Our Insights

SUMMARY

1. A so-called “MTIC case”, in which HMRC alleged knowledge or means of knowledge of fraud.  The taxpayer, PTGI, denied those states of knowledge.  After a relatively lengthy trial, the Tribunal allowed the appeal of PTGI.
2. The decision represents a good reminder that HMRC’s “MTIC” decision-making mould is not a “one size fits all”, unbeatable formula at the Tribunal.  The Tribunal will robustly analyse HMRC’s (usually) inference-led allegations.

BACKGROUND AND ISSUES

1. PTGI was a telecommunications company with a retail and a wholesale arm.  The retail arm focused on selling pre-paid telephone cards to individuals, and the wholesale arm focused on purchasing minutes used for the retail component and arbitrage trading.  At all material times, PTGI was wholly owned by its US parent company, PTGI-ICS Inc, a public company listed on the New York stock exchange.
2. On 20 February 2017, HMRC denied PTGI-ICS Limited (“PTGI” or the “Appellant”) the right to deduct input tax (£13.75M) claimed in VAT periods 06/15, 09/15 and 12/15.
3. On 18 August 2017, HMRC denied the same right (£5.42M) for VAT period 03/16.
4. HMRC claimed that PTGI incurred the input tax in transactions connected with the fraudulent evasion of VAT and that PTGI knew or should have known of this.
5. HMRC accepted that the burden of proof was on them and that the standard of proof was the balance of probabilities.
6. PTGI accepted that there was a tax loss at the start of each transaction chain and that the tax losses were attributable to the fraudulent evasion of VAT.
7. The issues are:
   1. Is there a tax loss?
   2. If so, does the tax loss result from fraudulent evasion?
   3. If there is fraudulent evasion, were the Appellant’s transactions connected with the fraud?
   4. If they were connected, did the Appellant know or should the Appellant have known that its transactions were connected with fraud?
8. PTGI accepted that there was a tax loss resulting from fraudulent evasion.  It also accepted the accuracy of the transactions’ descriptions, which were found to be connected to each loss via IKB or Indigo.  Therefore, the focus of the appeal was on the fourth question (the “knowledge question”).

FINDINGS

1. The FTT found that “what must be established, on the balance of probabilities, is that the Appellant should have known or should have known that the only reasonable explanation for the circumstances in which the relevant purchases took place was that they were transactions connected with such fraudulent evasion”.
2. The FTT said that it was “telling” that despite HMRC’s regular visits and the amount of information received from IKB and Indigo, neither was de-registered for VAT nor had input VAT claims been denied during the relevant period.  The Tribunal, therefore, concluded that, even if the due diligence had been different, it was unlikely that this would have given PTGI the means of knowing that the transactions were connected with fraud.
3. The FTT further concluded that the relevant surrounding circumstances did not establish that PTGI should have known of the connection to fraud and nor should it have known that the only reasonable explanation for its transactions was a connection with fraud.
4. The surrounding circumstances established a heightened risk that trading with IKB and with Indigo might have resulted in a connection with fraud and no more.
5. The FTT allowed this appeal.

HMRC has published a consultation on draft regulations to implement the Organisation for Economic Cooperation and Development (OECD) rules on mandatory disclosure of certain avoidance arrangements. Helen McGhee and Nahuel Acevedo-Peña explain the background to the new rules and their implications.

What is the history of the UK’s current disclosable arrangements regulations?

The OECD published the Model Mandatory Disclosure Rules (MDR) for CRS Avoidance Arrangements and Opaque Offshore Structures back in March 2018. The EU engineered its own version of these rules in parallel to the OECD, and these are set out in an amendment to the Directive on Administrative Cooperation, known as DAC 6.

DAC 6 was designed to give EU tax authorities early warning of new cross-border tax schemes by requiring intermediaries (including law firms, accountants and tax advisers) to file reports where arrangements met one of a number of hallmarks (in Categories A to E) that could be used to avoid or evade tax. As the UK was, at that time, an EU Member State, DAC 6 was implemented in the UK in January 2020 in the form of the International Tax Enforcement (Disclosable Arrangements) Regulations 2020, SI 2020/25 (for the purposes of this News Analysis the UK implementing regulations are simply referred to as DAC 6). It will not have gone unnoticed that the UK has now left the EU and the government has made the decision to implement the OECD model rules to replace the somewhat controversial EU version of the rules.

Why is the government proposing to introduce new regulations?

DAC 6 prompted some concern among the professional services industry regarding the onerous level of reporting required and the increased administrative burden placed on advisers. Perhaps as a result of the uproar and certainly to reflect the UK’s more global approach to tax transparency following its EU departure, the government amended the UK regulations (to ensure they remained operative from 1 January 2021) and introduced significant modifications to achieve closer alignment with the OECD MDR.

The hope is that adoption of a global MDR further promotes country by country consistency in the application of disclosure and transparency so that aggressive tax planning can be tackled at a global level.

What is the effect of the new regulations, and what differences are there from the existing rules?

The new regulations seek to achieve the same objectives as DAC 6 in requiring the disclosure and reporting of any aggressive cross-border tax arrangements (designed to facilitate non-compliance through the use of CRS avoidance arrangements and opaque offshore structures) in order to allow tax authorities to react promptly to tackle harmful tax practices.

MDR sets out broadly similar reporting requirements for intermediaries (including promoters who design or market the arrangement, service providers who assist or aid the implementation of the arrangement and sometimes taxpayers) as DAC 6 but with some discernible differences and important exemptions.

Many of the differences between the two regimes are minor nuances in the definitions (including a reference to reportable taxpayer in the MDR as opposed to a relevant taxpayer) but importantly HMRC proposes to take a similar approach to the interpretation of these terms in the context of the MDR as it took for DAC 6.

The key differences are the exemptions: see below.

