxed in the hands of the members by means of a deduction at source.
The Fidelity UCITS were not resident in Denmark and had not applied to the Danish tax authorities for Article 16 C status. They argued that it was impossible, or extremely difficult, to satisfy the Article 16 C fund status condition, and that they had no incentive to do so, because as non-resident UCITS they did not meet the first condition and were thus ineligible for the exemption in any case.
The judgment of the Danish Supreme Court
The Supreme Court held that the incompatibility of the first condition (UCITS resident in Denmark) with EU law did not mean that the funds were entitled to a repayment of the amounts of dividend taxes withheld. Turning to the second condition (Article 16 C fund status), the Court held that the condition was justified by the need to safeguard the coherence of the tax system and the need to ensure a balanced allocation of taxing rights between Member States, and that it was not a disproportionate restriction on the free movement of capital. The Court added that because the Fidelity UCITS had not applied for an Article 16 C fund status, their claims for a repayment failed because the second condition set out in the legislation for the granting of the exemption had not been complied with.
The Professional Footballers’ Association (“PFA”) has waded in on the long running tension between HMRC and the way that footballers and their agents are remunerated. The PFA is pushing for a dialogue with HMRC to consider a joined-up approach to establishing some clear and agreed principles and parameters particularly in the realm of dual representation of agents. It has become quite common for an agent to act for both the club and the footballer (as specifically permitted by FIFA) when it comes to negotiating transfers. The agent will be compensated handsomely by the club on behalf of both the club and the player for his efforts. The footballer can mitigate the correspondingly hefty tax liability on the agent fee by treating it as a benefit in kind and the footballer is exposed to tax on only half of the total sum paid by the club given the fee is shared between both parties. Given the tax at stake, plus interest and penalties, if HMRC disagree with the position taken by the parties, any headway that the PFA can make will be most welcome and might avoid an emotional penalty shoot-out once an investigation is started.
HMRC have for a long time paid close attention to the tax compliance of footballers likely due to the huge sums involved. In the tax year 2018/19, 87 professional footballers were under investigation by HMRC, this rose to 246 for 2019/20. For agents, the numbers under investigation went from 23 to 55 over the same two tax years and for the clubs themselves from 23 to 25. The additional tax yield following the outcome of the investigations into footballers alone was over £73m in 2019/20.
As well as agents’ fees, image rights payments continue to be scrutinised by HMRC. Images rights payments can be substantial amounts paid to the player on top of salary for use of their image by the club or other parties for advertising and endorsements such as Messi’s controversial Danone/Adidas/Pepsi deals. As a form of intellectual property, the image rights can be owned by a UK company thus taxable at the corporation tax rate of 19% rather than at the 45% rate of earnings for additional rate taxpayers. For non-UK domiciled footballers paying tax on the remittance basis, image rights payments are often split between a UK and non-UK company sheltering an agreed proportion from UK tax entirely.
HMRC have always been uncomfortable with the agreed UK versus offshore split arguing that more falls in the UK tax net than has been declared as UK source hence it is vital that this split is properly documented and justified. HMRC also continue to challenge the commercial reality of the actual payment itself. Buoyed by recent successes before the tax tribunal in relation to their argument that the image right payment is essentially just additional salary and should be taxable as such, HMRC are certainly on the attack and footballers on the defensive. The pandemic adds to the Government’s need for cash so even if you thought it was all over, it’s not yet! Hopefully the PFA can make some inroads in agreeing a universally applied and accepted stance in relation to both agents’ fees and image rights payments but until then advisers must assume a robust and clearly established position and accept that the receipt of image rights payments over and above what a player’s profile might reasonably merit will be ripe for HMRC investigation.
Key Points
In the context of tax disputes, privilege as referring to the fundamental is commonly understood legal right which allows individuals and companies to resist disclosure of confidential evidence. Under English law, there are strict rules on when privilege may apply and this article explores two distinct categories of legal professional privilege: legal advice privilege and litigation privilege.
Another form of commonly encountered privilege is ‘without prejudice’ privilege, which operates to prevent statements made in a genuine attempt to settle an existing dispute from being put before the court as evidence of an admission against the interest of the party making them.
Legal advice privilege
Legal advice privilege only applies to communications between a lawyer and client which have come into existence for the dominant purpose of giving or receiving legal advice. Legal advice privilege is narrower in ambit than litigation privilege but is claimed more commonly. The communications remain privileged at all times unless privilege is waived by the client or inadvertently lost; for example, when confidential information is unintentionally disclosed.
The underlying purpose of legal advice privilege is to ensure that the lawyer’s professional skill and judgment is given freely and is not subject to any constraints. The risk areas in the context of legal advice privilege lie in:
Litigation privilege
Litigation privilege applies to confidential communications between a lawyer and the client or a third party created for the dominant purpose of litigation, which is existing, pending or reasonably contemplated.
The burden of proof in establishing privilege is on the party claiming it. Litigation privilege exists in order that a potential litigant is free to seek evidence without being obliged to disclose their research results.
Recent case law
Two recent pertinent cases address how privilege can be maintained and also so easily lost. These are both worth examining.
Frasers Group: protection by litigation privilege?
The first case is FRC v Frasers Group Plc (formerly Sports Direct International Plc) [2020] EWHC 2607 (Ch). The background to this case was the investigation by the Financial Reporting Council (FRC) into Grant Thornton’s 2015/16 audit of the financial statements of Sports Direct International Plc (SDI), controlled by UK billionaire Mike Ashley.
In 2014, Sportsdirect.com Retail Ltd (SDR), SDI’s subsidiary, received an email from the French tax authorities asking SDR, amongst other things, whether it had paid English or French VAT. The email was interpreted as being in contemplation of a potential enquiry and possible ensuing litigation, and SDR instructed SDI’s solicitors and accountants.
As instructed, SDR’s professional advisers prepared a series of reports on:
The issue for the judge to consider was whether these reports in the hands of SDI were protected by litigation privilege and therefore not required to be disclosed to the FRC. The High Court held that the advice was not protected by privilege as it was ostensibly not prepared for the sole or dominant purpose of litigation.
