UK: Weekly Tax Update - Monday 23 May 2011

Last Updated: 24 May 2011
Article by Richard Mannion

1. GENERAL NEWS

1.1. Office of Tax Simplification ('OTS')

The Exchequer Secretary to the Treasury David Gauke MP has written to the OTS responding to its reports on tax reliefs and the taxation of small businesses. (See detailed reports later in this Informal)

www.hm-treasury.gov.uk/d/ots_xstletter_small_business_tax_review_090511.pdf

1.2. Review of tax reliefs

The Coalition Government set up the Office of Tax Simplification last year and set it two initial tasks, firstly to review over 1,000 tax reliefs and secondly to review the taxation of small businesses and recommend priority areas for simplification.

The OTS' final report on tax reliefs was published in March 2011 and looked in detail at 155 reliefs. The report identified two reliefs which were out of date, 45 reliefs which OTS considered had no ongoing policy rationale and should be abolished, and 17 reliefs which could be simplified.

In the 2011 Budget report the Government accepted most of the OTS' recommendations and signalled its intention to abolish 7 obsolete reliefs this year and then abolish a further 36 in due course.

However the OTS' March report also identified a number of complex areas deserving of further detailed review:

  • the merger of income tax and NIC;
  • reforming the treatment of benefits in kind for employees;
  • IHT and the taxation of trusts;
  • the capital gains tax regime and in particular the growing difference between the sub-systems for individuals and companies.

The Budget report said that the Government was going to consider these points 'within a wider programme of work for the OTS'.

HM Treasury has now announced that Ministers have agreed that the work on the review of tax reliefs is now fully concluded, but it should form the basis for future reviews by the OTS.

Does that mean the Government agrees that an overhaul of IHT and the taxation of trusts is indeed required, but not yet? Or does it mean that the present flawed system is here to stay?

The answer seems to be that the next step will be for OTS to identify areas which merit further investigation particularly those with the most scope for simplification. So this announcement is really just a progress report and we should get a better picture of the areas to be considered further when OTS puts forward its proposals for future simplification reviews.

1.3. Amendments proposed for Finance Bill 2011

Further amendments have been tabled and include the following:

  • Degrouping charges – a tax avoidance main purpose test has been introduced into the anti-avoidance in clause 31.
  • Disguised remuneration rules – further refinements to the widely drafted provisions of schedule 2.
  • Withdrawal of Childcare relief for higher earners – refinements to the applicable definitions.

The full list of further amendments can be found at:

www.publications.parliament.uk/pa/cm201011/cmbills/175/amend/pbc1751205a.57-63.html

www.publications.parliament.uk/pa/cm201011/cmbills/175/amend/pbc1751305a.65-66.html

www.publications.parliament.uk/pa/cm201011/cmbills/175/amend/pbc1751705m.67-73.html

www.publications.parliament.uk/pa/cm201011/cmbills/175/amend/pbc1751905m.95-101.html

1.4. DOTAS update

HMRC has published an April 2011 update on its DOTAS guidance and developments. Points to note in connection with its views include the following:

  • If the promoter, or a body controlled by the promoter such as an investment vehicle, is counterparty to a scheme transaction, and the engagement letter amounts to a contract to enter into such a transaction, then the engagement letter may be a scheme transaction.
  • HMRC is working on a consolidated version of the DOTAS guidance, intended to be available in the early summer.
  • HMRC considers a DOTAS obligation can arise in respect of draft legislation.
  • There are new disclosure forms that take account of IHT.
  • The programme of work for 2011/12 includes the following:
  • A consolidation of the following regulations which have been amended a number of times:
    • the Tax Avoidance Schemes (Information) Regulations SI 2004/1864;
    • the National Insurance Contributions (Application of Part 7 of the Finance Act 2004) Regulations 2007, SI 2007/785.
  • HMRC intend to issue a discussion paper on the second tranche of hallmarks in late June.
  • A consultation document will be issued in May 2011 with a view to including legislation in Finance Bill 2012 to ensure that users of specific high risk schemes do not receive a cash flow advantage from delayed payment of tax.

www.hmrc.gov.uk/avoidance/dotas-update-april11.pdf

2. PRIVATE CLIENTS

2.1. HMRC High Net Worth Unit e-magazine

HMRC's High Net Worth Unit has launched a new e-magazine to give agents an insight into how the unit works and how it will develop in the future.