Are there any exemptions from the requirement to report?

The exemptions represent a welcome relief for many tax professionals.

The consultation document states that the regulations are intended to avoid duplicate reporting where possible. Therefore a person may be exempted from reporting where the information has already been reported to HMRC or to a tax authority in a partner jurisdiction. Of real significance (following vehement discussions with the Law Society surrounding DAC 6), there is an exemption from reporting where disclosing the information would require the person to breach legal professional privilege.

For arrangements entered into during the period between 29 October 2014 and the date the regulations come into effect, the regulations will only require reporting of CRS avoidance arrangements, and not opaque offshore structures. Additionally in this period, the reporting requirement will only apply to promoters and not to service providers or taxpayers.

There is also a very welcome de minimis exemption that applies to exempt from reporting a potential CRS avoidance arrangement where the value of the financial account is less than US$1m.

Do historic arrangements need to be reported?

CRS avoidance arrangements entered into between the publication of the CRS (29 October 2014) and the date the MDR regulations come into force will need to be reported subject to the preceding exemptions.

Are we expecting revised HMRC guidance?

HMRC intends to publish guidance on MDR once the regulations are finalised and before the rules come into effect. We can expect that the guidance will be broadly consistent with the existing guidance at HMRC International Exchange of Information Manual IEIM 600000 except where there will be tweaks to reflect the OECD model or to address any gaps in the existing guidance.

When are the new regulations expected to come into force?

The new regulations are expected to come into force in summer 2022. It should be noted that while SI 2020/25, which implemented DAC 6 in the UK, will be replaced and repealed, those regulations will still have effect in relation to arrangements entered into before the MDR regulations come into force.

Should lawyers be advising their clients to do anything now to prepare?

As with DAC 6, there will potentially need to be an audit to ensure any necessary reporting of historic arrangements. The government has acknowledged that this retrospective reporting requirement is likely to create an onerous obligation on businesses and the exemptions outlined above are designed to ease this burden. Where HMRC has previously been informed of an arrangement there is no requirement to notify again. Going forward, when reporting is required, the client must comply with its disclosure obligations within 30 days of the first step of the arrangement being implemented.

Clients ought to be aware of the differences between MDR and DAC 6 where they had previously prepared for the implementation of DAC 6.

The narrative surrounding legal professional privilege is important to note. Lawyers who are unable to report as a consequence of legal professional privilege are still required to ‘notify their client in writing of the client’s disclosure obligations (regardless of whether the client is another intermediary or a reportable taxpayer) within 30 days of the arrangement being made available or the assistance or advice being given’.

On 8 December 2021, judgment in the Post Prudential Group Litigation was handed down by the First-tier Tribunal (Tax Chamber) (“FTT”). These were appeals and applications for closure by approximately 200 taxpayers, who had made a variety of claims seeking repayment of unlawful DV tax imposed on dividends received from foreign portfolio holdings. The FTT considered the validity of these various statutory claims following decisions in test cases in the CFC & Dividend GLO, namely Claimants in Class 8 of the CFC and Dividend Group Litigation v Revenue and Customs Commissioners [2019] EWHC 338 (Ch), [2019] 1 WLR 5097 (“Class 8”) and Prudential Assurance Co Ltd v HMRC [2018] UKSC 39; [2019] AC 929 (“Prudential SC”).

The taxpayers succeeded in all the major issues raised. Some points were decided in HMRC’s favour but, as these were only argued in the alternative to the taxpayers’ main case, the ultimate result of the decision was that all of their claims succeeded.  It is of course now open for HMRC to apply for permission to appeal the decision.

In the meantime, following the Tribunal’s decision, it is now possible to make DTR claims under the extended time limit provided under s806(2), with the starting date in most circumstances being the Prudential SC decision in July 2018.  Taxpayers should note that where management expenses or other forms of losses or group relief were applied against DV income the DTR is not lost but carries forward automatically and applies against the next payment of CT on any income. Steps should be taken to ensure that the carried forward DTR is applied where it can be.  In addition, the FTT has held that EUFT can be claimed at the foreign nominal rate where s806(2) is engaged.

The full judgment in The Applicants in the Post Prudential Closure Notice Applications Group Litigation and Another vs The Commissioners for HM Revenue and Customs [2021] UKFTT 0459 (TC) (“Post-Prudential”) can be found here.

On 26 November 2021, the High Court of Justice issued its judgment in S&S Consulting Services (UK) Ltd, R (On the Application Of) v HM Revenue and Customs [2021] EWHC 3174. The case concerned the issue of availability of injunctive relief in the context of VAT deregistration appeals in the First-tier Tribunal (“FTT"). S&S also made an application for judicial review of HMRC’s decision to deregister it for VAT, which at the time of the hearing, had not yet been considered on the papers.

HMRC cancelled S&S’s VAT registration because it concluded that the company had been principally or solely registered to abuse the VAT system by facilitating VAT fraud. S&S denied any wrongdoing and claimed that it might become insolvent before the hearing of its appeal as a result of the deregistration.

It was also common ground that although S&S had lodged an appeal to the FTT, the FTT had no power to require HMRC to re-register S&S by way of interim relief pending the outcome of the appeal. S&S made an application to the High Court for relief.

Held: Application rejected.

Key points:

• The decision to grant an injunction in a public law case involves the exercise of discretion which takes into account all relevant matters, including the strength of the case advanced by the party seeking relief, but without applying a rigid test, such as requiring a ‘strong, prima facie case’.
   
• The Court considered the difference between the cases concerning alcohol approval schemes (CC&C v Revenue and Customs Commissioners [2015] 1 WLR 4043, R (ABC Ltd) v Revenue and Customs Commissioners [2018] 1 WLR 125) and the process of registering for VAT. It was held that the differences did not warrant a different approach to the Court’s grant of injunctive relief, as the processes involved were, in material terms, the same.
   