In his judgment, Lord Justice Nugee made it clear that the ‘sole or dominant purpose test’ for litigation privilege was an extremely high hurdle which could not be overcome in this context simply because, at the time the reports were produced, SDR expected there to be litigation with respect to its VAT arrangements. He said:
‘A taxpayer who takes advice as to how to structure his affairs does not do so for litigation purposes. He does so because he wants to achieve a particular result for tax purposes… Even if it is contemplated that the particular structure will be likely to be attacked by the relevant tax authorities and that there will be litigation, the advice as to how to implement the new structure … is not primarily advice as to the conduct of the future possible litigation. It is primarily advice as to how to pay less tax.’
Advice about a potential course of action may not be covered by litigation privilege, even if that course of action is expected to lead to litigation. However, where the document or advice in question is legal advice given by lawyers, legal advice privilege (rather than litigation privilege) is likely to apply.
The Supreme Court in R (Prudential plc) v Special Commissioner of Income Tax [2013] UKSC 1 confirmed that legal advice privilege does not apply to advice from other professionals. Until Parliament decides otherwise, it continues to be the case that legal advice privilege can only protect legal advice given by members of the legal profession to their clients. The same advice emanating from accountants or other non-lawyers is still vulnerable to disclosure.
Civil Aviation Authority: protection by legal advice privilege?
The judgment in the case of Civil Aviation Authority v R (on the application of Jet2.com Ltd) [2020] EWCA Civ 35 is essential reading for companies relying on the advice of in-house legal teams.
In this case, Jet2 brought judicial review proceedings against the Civil Aviation Authority (CAA) in relation to the CAA’s publication of material critical of Jet2’s lack of participation in a consumer complaint scheme. Jet2 argued that the CAA made the materials public for an improper purpose and applied for disclosure of all relevant drafts and discussions relating to the disclosure. The CAA asserted that such were protected by legal advice privilege.
The Court of Appeal concluded that drafts of the materials should be disclosed unless specifically drafted by lawyers for the ‘dominant purpose’ of obtaining legal advice. Documents circulated to or by in-house lawyers, or the mere presence of a lawyer at a meeting, did not automatically satisfy this dominant purpose test.
Where the dominant purpose is to obtain or give advice, even if in a commercial context, then this should satisfy the dominant purpose test. Communications addressed to lots of different recipients need to be considered very carefully so as not to dilute the legal advice and render it merely a subsidiary purpose. Where external lawyers are appointed, legal advice privilege will clearly apply.
Points to take away
In order for litigation privilege to apply, the relevant document must have been created for the dominant purpose of obtaining advice in relation to litigation that is reasonably in contemplation. This does not include litigation that may possibly arise in future as a result of a particular course of action.
It is always difficult where a communication has a mixed commercial and litigation purpose. A safe way to protect such communication is to ensure that it is also covered by legal advice privilege.
Legal advice privilege is also subject to the dominant purpose test. Where not inextricably intermingled, it may be possible to separate out the component parts of some advice but if there are commercial as well as legal issues being discussed great care is recommended.
Draft legislation for inclusion in Finance Bill 2021 was published on 21 July 2020, the day before Finance Act 2020 received royal assent. The draft measures include detailed proposed legislation to further reduce the scope for promoters and enablers to market tax avoidance schemes and to strengthen the sanctions against those who continue to promote or enable such schemes. The government published a consultation in conjunction with the draft clauses on 21 July 2020 which closed on 15 September 2020. The consultation ran alongside a call for evidence on disguised remuneration wherein the government is seeking insight as to the drivers for any continued use of disguised remuneration tax avoidance, what if any schemes are not presently covered under current legislation and what the government can do to further tackle disguised remuneration tax avoidance with a closing date for comments of 30 September 2020.
The proposed new clauses also form part of the House of Lords Economic Affairs Finance Bill Sub-Committee inquiry (deadline for submissions 7 October 2020) which seeks written evidence on:
• How effective are the existing powers of HMRC in tackling promoters and enablers of tax avoidance schemes?
• What experience do practitioners have of the promoters of tax avoidance schemes (POTAS) rules and the enablers rules in practice?
• How effective will the proposed measures be against those who promote aggressive tax avoidance schemes, and in informing and deterring potential scheme users?
It is evident that significant government time and resource is being channelled into this area, which is of course very reassuring. HMRC is clearly of the view that promoters continue to frustrate and try to circumvent their obligations under POTAS, DOTAS and GAAR, and thus further action is required. Still more powers are expected to be bestowed upon HMRC in the next Budget (which will now be next spring) to tackle those in persistent default. There is no doubt that this is an ever-evolving area that needs to be kept under constant review.
Proposed changes
The new rules contained in Finance Bill 2021 apply to three distinct areas of existing legislation, namely POTAS, DOTAS and the GAAR. It should be acknowledged from the outset that there is concern among the professional bodies that any newly drafted legislation ought only be enacted to the extent that it is properly and specifically targeted, so as not to increase compliance burdens on those already conforming.
The new draft rules are framed in the following way.
POTAS
The government is keen to strengthen the promoters of tax avoidance schemes (POTAS) rules, contained in FA 2014 Part 5, by giving HMRC power to issue a stop notice (to stop the scheme being marketed while HMRC investigate) at an earlier stage and in a wider range of circumstances, as well as enabling HMRC to name and shame where a stop notice has been issued.
The conditions in the draft legislation, incorporating new s 236A into FA 2014, are very widely drawn as they presently stand and the threshold for HMRC to issue a stop notice is very low. The definition of ‘arrangements’ within the new clause would potentially apply to many commercial arrangements simply by virtue of conferring a ‘tax advantage’ (as widely drafted). A similar concern is that the power to issue a stop notice would be based on whether the authorised HMRC officer merely ‘suspects’ that a person promotes arrangements; this is a very low bar which creates scope for its misapplication. Some tweaks might be needed to these rules before they reach the statute book, and we are yet to see how the internal review and appeals process would apply to these new sections, so as to protect those that are explicitly not the target of these new rules. It is important
not to over burden those legitimate and honest advisers who should simply not be within the ambit of the rules.