HMRC established its High Net Worth Unit in 2009 to deal with the personal tax affairs of the UK's wealthiest individual customers. It aims to build a deeper understanding of its customers' overall tax and financial positions, and work cooperatively and constructively with individuals and their agents to establish the tax that is properly due. The contents include:

  1. Introduction from the Chief Executive and Permanent Secretary of HMRC - Dame Lesley Strathie shares her views on the High Net Worth Unit (HNWU).
  2. In conversation with Martin Randall Head of HNWU
  3. Things that might interest you about the High Net Worth population.
  4. HNWU Tax Clinic - Points of general interest.
  5. Introducing Cooperative Compliance - A new relationship.
  6. Case studies: Cooperative Compliance - Examples in action.
  7. Enhancing the Relationship - Changing our working practices.
  8. Continuing the dialogue through the External Stakeholder Forum and Agent Survey.

www.hmrc.gov.uk/menus/hnwu-magazine.pdf

3. BUSINESS TAX

3.1. Annual Investment Allowance calculations for capital allowances on a change of amount

The maximum amount of annual investment allowance permitted in an accounting period that crosses the date of change is very dependent on the date expenditure is incurred and whether the rate rises or falls. The way the amount of allowance is allocated under the transitional rules in Finance Act 2010 and Finance Bill 2011 is different.

The following note explains the change for a company with a 30 June year end.

Finance Act 2010 increase in AIA from £50,000 to £100,000

The maximum AIA allowable is calculated as if the periods before and after the date of change were separate periods. However for AIA expenditure incurred before the date of change the maximum amount of allowance is limited to the old rate.

 

Apportioned AIA 1 July 2009 to 31 Mar or 5 April 2010

(Days x £50k)

Apportioned AIA 1 or 6 April to 30 June 2010

(Days x £50k)

Maximum allowance if expenditure before date of change

Company

£37,534

£24,932

£50,000

Unincorporated business

£38,219

£23,652

£50,000

Thus if £52,000 of AIA qualifying expenditure was incurred on 1 September 2009, the maximum AIA that could be claimed was £50,000. If further AIA qualifying expenditure of £20,000 was incurred on 25 May 2010, a further AIA claim could be made of £12,466 in the case of a company and £11,871 in the case of an unincorporated business. In each case the non-AIA qualifying expenditure could be allocated to the appropriate pool of plant or machinery.

Finance Bill 2010 decrease in AIA from £100,000 to £25,000

The maximum AIA allowable is calculated as if the periods before and after the date of change were separate periods in the same way as before. However if the expenditure is incurred after the date of change, the amount of allowance for the period before the date of change is ignored. 2012 is a leap year.

 

Apportioned AIA 1 July 2011 to 31 Mar or 5 April 2012

(Days x £50k)

Apportioned AIA 1 or 6 April to 30 June 2012

(Days x £50k)

Maximum allowance if expenditure before date of change

Amount allowed if expenditure incurred after date of change

Company

£75,137

£6,233

£81,370

£6,233

Unincorporated business

£76,503

£5,890

£82,393

£5,890

Thus if £90,000 of AIA qualifying expenditure was incurred on 1 September 2011, the maximum AIA that could be claimed was £81,370 for a company and £82,393 for an unincorporated business. However, if the same expenditure was incurred on 25 May 2012 (no previous AIA qualifying expenditure having been incurred), the maximum AIA claimable would be £6,233 for a company, and £5,890 for an unincorporated business. In each case the balance of expenditure would be allocated to an appropriate pool of plant and machinery. If faced with the problem of such a reduced AIA claim for expenditure incurred after the April 2012 commencement date, one consideration could be a change of accounting date to ensure the expenditure was incurred in an accounting period that attracted the full AIA allowance of £25,000.