• The Court reaffirmed that, following the UK’s exit from the EU, Section 42(4) and 42(4A) of the Taxation (Cross Border Trade) Act 2018 specifically preserve the effect of EU law principles preventing the abuse of the VAT system.
   
• The Court also reaffirmed the Ablessio principle, under which HMRC is entitled to cancel a person’s VAT registration where it is satisfied that the registration is being used to facilitate fraud on the VAT system. This confirms the criteria previously followed in R. (Ingenious Construction Ltd) v HM Revenue and Customs [2020] EWHC 2255 (Admin).
   
• The allegations made by the company, that HMRC broadly misunderstood the facts and failed to consider relevant matters, did not amount to abuse of power, and were in any case points that fall within the scope of the FTT appeal.
   
• It is not an absolute rule that HMRC must always give notice of intended VAT de-registration.
   
• In respect of the substantive argument, the High Court concluded that “whilst there may be a risk of the Claimant becoming insolvent before the presently listed appeal… it has not shown that there is a sufficiently high probability that that will be so”.
   
• Further, the Court indicated approval of HMRC’s arguments on why the balance of convenience and consideration of all relevant factors in the present case comes down in favour of refusing the injunctive relief. The Court noted a question of the overall appropriateness of the order to re-register someone whom HMRC, rightly or wrongly, had found to be facilitating VAT fraud. The Court referred to the decision in R (OWD Ltd (t/a Birmingham Cash and Carry)) v Revenue and Customs Commissioners [2019] 1 WLR 4020 at [70]-[72], where the Supreme Court expressed ‘unease’ at the High Court making an order to safeguard the position of a wholesaler in the circumstances where it would involve the Court requiring HMRC to treat a trader as a fit and proper person when it had concluded that it was not.

HMRC has recently published a policy paper on its approach to tax fraud, as well as new guidance on joint and several liability notices for tax avoidance, tax evasion and repeated insolvency.

On 18 November 2021, the Court of Justice of the European Union (the “CJEU”) delivered its judgment in Case C-385/20 (Promexor Trade SRL v Directia Generala a Finantelor Publice Cluj – Administratia Judeteana a Finantelor Publice Bihor). Promexor is a Romanian company whose VAT number was revoked by the local tax authorities following a period of six months in which its VAT returns did not record any transactions subject to VAT. Under Romanian legislation, a company whose VAT number has been revoked could re-register and retroactively deduct input VAT for the period when it was not registered. However, in this case, Promexor was prevented from doing so because its director was also a shareholder of a company that was going through insolvency proceedings.

The key reasons for the CJEU finding for the taxpayer were:

• The deduction of input tax must be allowed if the substantive requirements are satisfied, even if certain formal requirements are not.
• The principle enshrined in Ablessio (C-527/11) that a Member State cannot refuse to assign a VAT number to a taxable person without legitimate grounds was reaffirmed.
• Refusing to assign a VAT number to a company merely because its director is a partner in another company which is subject to insolvency proceedings is not a legitimate ground.
• A country can continue to levy output VAT on the transactions of a taxpayer that no longer has a VAT number, provided that taxpayer can re-register for VAT purposes and deduct the input VAT paid.

CJEU Judgements after Brexit

Following the European Union (Withdrawal) Act 2018 (the “WA”), UK courts are no longer bound by principles laid down by the CJEU and general principles of EU law are not part of UK domestic law if they were not recognised as such in a case decided before Brexit. In addition, Chapter 5 of the Trade and Cooperation Agreement between the UK and the EU, which governs tax issues, does not establish any exceptions regarding VAT legislation, only obligations related to fraud.  The WA, however, does allow UK courts to consider CJEU decisions post-Brexit if they are relevant to any matter before a UK court.

Schedule 13 of the Finance Act 2020 (the “FA 2020”) introduced measures that allow HMRC to give joint and several liability notices (“JSLN”) to company directors, shadow directors and members of LLPs in certain circumstances. Although the FA 2020 came into force on 22 July 2020, HMRC only recently published a guidance note about these new powers.

JSLNs provide HMRC with a power to recover from individuals taxes that might otherwise not be paid by a corporate taxpayer.

When does it apply?

There are three cases in which these provisions apply.

      (1) Tax avoidance and tax evasion cases

The first case is when a company has entered into tax avoidance arrangements or has engaged in tax evasive conduct. Paragraph 6 establishes what comprises that type of arrangement, e.g. one for which a notice of final decision has been given under the GAAR legislation.

The conditions are: (1) that the company is subject or likely to be subject to an insolvency procedure; (2) that the individual was responsible for the company’s conduct or benefited from it; (3) that there is, or is likely to be, a tax liability related to the conduct, and (4) that there is a serious risk that the tax liability, or part of it, will not be paid.

     (2) Repeated insolvency and non-payment cases

The second case is related to repeated insolvency and non-payment. It is aimed at those who set up companies that do not pay their tax liabilities – becoming insolvent after some time – and “replace” them by setting up a new company that carries on the same business.

The conditions are: (1) that during the last five years there have been two or more old companies connected to an individual, each of which became insolvent and had a tax liability; (2) that a new company connected to the individual has been carrying on a similar business to the old ones, and (3) that the old companies have a tax liability of both more than (a) £10,000 and (b) 50% of the total amount of those companies’ liabilities to their unsecured creditors.

      (3) Penalties for facilitating tax avoidance or evasion

The third case is where a penalty for facilitating tax avoidance or evasion has been issued.

The conditions are: (1) that the company is subject or likely to be subject to an insolvency procedure; (2) that the individual was a director or shadow director of the company or a participator in it at the relevant time, and (3) that there is a serious risk that the penalty, or part of it, will not be paid.