In addition, the intention is to widen the POTAS rules to include individuals who control, or significantly influence, entities that carry on promotion activities. This should prevent errant scheme promoters from using a corporate vehicle to circumvent the existing rules.
The legislation also introduces a range of technical amendments in relation to conduct notices, including extending their application up to a maximum of five years (currently two years) to take into account the promoter’s behaviour, and further conduct notice threshold conditions have been added.
As the draft legislation stands, it is notable that noncompliance with DAC 6 may lead to the issue of a POTAS conduct notice, which is especially surprising given that some DAC 6 hallmarks do not even require any tax avoidance or advantage motive. This will no doubt add to the current anxiety over the looming onerous compliance obligations of DAC 6.
DOTAS
The draft legislation would also introduce yet more HMRC information powers under the FA 2004 Part 7 disclosure of tax avoidance schemes (DOTAS) and enabler regimes.
The DOTAS changes would enable HMRC to act more promptly where promoters fail to disclose or provide information about their scheme within 30 days, primarily by introducing a new information notice which could be issued in a broader range of circumstances. If the information required is not forthcoming or insufficient, HMRC would have the power to issue a scheme reference number (SRN), which in turn may be published.
Advocating and legislating for the use of early intervention tactics is a good policy; however, under the current draft rules, there would be no right of appeal against a new information notice under FA 2004 new s s31D, so even compliant advisers would need to safeguard themselves against the potential for these new rules to inadvertently bite.
F(No.2)A 2017 Sch 16 would be amended to enable HMRC to use its Sch 36 information powers as soon as a scheme has been identified. Advisers would need to be more vigilant than ever in ensuring that HMRC strictly adheres to the limits of these powers and only requests such information that is reasonably required.
GAAR
The ambit of the general anti-abuse rule (GAAR) in FA 2013 Part 5 would also be amended, so that it would apply to partners and partnerships who enter abusive arrangements. This is intended to operate on a similar basis to the representative partner approach that currently exists for enquiries conducted under TMA 1970.
Interaction with PCRT
The professional bodies are frustrated by the perceived need for yet more legislation targeted at a small number of boutique firms or individuals that bring the profession into disrepute. Over the past few years, the Chartered Institute of Taxation (CIOT) and other professional bodies have spent a significant amount of time and effort on the professional conduct in relation to taxation (PCRT) rules to ensure they set a minimum industry standard on professional behaviour expected of their members when undertaking tax work, such as forbidding tax planning on a generic basis. Failure to comply with PCRT may expose a CIOT member to disciplinary action. The problem, of course, is that scheme promoters may not be affiliated with a professional body.
Tackling disguised remuneration
As discussed, the new draft provisions sit alongside the call for evidence on tackling disguised remuneration. Appreciating this context is important in understanding the perceived need for and scope of the proposed new rules. Back in 2016, the government announced the introduction of the loan charge which it intended would draw a line under disguised remuneration schemes. The subsequent Morse review that looked into the controversies surrounding the loan charge highlighted concerns that such schemes were unfortunately still being used and henceforth the government set out that further action would need to be taken. In fact, reportedly as late as December 2019, over 20,000 new schemes had emerged with 8,000 of those in 2019/20. The recent HMRC call for evidence in tackling disguised remuneration focuses not only on promoters but on how to disrupt the employment supply chains where such schemes are being used and how to help taxpayers avoid schemes. To its credit, HMRC is hosting a series of virtual roundtables on this call for evidence to better understand how to tackle the continued use of schemes.
The tax gap
The National Audit Office (NAO) entitled report Tackling the tax gap, published on 22 July 2020, examined the effectiveness of HMRC’s approach in reducing the tax gap. The tax gap is certainly diminishing; however, given the inevitable significant fiscal impact of Covid -19, the House of Commons Public Accounts Committee inquiry furthered the work of the NAO questioning senior members of HMRC and HMT in relation to inroads being made to further reduce the tax gap on 7 September 2020.
It should be borne in mind that the tax gap attributable to avoidance is low compared to the gap attributable to error and non-payment, and evasion is the real issue which is a criminal offence. In relation to taxpayer error, the NAO highlighted that significant tax is lost as a result of mistakes, undoubtedly attributable to the complexity of the tax system so adding more legislation arguably is not the answer. Anti-avoidance legislation trying to squeeze diminishing returns from this area might be a vote winner and grab the headlines, but perhaps it is time for a change of direction or the compliant risk being overburdened.
Where does this leave us?
The reality is that there are still determined profiteers from certain schemes who are able to quickly bring these schemes to market, realise a hefty profit and then disappear. As some of these individuals or outfits are committing fraud and undertaking serious criminal activity, it is questionable as to whether yet more legislation will discourage their behaviour. Perhaps a better way to tackle this residual abuse would be for HMRC to more effectively use the information it has available via RTI and take more effective enforcement action. HMRC could consider applying a PAYE or VAT security notice at an early stage.
Ultimately, we need to see a clear and strong public message that these promoters can no longer get away with such tactics (HMRC spotlights arguably do not reach their intended audience), perhaps coupled with more leniency for whistleblowers. HMRC should also work harder to ensure that the unwary taxpayer is not fooled by these schemes. HMRC s counter avoidance and fraud investigations teams need to communicate and work on a more rapid response. Efforts should be concentrated on better policing, as many tax evaders may still undertake illegal activity on the basis that they are unlikely to be caught.
What changes, in overview, are made by this draft legislation?
Over the past ten years the government has introduced significant additional powers for HMRC to use to combat the promotion of abusive tax schemes. There is a lack of detailed evidence to undertake a useful evaluation of how effective these changes have been but given that the government is now seeking to further strengthen the sanctions against those who have continued to promote or enable tax avoidance schemes, it must be assumed that those promoting tax schemes have been able to frustrate HMRC’s ability to quickly suppress the promotion of such schemes.
The following key changes are now suggested:
Why does HMRC want to strengthen the existing regimes in this way?
The proposals are part of a wider policy to further curtail the behaviours of those who continue to design and promote aggressive tax avoidance schemes and to provide further clarity for the taxpayer in deciphering where they are being misled.
There is still a concern that taxpayers are being enticed into schemes without any real understanding of the risks. These powers will enable HMRC to intervene at an earlier stage to address this issue and allows HMRC to act where it concludes that the scheme cannot achieve what is being promised by the promoter.
The policy intent of the new powers can be considered alongside the continued action HMRC is taking against disguised remuneration schemes. In a recent call for evidence specifically related to such schemes HMRC talked about wanting to ‘disrupt the business model/ economics and supply chains of avoidance as well as helping taxpayers steer clear’.
Has HMRC used the POTAS rules much since their introduction in 2014?
The POTAS rules were really an additional deterrent and a means by which HMRC could monitor the activities of a small number of persistent repeat offenders. There is little tangible evidence of their use, but it may be reasonable to assume that HMRC has been more active than the evidence suggests.
Notwithstanding, it is clear that the overall level of tax avoidance activity has been significantly reduced in the main due to the combination of the DOTAS and accelerated payment notice regimes that plugged a significant gap. It was always hoped that few promotors would meet the given POTAS threshold conditions and thus be issued with conduct notices, and that from there most would comply with a conduct notice so that there would be no need to issue a subsequent monitoring notice.
HMRC describes the changes as 'necessarily far-reaching'. Should law-abiding tax advisers be concerned?
It was surprising that Sir Amyas Morse’s independent review of the loan charge published in December 2019 stated that since the introduction of the loan charge in 2016 over 20,000 new schemes had emerged and 8,000 of those emerged as late as 2019–20. This data was somewhat difficult to believe given the controversy caused by the loan charge and the extent of the consequent publicity but plainly some individuals have continued to play fast and loose with the rules.
The rules should not apply to those tax advisers who steer well clear of tax schemes and many advisers will support these changes as targeting anyone who continues to promote tax avoidance schemes and undermine the integrity of the profession.
Does the new consultation document shed any additional light on how the new provisions will be applied?
As with all new anti-avoidance measures HMRC must ensure that adequate procedural safeguards exist for the protection of the taxpayer and the difficulty is always ensuring that these do not compromise the effectiveness of the rules. Some further thought will be needed in relation to an appeals process.
Further measures are promised for the Autumn Budget 2020, do you have any views on what we might see?
As mentioned above, the new rules sit alongside a call for evidence on tackling disguised remuneration schemes so we should expect to see additional measures in this area. The existing rules are complicated for HMRC to apply and even with these changes HMRC is likely to find that there remain issues in how effectively it can tackle those most determined.
It seems likely that many of the anti-avoidance rules and corresponding taxpayer protection measures will continue to be streamlined to increase their effectiveness.
There are presently many strands of evidence-gathering concerning promoters of tax avoidance schemes, including a recent All-Party Parliamentary Group paper on responsible tax practices. As a result the government may conclude that even more wide-ranging changes, including a possible new Taxes Management Act, are required.
When will the Finance Bill 2021 measures take effect?
Many of the tweaks to the existing rules will take effect for all new schemes which are or continue to be promoted after the date of Royal Assent. The new information powers will apply to all current as well as future investigations into potential enablers.
Interviewed by Halima Dikko.
The General Court of the European Union has today annulled the Commission’s decision regarding two Irish tax rulings in favour of Apple. The Commission had considered that the two rulings constituted State Aid, granting Apple €13bn in unlawful tax advantages.
The annulment of the Commission’s decision was on the basis that the Commission had failed to meet the requisite standard of proof. In that regard the outcome is similar to the Court’s rejection of other state aid decisions.
While accepting the Commission’s argument that an OECD arm’s length test was an appropriate tool to assess profit allocation (notwithstanding the absence of such a test in the national law at the time) the Court has concluded that the Commission has failed to prove that profits should have been allocated to the Irish branches. The Commission also failed to show that the tax rulings in dispute were methodologically unsound or the application of discretion.
The Commission will have the ability to appeal this decision to the Court of Justice however, the nature of these findings may make appeal on some of the issues difficult.
The decision is very helpful to those taxpayers in the UK who are affected by the Commission’s decision to regard the partial and full exemption of non-trading financing profits as state aid. The nature of this ruling, consistent with other similar outcomes annulling state aid decisions in the Belgian Excess Profits and Starbucks cases, challenges the Commission’s approach to the UK provisions which assumes that those provisions produce an advantage generally to all taxpayers benefiting from them. Rather, the Court has now consistently required the Commission to prove an advantage in specific cases. The “one-size-fits-all” approach to state aid appears, at the level of the General Court at least, to be precarious.
For those interested in the UK financing profits state aid case, a virtual seminar is being arranged to discuss recent developments and issues which have arisen from HMRC’s collection activities. Please contact Michael Anderson if you would like to attend.
The Finance Bill 2020 contains relatively few inheritance tax changes. However, clauses 72 and 73 introduce some important amendments to the excluded property provisions governing settlements and, in particular, to IHTA 1984 s 48(3) and ss 80–82.
Background
Generally, non-UK assets held in a trust established by a foreign domiciled settlor qualify as excluded property. Excluded property is not ignored for all IHT purposes but importantly it is not subject to the relevant property regime nor charged under the reservation of benefit rules. Nor is the foreign domiciled settlor liable to an entry charge when settling such property into trust. The foreign settled property remains free of inheritance tax charges even if the settlor later becomes domiciled or deemed domiciled in the UK (IHTA 1984 s 48(3)).
When determining whether the trust holds non-UK assets, one looks at the situs of the property held by the trustees directly, not the property held in underlying holding companies. This means it is relatively easy to ‘resite’ UK property such as shares and art by holding it in trust in a foreign incorporated holding company. This process is sometimes called ‘enveloping’.
It is no longer possible to envelope UK residential property; such ‘Sch A1’ property is no longer excluded property. Furthermore, if the settlor was foreign domiciled when he settled the trust but had a UK domicile of origin, was born here and later becomes UK resident, the trust can lose its excluded property status going forward while the settlor remains UK resident. These exceptions are not discussed further here.