Time limits

For tax avoidance and evasion cases, and for repeated insolvency and non-payment cases, Schedule 13 of the FA 2020 only applies to liabilities relating to any period that terminates on or after 22 July 2020. If the period started before that date, the legislation applies to the entire period. For penalties for facilitating tax avoidance or evasion, it applies only to defaults and events occurring on or after the same date.

Are there any safeguards?

Yes, Schedule 13 of the FA 2020 does contain safeguards:

• Important decisions must be taken by a properly qualified member of staff known as an “authorised officer”.
• HMRC must withdraw a JSLN given to an individual if any condition was not met when giving the notice.
• HMRC must also withdraw a JSLN given to an individual if it is not necessary for the protection of the revenue that the JSLN continues to have effect.
• HMRC must offer a review of its decision to an individual who has been given a JSLN, provided the tax liability has been established. The individual has 30 days to accept the offer.
• An individual has the right to appeal against a JSLN to the First-tier Tribunal within 30 days from the date shown on the JSLN, or from the date of HRMC’s notice informing the individual of the outcome of the review mentioned in the previous point.
• An individual has the right to take full part in the appeal hearing or to continue the appeal if the company is unable or unwilling to do so, provided the individual was given a JSLN and the company is subject to an insolvency procedure.

This article is an update from a previous article published on 20 August 2021.

On 8 October 2021, the OECD/G20 Inclusive Framework published a statement where 136 jurisdictions^[1] agreed to a global minimum tax on corporations (“GMCT”). The previous article noted that much will depend on the outcome of future political negotiations. After some negotiations, the new statement represents an improvement from the previous one, incorporating more countries.

Background

• Pillar One allocates profits (“Amount A”) to market jurisdictions whose customers contribute to the success of large MNEs without raising fiscal revenue in return. In-scope companies are MNEs with global turnover above €20bn and profitability above 10%, which has remained unchanged from the July statement.
• The GMCT is expected to raise c.$150bn in additional global tax revenues^[2].
• Pillar Two of the agreement establishes a rule consisting of a top-up tax on parent companies in respect of the low taxed income of subsidiaries, which would decrease the leverage of tax havens.
• It also incorporates another rule in the same direction, which denies deductions or requires an equivalent adjustment as an alternative to the first rule.

Changes from the previous statement

• The initiative is now supported by Estonia, Ireland and Hungary, which means that the last statement has been agreed by all 38 OECD member countries.
• For Pillar One, the Multilateral Convention (“MLC”) to implement Amount A will be developed in 2022. The new statement includes an annex setting out a detailed implementation plan.
• For Pillar Two, the new statement establishes a partial exclusion for smaller MNEs (defined as those with maximum €50m of tangible assets abroad and operation in five or less jurisdictions).
• Pillar Two also provides for a de minimis exclusion, and the new statement clarifies that this will be for jurisdictions where an MNE has revenues of less than €10m and profits of less than €1m.
• The GMCT sought to introduce a minimum corporate tax of “at least” 15%, which meant it could be higher than that. After negotiations with countries like Ireland, which has a corporate tax rate of 12.5%, the new agreement establishes a minimum corporate tax of 15%.
• Finally, the proposal incorporates a Subject to Tax Rule (“STTR”) for developing countries, applying to interest, royalties and other payments. The July statement had determined that the minimum rate for the STTR would be between 7.5% and 9%, whereas this new statement clarifies that it will be 9%. This lessens the advantage that developing countries may obtain from this provision.

Key points for the future

• Many countries have recently introduced Digital Services Taxes (“DSTs”), which are proposed to be abolished in the new statement. DSTs are broadly considered to be discriminatory by the US, so the success of the GMCT partially depends on their abolition. The joint statement signed on 21 October between the UK, France, Italy, Spain, Austria, and the US provides for DSTs to remain in force until Pillar 1 takes effect. The US and India reached a similar agreement on 24 November 2021.
• In addition, the new statement adds that no newly enacted DST will be imposed from 8 October 2021 until either (1) 31 December 2023, or (2) the coming into force of the MLC, whichever comes first. Nevertheless, the Autumn Budget confirmed that the UK will introduce an online sales tax. Whether this is considered a “relevant similar measure” to a DST will be an important discussion, particularly for the UK.
• We argued in our previous article that much of the success of the GMCT will depend on its local implementation. The new statement acknowledges that caveat, mandating the Task Force on the Digital Economy to develop model rules for domestic legislation by early 2022 in order to facilitate the incorporation of Pillar One.
• In the US, the Republican opposition is still staunchly against Pillar One,^[3] which could relocate 30% of the targeted MNEs’ global profits from the US to “market jurisdictions”. Without Republican support, it would take one Democratic senator to vote against the proposal for it to fail in the US.
• Although Ireland, Hungary and Estonia joined the new agreement, Cyprus, another EU member, has not done so yet. Some say that Pillar Two may be incompatible with the EU’s freedom of establishment under Cadbury Schweppes. Although implementing Pillar Two through an EU Directive could help the CJEU conclude that they are compatible, Cyprus could block said Directive. Whether Cyprus will eventually join this initiative remains to be seen.
• Finally, a model treaty provision to give effect to the STTR, which favours developing countries, was supposed to be published by the end of November 2021.^[4] In this regard, which types of payments fall under this special rate is likely to be the subject of future political negotiations.

^[1] 137 now with the inclusion of Mauritania on 4 November 2021.
^[2] OECD, ‘International community strikes a ground-breaking tax deal for the digital age’ (8 October 2021).
^[3] Politico, ‘Global tax deal risks having US half in, half out’ (22 October 2021).
^[4] As of 7 December 2021, it has not been published.

KEY POINTS

What is the issue?
On 6 October 2021, the Court of Appeal handed down its hotly anticipated judgment in HMRC v Fisher and others [2021] EWCA Civ 1438. The case considers various aspects of the application of the complex transfer of assets abroad legislation, and how the rules applied to the transfer of a UK telebetting business to a company in Gibraltar.

What does it mean to me?
The Court of Appeal decided that the transfer of assets abroad rules may be invoked where the transfer is procured by a minority shareholder voting in favour of a course of action. It is also clear from the judgment that the motive defence is lost if any commercial rationale is too closely linked to a tax mitigation objective.

What can I take away?
If practitioners are actively pursuing any of the arguments which were the subject of discussion in the Court of Appeal in Fisher, they might be well advised to pause and await an almost inevitable appeal to the Supreme Court. This might offer some much needed finality and clear limits to the scope of the potentially very far reaching transfer of assets abroad code.

The transfer of assets abroad provisions exist to counteract tax avoidance achieved by means of
a relevant transaction which results in income becoming payable to a person abroad by virtue of a transfer of assets. Where the transfer of assets abroad code applies, it operates to treat income arising to the person abroad as belonging for UK tax purposes to any UK resident individual responsible for the original transfer of assets to a non-UK person.

In the case of HMRC v Fisher and others [2021] EWCA Civ 1438, the Court of Appeal allowed HMRC’s appeal and reversed the decision of the Upper Tribunal, ruling (subject to a convincing dissenting judgment from Philips LJ) that:

• the transfer of assets abroad anti‑avoidance legislation was indeed triggered;
• the motive defence was not available;
  and
• EU law did not offer any respite for the taxpayers.

The story so far
The facts of the case have been rehearsed previously in the Tax Adviser article ‘All Bets Are Off’ (June 2020). To briefly set the scene, the case concerned the Fisher family, who consisted of four members – Stephen, Anne, Peter and Dianne. From the late 1980s until 1999, the family ran a telebetting business (SA) in the UK through a UK company.

The patriarch Stephen dealt with the shops and administration, and had overall responsibility for the company. He and his son Peter were responsible for the day to day running of the business, future planning and strategy, and they made the majority of the decisions. Dianne worked on accounts administration, while the matriarch, Anne, had virtually nothing to do with the business from 1996 onwards and played no active part in the company’s decision making processes. No assessments were raised on Dianne as she had not been UK resident at the relevant time.

In 1999, a major competitor in the betting industry moved its entire betting operation to Gibraltar, which charged a much lower rate of betting duty. The entire industry quickly followed and by July 1999, it had become clear that the only way in which to save the business would be to move it to Gibraltar.

On 29 February 2000, the majority of the SJA business was sold to a Gibraltar company which was also owned by the family (SJG). On the date of the transfer, Stephen and Anne held approximately 38% of the shares of SJA and Peter and Dianne each held approximately 12%. Following the transfer, Stephen and Anne each held 26% of the issued share capital of SJG and Peter and Dianne each held 24%.

Stephen, Anne and Peter were assessed by HMRC under the transfer of assets abroad code to a proportion of the profits of SJG in line with their shareholding from 2000/01 to 2007/08.

The First‑tier Tribunal held that the assessments had been validly raised and that the transfer of assets abroad code was invoked. The FTT also held that the code infringed Anne’s EU law rights as an Irish citizen.

The Upper Tribunal quashed HMRC’s assessments in their entirety, holding that the transfer of assets abroad code did not apply; and that even if it had applied, the taxpayers were entitled to claim the motive defence contained in Income and Corporation Taxes Act 1988 s 741.

The Court of Appeal
Before the Court of Appeal, the following issues were considered:

1. Given that the transfer of the business had been effected by the company SJA, rather than by Stephen, Anne and Peter personally, was the transfer of assets abroad code engaged at all?
   This is referred to as the quasitransferor issue.
2. For the code to apply, did there need to have been avoidance of income tax?
3. In the event that the transfer of assets abroad code applies, was the motive defence available?
4. Was the transfer of assets abroad code compatible with EU law? If not, was it open to Stephen and Peter, as well as Anne (as an Irish citizen), to rely on a breach of EU law to argue that the transfer of assets abroad provisions should be disapplied?
5. Was some of SJG’s income too remote from the transfer of the business to be the subject of the charge? This is not considered in detail in this article. The taxpayers were seeking to establish that the income being assessed did not arise from the transfer but was instead retained profits. Importantly, the Court of Appeal did not allow the taxpayers to challenge a finding of fact at this stage in the proceedings that they had not challenged at the appropriate time at first instance – a valuable learning point.
6. Were the assessments on Stephen and Anne for 2005/06 and 2006/07 defective, having regard to the requirements of the Taxes Management Act 1970 s 29? We do not consider the discovery issue in this article – suffice to say the assessments were not considered to be defective.

The tax years under appeal straddled the rewrite of the transfer of assets abroad code from the Income and Corporation Taxes Act (ICTA) 1988 to its current location at Income Tax Act (ITA) 2007 Part 13 Chapter 2. The parties agreed that the rewrite had not altered the law in any relevant way and the judgment refers to the ICTA 1988 provisions.

Who can be a quasi-transferor?
The concept of a quasi‑transferor was first alluded to in the case of Congreve v IRC (1948) 30 TC 163, where the idea emerged that the transfer of assets abroad code could apply even if an individual didn’t actually effect the transfer but instead procured it.

In Vestey v IRC [1980] AC 1148, the concept of a quasi-transferor was narrowed by the House of Lords and considered more akin to individual associated with the transfer. Walton J, who
coined the actual phrase ‘quasi‑transferor’ in IRC v Pratt [1982] STC 756, contributed to the evolution of the concept further and considered (albeit in a different context) whether there could be multiple transferors and a corresponding apportionment of income between taxpayers.