Note that the domicile of any beneficiary, even the life tenant, with one exception, is generally irrelevant for IHT purposes, as is the residence of the trustees. The only thing that matters is the domicile of the settlor at the time the ‘settlement was made’.
Example 1: Mr X is foreign domiciled and on his death leaves foreign assets into an interest in possession trust for his wife, Mrs X. Mrs X dies domiciled in the UK. The settled property is still free of inheritance tax on her death, provided the settled property at that time is foreign situated (and is not Sch A1 property). However, note that if the trust does not end then but the property continues to be held in trust, it will not be excluded property going forward but fall within the relevant property regime. This is because for the purposes of the relevant property regime Mrs X’s domicile is retested at the time her IIP ends (see IHTA 1984 s 80 and s 82).
Example 2: Conversely, assume that Mr and Mrs X are deemed domiciled. On Mr X’s death, he leaves his estate to his spouse, Mrs X, on a qualifying interest in possession trust. There is no tax on his death because the transfer qualifies for spouse exemption. However, Mrs X dies many years later having lost her deemed domicile because she returned to her country of origin. Although she is foreign domiciled at the date of death, IHT arises on her death because the property was settled by a settlor who was UK domiciled. If the trust continues it will be relevant property (see IHTA 1984 ss 48, 82). The one exception would be if Mrs X died non-UK resident and at that time the trust held certain qualifying UK government gilts, but that would not depend on her domicile.
Example 2A: Assume that Mr and Mrs X are both foreign domiciled. In 2005 he gives property on qualifying interest in possession trusts for his spouse. Then she dies foreign domiciled at which point the property is held on discretionary trusts. By then Mr X (but not Mrs X) is deemed domiciled. There is no tax on her death as all the property was settled when Mr X was foreign domiciled. However, going forward although the requirements of both s 80 and s 82 are satisfied, IHTA 1984 new s 81B will soon impose an additional requirement once the Finance Bill 2020 is enacted. Mr X’s domicile will also have to be retested at the date Mrs X’s IIP ends and if he is UK domiciled the property becomes relevant property (albeit it would appear that it is still excluded property for the purposes of reservation of benefit as s 81B only applies for the purposes of the relevant property regime.) In practice this must be relatively rare as in most cases by the time Mrs X’s IIP has ended Mr X will be dead anyway in which case his domicile will be irrelevant.
The problems
A longstanding argument with HMRC relates to:
Additions to trusts
Section 48(3) simply tests the settlor’s domicile at the time the settlement is made. Read literally, this means that property added by the settlor to a settlement made when he was foreign domiciled will always be excluded property irrespective of his domicile. HMRC’s view was that, in relation to any particular asset, ‘a settlement was made’ when that asset was transferred to the trustees to be held on the declared trusts. HMRC’s Inheritance Tax Manual (at IHTM27220) notes:
‘[T]he legislation refers to the settlor’s domicile at the time the settlement was made. You must proceed on the basis that, for any given item of property held in a settlement, the settlement was made when that property was put in the settlement… S, when domiciled abroad, creates a settlement of Spanish realty. Later he acquires a UK domicile and then adds some Australian property to the settlement. The Spanish property is excluded property because of S’s overseas domicile when he settled that property. However, the Australian property is not excluded property as S had a UK domicile when he added that property to the settlement.’
In effect, HMRC considered that every addition to an existing settlement constituted the making of a new settlement in relation to that property. The example above makes it clear that adding property to an existing settlement which is excluded did not, in HMRC’s view, jeopardise the exemption from inheritance tax for the original property, provided that it was kept segregated. It merely meant that the new property did not qualify for protection.
In Revenue Interpretation RI 166, HMRC said: ‘If assets added at different times have become mixed, any dealings with the settled fund after the addition may also need to be considered.’ Most commentators doubted that this view was correct. It is true that property becomes comprised in the settlement at the time when it is added, but this is different from saying that a new settlement is ‘made’ when the settlor adds the property. As a matter of trust law, there are not two separate settlements and there is no deeming provision in the IHT legislation to treat additions as separate settlements.
HMRC justified its view on the basis of the definitions of settled property and settlement in IHTA 1984 s 43. It considered that each gift to a settlement was a disposition and that each disposition represented a new and separate settlement. However, this view did not easily fit with the wording either in s 43(2), which itself defined settlement as meaning any disposition or dispositions of property; or in s 44(2), which provides for separate settlements where two settlors add property to the same settlement. Such a section would be largely unnecessary if every disposition of property was treated as a separate trust. The case of Rysaffe Trustee Co v IRC [2003] STC 536 was also unhelpful for HMRC.
Transfers between trusts
Example 3: Assume that trustees of Trust 1 transfer property from Trust 1 (made when the Mr X was foreign domiciled) to a new Trust 2 (made when Mr X was UK domiciled). Does the requirement that the settlor is not domiciled at the time ‘the settlement was made’ focus on the settlor’s domicile at the time Trust 1 is created or on the domicile of the settlor when Trust 2 is created?
In these circumstances, not only s 48(3) but also ss 81 and 82 are in point. Section 81 provides that when property passes from one settlement to another, it is treated for the purposes of the relevant property regime as remaining comprised in the first settlement. Section 82 provides that the property transferred to Trust 2 is not thereafter excluded property for the purposes of the relevant property regime unless the settlor of Trust 2 was neither domiciled nor deemed domiciled in the UK when Trust 2 was made. In this example, Trust 2 would not hold excluded property even under the old rules. The transfer to Trust 2 has lost that favoured treatment.
Example 4: More complicated scenarios often arise. For example, the trustees may transfer property from Trust 1 to Trust 2. Both trusts might have been made when the settlor was foreign domiciled but the transfer actually takes place when he is UK domiciled. In these circumstances, is the property transferred excluded property? HMRC accepted that where both trusts were settled when the settlor was foreign domiciled and the transfer was made by the trustees when the settlor was deemed domiciled, it nevertheless remains excluded property for all purposes.