With this backdrop of jurisprudence, the Fisher judgment considers the question as to whether the taxpayers had procured the transfer at length. It was decided that this is a broad spectrum anti‑avoidance provision intended to apply to any number of transferors (or quasi‑transferors) who
could be said to have procured the transfer by virtue of doing something positive to bring about the transfer.

Note that taking no active part in the decision making, merely passively allowing someone else to do something (as Anne had done here), was not enough to bring her within the scope of the provisions – Anne had not procured the transfer and so could not be a quasi-transferor.

In addition, a director who is not also a shareholder could not be a quasitransferor, as he would be acting solely in his capacity as an officer of the company and not on his own behalf. However, directors/shareholders having control jointly (but not individually) of a company may be regarded as together procuring a transfer, thus invoking the transfer of assets abroad provisions.

Lord Justice Phillips, dissenting, considered it wrong in principle and illogical to regard a minority shareholder as procuring an act by the company of which the shareholder was a member simply by voting in favour or otherwise supporting that act. Unless there was a voting pact with other shareholders, a minority shareholder had no power in his own person to procure any outcome. Phillips LJ would therefore have dismissed the appeals in their entirety. Of course, the trouble with arguing that minority shareholders are not able to procure – even if they vote in favour – is that some careful fragmentation takes the taxpayers outside the scope altogether, because no single shareholder’s vote would be decisive. The context here is a company controlled by two parents and their two children.

Was it necessary to have avoidance of actual income tax?
The taxpayers contended that for the transfer of assets abroad code to apply, there needs to have been avoidance of income tax as a result of the transfer – and here the Fisher family were seeking to mitigate betting duty payable by the company.
 

The House of Lords had previously considered this question in the case of IRC v McGuckian [1997] 1 WLR 991 and had held the contrary – that no actual avoidance of income tax was required. The Court of Appeal saw no reason to disapply the rationale of McGuckian and seemed to state that although s 739 refers to income tax, the underlying objective of the legislation would be undermined if the section could only be in point if there had been income tax avoidance.

The motive defence
Given how potentially far reaching the transfer of assets abroad code is, the motive defence is intended as a means of taxpayer protection to provide some limits to its application; however, it is notoriously difficult to invoke and prove in practice. It was accepted that the transfer was a genuine commercial transaction – the taxpayers were trying to keep up with their competitors. The Upper Tribunal had said that the avoidance of betting duty had simply been the means of achieving the
main purpose, which had been saving the business. Regardless, the Court of Appeal opined that the tax saving or avoidance here was too pivotal and intertwined with the commercial rationale – it was impossible to separate the avoidance of betting duty and saving of the business – and thus it simply could not be said that the avoidance was not one of the purposes of the transaction.

Having a commercial driver is seemingly not sufficient to secure the motive defence where there is also a tax saving on the agenda. Any decision on this subject will be very fact specific and the decision is certainly vulnerable to an appeal.

The EU law defence
The court considered the previous CJEU case law on direct tax infringements, including a reasoned order of the CJEU dated 12 October 2017 in response to a reference from the Upper Tribunal in this case. The CJEU held that Gibraltar is, for the purposes of EU law, a part of the UK and not a separate member state or a third country. It also held that the fundamental freedoms of establishment and free movement of capital do not apply to a situation happening wholly internally within a member state; to say otherwise would compromise the fiscal autonomy afforded to each member state.

Conclusion
No doubt HMRC will be buoyed by the victory and potentially seek to apply the transfer of assets abroad provisions to more circumstances whereby individuals, holding shares in a company which transfers assets outside of the UK, could be said to have procured the relevant transfer.

The transfer of assets abroad code is intricately drafted and the court seems to seek to apply it in a way so as to ensure a fair outcome. It will be interesting to see if the Supreme Court comes to a different conclusion as to what would be fair in this context – one assumes an appeal will be forthcoming.

KEY POINTS

What is the issue?

Her Majesty’s Revenue and Customs has recently closed down the special unit tasked with the investigation of family investment companies (FICs) and broadly given them a clean bill of health.

What does it mean for me?

Those who have been anxious about utilising FICs can now cautiously proceed with an exploration of their usefulness in achieving the objectives of the family.

What can I take away?

FICs are a useful vehicle in any succession planning strategy; however, the tax issues involved are complex so detailed advice should be sought.

Her Majesty’s Revenue and Customs (HMRC) has recently released a report from a dedicated compliance team tasked with looking at the strategy and mechanics of family investment companies (FICs). HMRC has said that it now has a better understanding of who uses FICs and found no evidence of a correlation with non‑compliant behaviour.

Given taxpayers effectively have the green light to proceed, business as usual, in utilising these structures where appropriate, this article considers the practical set‑up and relevant tax considerations for FICs. There is inevitably a tax cost to profit extraction, so it is more common to use the structure for investment roll‑up purposes. It is also worth making reference to the continued use of the trust as a family tax and succession planning vehicle.

There are considerable tax advantages to sheltering the profits of a family enterprise inside the savings box of a corporate vehicle. The relatively low corporation tax rate allows profits to accumulate for the ultimate benefit of future generations.

Set‑up

An FIC can be established with the desired proportions of shareholdings allocated among the family ab initio or, alternatively, by later injecting cash or assets into a company and creating different types of shares for different family members that carry different rights to dividends, entitlement to vote and entitlement to capital on winding up (commonly referred to as alphabet shares). In most cases, ordinary shares are used, but it is possible to issue preference shares that carry priority rights to dividends.

The matriarch or patriarch will want to retain control and will therefore be named directors and possibly preferential shareholders, perhaps retaining voting rights (caution is recommended), but will likely limit their rights to underlying capital for succession planning reasons. Other shares may be gifted to family members when the company is set up with little or low value or, if gifted later, the value of the money or property transferred (as long as no beneficial interest is retained) will fall outside of the parent’s estate for inheritance tax (IHT) purposes after seven years.

In the event family members are aged under 18 and have no legal capacity to hold shares, a simple nominee declaration or bare trust can be used to hold the legal title without affecting the underlying beneficial interests.

Profit extraction

Profits are commonly extracted as dividends and taxable at the normal dividend rate of the recipient. The directors are entirely at liberty to pay or legally waive declared dividends in accordance with how all members of the family (i.e., the shareholders) wish to direct.

IHT

During a dividend waiver, which must be done by deed and before entitlement arises (i.e., before payment in the case of an interim dividend or resolution and declaration for a final dividend), a person waiving a dividend could, prima facie, be making a transfer of value by the omission to exercise a right under s.3(3) of the Inheritance Tax Act 1984 (the Act). However, s.15 of the Act explicitly states that a person who waives any dividend on shares within 12 months of a declaration does not, per se, make a transfer of value.

Income tax

When looking at income tax on profit extraction via dividends, one needs to be wary of s.620 of the Income Tax (Trading and Other Income) Act 2005 (the settlements legislation), which is intended to prevent a settlor from gaining an income tax advantage by making arrangements that divert income to a person who is liable to income tax at a lower rate. Where the settlements legislation applies to a dividend waiver, all the income waived is treated as that of the settlor. This legislation applies in certain circumstances for gifts between spouses or to a minor child as the settlor is treated as retaining an interest in an asset or income deriving from it.

These rules (now commonly referred to as ‘income shifting’) were debated in the House of Lords in the case of Jones v Garnett (Arctic Systems) [2007] UKHL 35. In this case, Mr and Mrs Jones owned equal shares in the family company. Mr Jones was the fee‑earner and Mrs Jones did the administration. They both took a small salary and a significant dividend. HMRC argued that the anti‑avoidance rules relating to settlements applied to the dividends paid to Mrs Jones to treat the dividends as income of Mr Jones.

Lord Hoffman commented that this arrangement was no normal commercial transaction between adults at arm’s length, but instead it was ‘natural love and affection’ that provided the consideration for the benefit he intended to confer upon his wife.

The House of Lords ultimately dismissed the HMRC appeal on a technical argument that the rules did not apply on the basis that, in this case, the ordinary shares were not substantially a right to income. This was an important distinction and, following this case, most shareholdings issued in this context involve shares that also carry full voting and capital rights.

In the context of a family company, although there might be a s.620 settlement, the legislation at s.624 would not operate to tax the settlor on income paid out to either a child who is no longer a minor or to a grandchild or any family member who it could not be said would result in the settlor retaining an interest in the income.

The mechanics of how a dividend is declared is of paramount importance in navigating the settlements legislation and ensuring that there is no income diversion. If it makes no difference to the amount received by the recipient shareholder that the other party waived their right to take a dividend, then it cannot be said that there has been any diversion of income. If, however, a global dividend sum is declared and then divided among the family member shareholders, and certain members waive their rights and the result is that some members consequently benefit from an increased dividend, then this is a different story. There need to be sufficient distributable reserves to cover the dividend payment as well as the waiver in this latter scenario, so it can truly be said that there has been no diversion of income, as it would not make any difference to anyone if the shareholder forgoes their right to a dividend or not.

Capital gains tax

If the market value of shares gifted exceeds the original cost, there will, prima facie, be a gain chargeable to capital gains tax (CGT). In the context of a family company, it may be possible to utilise exemptions or reliefs to mitigate this charge. Any gift between spouses will be exempt as the transfer is deemed to take place at no gain, no loss; the spouse simply inherits the base cost of the donor. Gifts into a trust can usually benefit from holdover relief from CGT on the basis that a lifetime IHT arises; however, this exemption will not work for transfers into a company.

Transferring immovable property into a company makes matters more complicated as this could potentially result in CGT and stamp duty land tax.

A trust as an alternative

There has been a large decline in the use of trusts in the context of family tax planning, following the enactment of the Finance Act 2006 and the introduction of the 20 per cent lifetime IHT charge on any amount transferred into a trust (absent any relief and if in excess of the GBP325,000 nil‑rate band). In addition, periodic charges (every ten years, tax is levied on the value of the trust property at circa 6 per cent) and exit charges (when property leaves a trust) apply to relevant property.

Notwithstanding these tax charges, a discretionary trust might still be appropriate if the aim is to hold shares in order to benefit beneficiaries at some future time and possibly on a discretionary basis; to prevent beneficiaries becoming entitled upon reaching majority; or to protect the shares from errant spouses.

Conclusion

Often, parents are reluctant to bestow substantial benefits on their children, but look more favourably on funds extracted to educate grandchildren, so the flexibility of using alphabet shares to direct profits where desired is attractive. Nevertheless, it is a tricky area to navigate, riddled with tax traps, so proper advice should be taken at all times.

On 10 November 2021, the Supreme Court delivered its judgment in Lloyd v Google LLC [2021] UKSC 50, finding unanimously in favour of Google and rejecting the claim brought by Mr Lloyd on behalf of himself and over 4 million other iPhone users in respect of alleged breaches of data protection law.

The judgment will come as a significant relief to data controllers of all sizes who, following the Court of Appeal’s decision, faced the prospect of large-scale data claims. The Supreme Court’s discussion of the representative claim procedure will also be of interest to anyone involved in multi-party litigation.

Key points

1. The Court rejected Mr Lloyd’s argument that data subjects are entitled to compensation for the mere “loss of control” of their data, without proof of financial loss or distress. In any event, the claim could not proceed as a representative claim, as facts relating to each represented person were needed to prove any entitlement to damages.
    
2. The case was decided under the data protection laws applicable at the time, which have since been superseded. Whilst it is possible that a different result might be reached on the “loss of control” issue under the new regime (based on potentially broader statutory wording), the need for individual facts would likely still cause issues for a representative claim.
    