The Barclays Wealth case
These points were considered in Barclays Wealth v HMRC [2015] EWHC 2878 (Ch) and [2017] EWCA Civ 1512. The facts were as follows. In 2001, Michael Dreelan settled property, including company shares, into a trust when he was not deemed domiciled in the UK. In 2008, when deemed domiciled here, the shares were appointed to a new trust that he had set up after he was deemed domiciled here (effectively example 3 above). The shares or sale proceeds were deemed to remain in the 2001 trust for the purpose of the relevant property regime by virtue of s 81 (and so the ten year anniversary of Trust 1 operated) but were not excluded property, as that would have required the second trust to have been made by a non-domiciled settlor.
Subsequently just before the ten-year anniversary of the first trust in 2011, the cash was appointed back from the second trust to the first trust. The question was whether the cash had become excluded property. HMRC argued that the cash had lost its status as excluded property once appointed to the second settlement, as this transfer was made when Dreelan was UK domiciled and was therefore caught by s 82; and that the cash could not regain excluded property status when appointed back to the first trust. The taxpayer argued that since the first settlement was ‘made’ when he was not domiciled in the UK, subsequent additions of property, including appointments back of the original cash, were irrelevant; and the cash could thereby reacquire its excluded property status. In a sense then, the case raised both problems outlined above.
The High Court found in favour of HMRC and determined that the word ‘settlement’ is capable of describing both the making of the original settlement and the subsequent addition of property to that settlement. It is not merely referring to the ‘trust structure’. The result of this was that if, at the time of any subsequent addition to an existing settlement, the settlor was domiciled in the UK, the property added is not ‘excluded property’, despite the settlor being non-domiciled at the time the settlement was set up.
However, the judgment was reversed by the Court of Appeal at [2017] EWCA Civ 1512. The taxpayer argued that:
HMRC argued that a new trust had been made when the trustees of Trust 2 transferred the sale proceeds back to Trust 1 in 2011; i.e. a separate settlement is created for inheritance tax purposes whenever a settlor (or trustee) adds property to an existing trust. As Mr Dreelan was then deemed domiciled in the UK, HMRC’s view was that the sale proceeds were not excluded property and were therefore subject to the anniversary charge.
The leading Court of Appeal judgment was given by Henderson LJ. First, he held that once the 2011 appointment moving the cash back from Trust 2 to Trust 1 had been made, the deeming effect of s 81 was spent and it was no longer property to which s 81 applied for the purposes of s 82. There was no need to deem the cash derived from the sale of the shares to be comprised in Trust 1 since that was now the reality. Hence, the issue of whether the cash was then excluded property depended on s 48(3), and particularly on the answer to the question of when the settlement was made [para 45].
Here, Henderson LJ held that it was implausible to suppose that in s 48(3) the same word ‘settlement’ was intended by Parliament to have two different meanings. A settlement is a single settlement, as it is constituted from time to time even if a number of transfers are made into the settlement. The settlement is made when the settlor first executes the trust document and provides the initial trust property and it is at that point only that his domicile is tested. As the cash was deemed to have remained throughout in Trust 1, it could not be treated as the subject of a separate disposition into Trust 1 at the same time. There was nothing surprising in the conclusion that the cash was excluded property.
Example 5: Christina is foreign domiciled when she sets up and funds trust 1 with foreign cash. Some years later when deemed domiciled here, she adds £1m to the trust. This is an immediately chargeable transfer and 20% inheritance tax is due. However, going forward the £1m may be excluded property and not subject to exit and ten year anniversary charges, although this point was left open by the Court of Appeal.
The proposed legislation
HMRC quickly announced that it intended to legislate to reverse the effect of Barclays Wealth. The draft legislation was published on 11 July 2019 and has been slightly modified in the republication in Finance Bill 2020. It is not easy to follow. The proposed revisions are as follows:
1. Additions
Where property is added to an existing settlement, the domicile of the settlor will be considered for the purposes of the excluded property rules at the time of the addition, rather than at the time the settlement was first created. Even if property was added to an excluded property trust before Finance Act 2020 comes into effect, it will not be protected from future inheritance tax charges arising after that date (including on the settlor’s death) if the settlor was domiciled in the UK at the date of addition.
The proposed draft legislation at clause 72 amends s 48 so that instead of referring to when a settlement is made, it tests the settlor’s domicile by reference to when property ‘becomes comprised’ in an existing settlement. Loss of excluded property status only affects the added property, not the property originally settled when the settlor was foreign domiciled. However, the change raises some serious issues if the settlor remains a beneficiary at the date of his death, as the added property is no longer excluded property.
Example 6: Sharma set up a discretionary trust when foreign domiciled in 2009, settling £10m into it. In 2015, when deemed domiciled for IHT purposes, Sharma added some business property to it (thus avoiding an entry charge). In 2019, there is no ten year charge as all the property is excluded; additions are not counted. Post-2020 (in 2029), there will be a ten year anniversary charge on the value of the business property (subject to the availability of any BPR), as this will no longer be treated as excluded property for the purpose of the relevant property regime. In addition, there is a potential reservation of benefit on Sharma’s death in relation to the addition if Sharma can still benefit from the settled property as it is no longer excluded property.
2. Transfers between trusts
Clause 73 provides that where property is transferred from one trust to another or from Trust 2 back to Trust 1 after FA 2020 is enacted, the settlor must be foreign domiciled at the time of each transfer, not just when each settlement was first made for the settled property to remain excluded property. If the settlor has died deemed or actually domiciled and the transfer takes place later (not on his death) then that transfer will not lose excluded property status. Hence, on that basis, in both examples 3 and 4 the settled property in Trust 2 will no longer be excluded property.
It is hard to know why HMRC would object to example 4 as no new property has come into the excluded property regime at a time when the settlor is UK domiciled. Of course, since April 2017 transfers between settlements can no longer be made anyway if a settlor is deemed domiciled and UK resident, as the recipient trust would lose protected trust status for income tax and CGT purposes by being tainted.
If the settlor has died deemed or actually domiciled but the transfer to Trust 2 takes place sometime after his death, then that transfer will not lose excluded property status if Trust 1 was an excluded property settlement. However, until then trustees have very little flexibility after a settlor has become domiciled or deemed domiciled to make transfers between trusts.
More worryingly, problems now arise if Trust 1 and Trust 2 were set up when the settlor was foreign domiciled but he was deemed domiciled at the time the transfer was made and the transfer was done many years ago before FA 2020 was enacted. In that event, the assets transferred will not be subject to relevant property charges, but if the settlor is a beneficiary of the transferee trust the assets transferred will be included in his estate on death meaning the excluded property rules no longer trump the reservation of benefit rules after Finance Act 2020.
Example 7: Kingsley set up two trusts when he was foreign domiciled with £1m in each. In 2016, when he was deemed domiciled for IHT purposes, the trustees transferred all the property from Trust 1 to Trust 2 and ended Trust 1. Trust 2 now holds all the property.
There are no relevant property charges going forward if no UK situated property is held by the trustees at that time, as the transfer was done prior to FA 2020 and both trusts were actually funded when the settlor was foreign domiciled. The property in Trust 2 remains excluded property for the purposes of the relevant property regime and no ten year charges should arise.
However, the addition to Trust 2 is no longer excluded property for reservation of benefit purposes, as property has become comprised in a trust at a time when Kingsley was deemed domiciled. Section 48(3) no longer protects the property in Trust 2. If Kingsley is a beneficiary of Trust 2, then there is IHT payable on his death at 40%. Kingsley should be excluded – ideally before FA 2020 receives royal assent to prevent a seven year run off. Otherwise he is deemed to make a PET under FA 1986 s 102(4).
Accumulations of income
There has been a welcome change to the provisions on accumulated income since the 2019 draft. On the basis that accumulated income ‘becomes comprised’ in the settlement when it is accumulated, a change in the domicile status of the settlor from non-UK domiciled to UK domiciled between the date of the settlement and the date when income is accumulated would result in such accumulations becoming relevant property comprised in the settlement at the time when the settlor was UK domiciled, even though arising out of excluded property. A new clause 72(2)(d) has been inserted, to become new IHTA 1984 s 48(3F), which ‘provides that accumulations of income are treated as having become comprised at the same time as the property (producing that income) became comprised in the settlement’. See also new IHTA 1984 ss 64(1BA) and 65(8BA). In effect, the legislation ensures that accumulations of income from property that was originally settled when the settlor was foreign domiciled remain excluded property.
Conclusions
As STEP commented in its recent submissions on these clauses: ‘Sections 80-82 are already complex and difficult to understand… [T]he proposed new legislation only adds to those uncertainties.’ The legislation on additions can be justified on the basis that this simply represents what HMRC always considered to be the case. Practitioners who ignored this advice did so knowingly. Transfers made between trusts where they were both funded when the settlor was foreign domiciled generally had no tax avoidance purpose and often fall within the facts of example 4 above, which HMRC previously confirmed gave rise to no IHT problems. It is particularly worrying, however, that such transfers could now end up losing excluded property status going forward for the purposes of the reservation of benefit rules. Such transfers will no longer qualify as excluded property for the purposes of the reservation of benefit rules, as in effect property has been ‘added’ when the settlor was deemed domiciled. This seems most unfair for those trustees who relied in good faith on HMRC practice and assurances (and indeed the view was sound in law as confirmed in the Court of Appeal Barclays Wealth judgment). Trustees will now need to look carefully at all inter trust transfers and additions and the status of the settlor at the date of each transfer.
No changes were made in committee to these clauses. The sensible approach would be to deal with additions of value but ensure that transfers between settlements funded where the settlor was foreign domiciled remains excluded property for all IHT purposes, not just for the purposes of the relevant property regime. However, it seems too late to achieve this objective now. The best option may be to obtain clear Revenue guidance.
HMRC’s Trusts and Registration Service (TRS) was born back in 2017 as part of the implementation of 4MLD[1]. 5MLD[2] has mandated notable amendments to the operation of the TRS that clients and practitioners should not overlook. We have created a Q&A to help to navigate the new upcoming compliance obligations.
Does my trust need to register under 4MLD?
Yes- if it is a relevant taxable trust. This means a trust with a UK tax consequence i.e. the trust has a liability to pay UK income tax, CGT IHT or SDLT. There is no deminimus threshold. Registration deadlines are tied to when a tax liability is crystallised which itself depends on the type of tax liability payable.
Under 4MLD it is possible for non-UK resident trusts to fall in and out of TRS depending on when they have a UK tax liability e.g. a liability arises only on the occasion of a 10-year charge.
What about a trust with an IHT liability due to enveloped property?
4MLD did not extend to ATED. Assuming the property was held at company rather than trust level and the company was not a mere nominee then there would be no TRS obligation despite the Schedule 10 F(no2)A 2017 IHT look through.
So, what has changed in light of 5MLD?
5MLD has removed the tax consequence requirement and now all UK resident express trusts and some non-EU resident trusts must register irrespective of whether they have incurred a tax liability.
A non-EU trust must register with the TRS where the trust either acquires land in the UK after 10 March 2020 or after this date enters into a business relationship with a UK-based entity which is subject to AML rules. It is irrelevant where the trust itself is resident.
What does business relationship mean?
One off advice from a UK accountant or law firm is not covered but if it is advice given to the trust over some period then the trust will have to register – this aspect of the rules is controversial and not yet finally accepted particularly by those who are worried it will deter clients seeking UK tax advice. If you’ve already got an ongoing legal relationship with the UK firm prior to March 2020 then you don’t need to register just because of this existing business relationship.
What about if the business relationship is with the underlying company?
The business relationship should have an element of duration between the relevant person and the trust itself.
Is the register public? If so who has access?
It is important to appreciate that under 5MLD, individuals who have a legitimate interest in information concerning the beneficial ownership of the trust can apply to access certain information. This is potentially quite alarming for those who value their privacy. Someone asserting that they have a legitimate interest will have to provide information to substantiate that interest, such as why the applicant suspects that the trust has been used for money laundering.
If you have already registered does this mean you are exempt from legitimate interest requests?
This remains unclear at the date of writing.
What about a Foundation?