3. Despite rejecting Mr Lloyd’s claim, the Court emphasised the representative procedure as “a flexible tool of convenience in the administration of justice”, particularly at a time when digital technologies have greatly increased the potential for mass harm and, therefore, the need for collective redress. It nevertheless considered that a detailed legislative framework would be preferable, although it remains to be seen whether Parliament will take any action.
    
4. As the legal test for a representative claim was not met, the Court did not have to consider whether to exercise its discretion to prevent the claim proceeding on that basis. It therefore did not need to engage with the desirability of this type of action, in particular whether it was “officious litigation” as the High Court had held (with which the Court of Appeal disagreed).

The facts

Mr Lloyd alleged that for several months in 2011-2012, Google had used a cookie to secretly track the internet activity of millions of iPhone users without their consent and sold that information to advertisers. This allegation was not new and had already given rise to substantial settlements in the US.

Mr Lloyd, with the backing of a commercial litigation funder, sought to bring his claim on behalf of everyone in England and Wales who had been affected, with an estimated value of £3bn.

The law

Data Protection Act 1998

The data protection law applicable at the relevant time was contained in the Data Protection Act 1998 (“DPA 1998”).

Section 4(4) DPA 1998 required ‘data controllers’ (such as Google) to comply with various data protection principles, which Mr Lloyd claimed had been breached.

Section 13 DPA 1998 gave individuals a right to compensation where they suffered “damage” due to a breach.

Representative claims (CPR 19.6)

The UK, unlike some other countries, does not have a general mechanism for bringing ‘class actions’. Instead, there exist a variety of procedures by which collective redress can be sought.

Mr Lloyd attempted to use the representative procedure in CPR 19.6, which allows a claim to be brought by (or against) one or more persons as representatives of others who have the “same interest” in the claim.

A key feature of this procedure is that it is ‘opt-out’ and, as such, represented persons do not need to take any positive step, or even be aware of the existence of the action, in order to take advantage of the outcome.

The Supreme Court’s judgment

It had previously been held in another case that “damage”, for the purposes of section 13 DPA 1998, includes (i) material damage (essentially financial loss) and (ii) distress. In either case, an individual assessment of the harm is needed, precluding use of the representative procedure (as the represented persons would not have the “same interest”).

Mr Lloyd, however, sought to “break new legal ground” by arguing that claims under section 13 DPA 1998 could also be made for the “loss of control” over personal data which, he said, inevitably results from a breach of the Act and which all members of the class had suffered. In other words, that damages were available for the breach itself, without the need to prove material damage/distress.

The Court rejected this argument on the basis that:

1. Such a reading of section 13 DPA 1998 was “untenable” as a matter of domestic law and was not required by EU law.
    
2. The fact that the tort of misuse of private information, for which damages can be awarded for the loss of autonomy itself, and the data protection legislation both sought to protect a person’s right to privacy did not mean that they must do so by affording identical remedies. In fact, there were material differences between the two regimes which made the analogy “positively inappropriate”.

The Court went on to hold that, even if “loss of control” did constitute “damage” for the purpose of section 13 DPA 1998, the claim could still not have proceeded as a representative claim, as it would have been necessary to establish, in each case, the extent of any unlawful processing by Google in order to determine the amount of damages (if any) to be awarded. Relevant factors would include the quantity and nature of the data, the period of time over which it was taken and the use to which it was put. This would inevitably differ from one individual member of the class to another.

Mr Lloyd had sought to overcome this issue by disavowing reliance on any facts relating to individual class members and instead claiming an “irreducible minimum harm” suffered by each of them for which a uniform sum of damages could be awarded. This, however, failed because the limited common facts on which Mr Lloyd sought to rely (only that each person had a cookie unlawfully placed on their device) were insufficient to establish anything more than trivial or de minimis harm and, therefore, any entitlement to damages.

The Court similarly rejected Mr Lloyd’s alternative method of assessment based on ‘user damages’ (a hypothetical sum which data subjects could have charged Google for releasing it from its duties), as, even if such damages were available (which was not the case), the sum which Google would pay to place a cookie on a user’s device, but not to collect or use any of their data, would be zero.

The future of representative claims

Whilst the judgment highlights a significant constraint on the ability to use the representative procedure to claim damages, the Court nevertheless held that this would be possible where the damages could be calculated on a basis common to all the persons represented (e.g. where they were each wrongly charged a fixed fee) or where the loss suffered by the class as a whole could be calculated without reference to individual claims.

The Court also considered that, where damages would require individual assessments, a bifurcated (two-stage) process might be used, whereby a declaration of liability is sought through a representative claim, followed by individual (or presumably group) claims for damages. This approach could have been adopted by Mr Lloyd but wasn’t, “doubtless”, the Court held, because pursuing the individual claims would not have been cost-effective.

Also, whilst the Court held that the representative procedure was not available in this case, it nevertheless endorsed a liberal approach to it and, in particular, the “same interest” requirement, which will no doubt influence lower courts for years to come. In particular, it held:

1. Contrary to the approach taken in some other cases, the “same interest” requirement does not impose a tripartite test (namely a common interest, common grievance and remedy beneficial to all). Instead, it should be interpreted purposively in light of its rationale and the overriding objective of the CPR.
    
2. The purpose of the requirement is to ensure that the representative can be relied on to promote and protect the interests of all represented persons. Whilst this would not be possible where there was a genuine conflict of interest between them, there was no issue with class members having “merely divergent interests”, in that an issue arises in respect of some of the claims but not others. Such concerns as may have once existed about whether representatives could be relied on to pursue vigorously lines of argument not directly applicable to their case are misplaced in the modern context, where proceedings are typically driven by lawyers/litigation funders, with the representative claimant merely acting as a figurehead.

The full text of the Supreme Court’s judgment is available here.