The obligations imposed on trustees should be assumed to apply to the managers of a Foundation which for English law purposes would generally be characterised as a trust.
Can you register voluntarily?
The prospect of highly sensitive information regarding key individuals being delivered to HMRC and potentially being available to interested parties perhaps including investigative journalists albeit in strictly controlled circumstances will make few want to register unless obliged to do so.
What’s the timing on all of this?
The deadline for registering all pre-10 March 2020 trusts is 10 March 2022 and new trusts created after 10 March 2020 have 30 days to register. Any changes to the beneficial owners of the trust must be reported within 30 days. The 30 days deadline may prove to be quite a challenge for many trustees and will certainly be problematic for trusts created on death as it can take time for assets to vest.
What information needs to be registered?
When registering, the following information will be required:
For UK resident individuals name, date of birth and NI number is required. For non-UK resident individuals name, address and passport/ID number must be provided.
Trustees are required to make an annual declaration that the details on the register are correct. Information provided will be retained on the register for 6-10 years after the trust is terminated.
Is the above different from existing information already held/ required under 4MLD?
Where a trust is already registered for TRS under 4MLD, some additional information will need to be provided in order to fulfil the requirements of the new 5MLD (including whether or not a trust holds a controlling interest in a third party entity).
Are all trusts included?
5MLD covers express trusts. An express trust is one established deliberately by a settlor. Therefore, excluded from scope are: statutory trusts, resulting trusts and constructive trusts. Unit trusts are also considered to be outside the scope of the definition of express trust.
UK registered pension schemes, UK charitable trusts are excluded as are trusts consisting solely of an insurance policy, such as a life insurance policy, which is a pure protection policy and payment is not made until the death or terminal illness of the insured. More detailed discussion of these exclusions should be considered if necessary.
Trusts established to meet legislative conditions such as PI trusts, trusts for the vulnerable, share option schemes, co-ownership trusts are also excluded.
What about nominee arrangements?
Bare trusts are expected to be excluded but HMRC clarification on this is still pending.
What happens if I don’t register?
Initial failure to register will be met with a nudge letter and there will be no financial penalty for a first offence of failure to update details but thereafter there will be a penalty of £100 per offence. Deliberate failure to register on time or update the register will carry significant penalties.
What if my trust is registered in another jurisdiction?
Some trusts will end up with registration obligations in multiple jurisdictions but if the trust is already registered in another EU member state then it does not need to also be registered in the UK under 5MLD.
[1] The Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (SI 2017/692) (MLR 2017) came into force on 26 June 2017 to implement the Fourth Money Laundering Directive ((EU) 2015/849)
[2] Directive (EU) 2018/843 of the European Parliament and of the Council of 30 May 2018 amending Directive (EU) 2015/849 on the prevention of the use of the financial system for the purposes of money laundering or terrorist financing, and amending Directives 2009/138/EC and 2013/36/EU
As the dust settles on changes to the non-domiciled regime and, moreover, changes to the way in which UK tax will dictate how non-UK-resident or non-UK-domiciled individuals hold UK property, is the UK, and London in particular, still as desirable a place to own a Mayfair pied-à-terre?
Tax on purchase
In the 2020 budget, Chancellor of the Exchequer Rishi Sunak announced plans for a 2 per cent stamp duty land tax (SDLT) surcharge for non-UK resident purchasers of UK residential property, in another attempt to discourage global high-net-worth individuals from using the UK property market as a financial instrument with huge returns and low risks. The surcharge will take effect from 1 April 2021. Taxpayers ought to be made aware that this prompts a test of residency at the point of purchase. It remains to be seen how these new rules will transpose into statute.
Tax on disposal
From April 2019, the disposal of any UK property (residential or commercial) held by a non-UK resident (individual or corporate) is within the scope of UK non-resident capital gains tax or corporation tax on chargeable gains where the disposal is by a non-UK-resident company.
More significantly, disposals of interests in companies whose value derives from an interest in UK land may also be chargeable to UK tax. The legislation refers to direct and indirect disposals, the former referring to an actual disposal of UK land and the latter giving rise to a tax charge where the asset actually disposed of is not UK land but rather shares in a company that holds UK land. No longer is the principle that companies are not transparent for UK tax purposes strictly observed.
Schedule 1 to the Finance Act 2019 (the Act) effectively rewrites part 1 of the Taxation of Chargeable Gains Act 1992, and applies where a non-UK resident holds an interest of 25 per cent or more in what is termed a property rich entity, or has done so at some point in the previous two years, ending with the date of the disposal. An entity is considered property-rich if, at the time of a disposal, 75 per cent or more of the value of the asset disposed of derives directly or indirectly from UK commercial or residential land. The 75 per cent test looks at the gross asset market value of the entity at the time of the disposal without any deduction for loans. A disposal might be of the interest in the entity directly, or it may be a disposal of a holding company or an interest in a trust or structure that, when looked at together, meets the property-rich test.
Note the potential for the same economic gain to be taxed twice if a non-resident shareholder disposes of their shares and the company then disposes of the property that is taxable on the company.
Inheritance tax
When considering inheritance tax (IHT) exposure, there remains a difference in treatment depending on whether the property is residential or commercial. Irrespective of whether it is commercially let, residential property held via a non-UK company whose shares are not UK-situs assets, and so were once considered to be excluded property for IHT purposes and outside the scope of IHT, are now within the IHT net, according to sch.A1 of the Inheritance Tax Act 1984 (the 1984 Act). The 15 per cent SDLT rate introduced in 2012 for the purchase of enveloped dwellings and the 2013 introduction of the annual tax on enveloped dwellings clearly did not do enough to discourage this common
tax structuring technique used by non-UK-domiciled individuals. It is important to note that IHT mitigation through the use of a non-UK company when it comes to purchasing and holding commercial property is still possible.
Going forward
The changes brought in by the Act are a clear step to try to align the tax treatment of UK residential and commercial property and a further move to eliminate tax advantages available by using corporate structures. Perhaps the next step will be to extend sch.A1 to the 1984 Act to cover commercial property as well. As the changes have been piecemeal, the legislation in this area remains disparate and complex, and great care is required.