3.2. David Howell v Revenue and Customs:TC01048

The issue

The issue in this case heard by the First Tier Tribunal was whether discovery assessments were validly made on allegedly under-declared profits.

Background

The following time-line may help in understanding the Tribunal's analysis:

1 May 1995. Partnership commenced between Mr Howell (DH), Mr Wood (BCW) and Mrs Wood (Mrs W).

January 2003. Mrs W died.

May 2003. BCW served notice on DH and exercised his option to buy DH's share in the partnership.

2004. DH took legal proceedings on the basis that BCW had not paid him out following his retirement. DH sought approximately £110,000 and a declaration that he had retired from the partnership on 21/7/04 or January 2003. The claim was shown as pursuant to Clause 11 of the Partnership Deed which was concerned with partner remuneration.

2006. The Court issued a Tomlin order which required BCW to pay DH £55,000 in full and final settlement. DH considered that this represented repayment of his initial capital of £20,000 and a further capital payment of £35,000.

8 February 2007. BCW's accountants wrote to DH's accountants saying that in their view the £35,000 was profits and that they intended to submit a revised partnership return for 2003/4.

2007. DH submitted his 2006/7 tax return which referred to him receiving a capital gain of £35,000. However because he was claiming business asset taper relief any net gain would be within the annual exemption and no detailed return was required in accordance with HMRC guidance. HMRC subsequently opened an enquiry into the 2006/7 return which was closed without amendment.

December 2009. HMRC issued discovery assessments charging the total of £35,000 to income tax over the years 1996/7 to 2003/4.

Points for decision

Error or mistake.

The Tribunal was clear that there was no basis for submitting a revised partnership tax return for 2003/4.

"The accountants went on to state their intention to submit a revised partnership return for 2003/04 allocating £35,000 of the profit assessable in that year to Mr Howell. Mr Maultby argues that there was no justification in fact or law for this unilateral reallocation of profits. In this connection he referred to the Respondents' letter dated 25 September 2009 in which the apparent justification for this treatment was suggested to be an Error or Mistake Relief claim. Mr Maultby directed attention to s 33A ss (1) TMA 1970 which provides:

"This section applies where in the case of a trade.....carried on by two or more persons in partnership, those persons allege that tax charged.....was excessive by reason of some mistake in a [partnership return].....

Mr Maultby argued, correctly we consider, that the use of the word "persons" required that both partners would need to agree an Error or Mistake Relief claim and not one only of them. This could not be dealt with unilaterally and accordingly neither Mr Wood's accountants nor the Respondents were entitled to deal with the matter in this way."

Section 29 assessments

S29 TMA 1970 requires one of two conditions to be satisfied as follows:

"4) The first condition is that the situation mentioned in subsection (1) above is attributable to fraudulent or negligent conduct on the part of the tax payer or a person acting on his behalf.

(5) The second condition is that at the time when an officer of the Board –

  1. ceased to be entitled to give notice of his intention to enquire into the taxpayer's return under section 8 or 8A of this Act in respect of the relevant year of assessment; or
  2. informed the tax payer that he had completed his enquiries into that return the officer could not have been reasonably expected on the basis of the information made available to him before that time, to be aware of the situation mentioned in subsection (1) above"

HMRC did not argue that the second condition had been satisfied. HMRC's argument was that DH's failure to include the £35,000 in his 2006/7 tax return as income meant that the first condition was satisfied.

The Tribunal found against HMRC on this point as follows:

"24. It is clear to the tribunal, and indeed it is not disputed by the Respondents, that in this case the partnership returns submitted by Mr Wood for the business Excel Refrigeration & Catering Equipment were complete in that they included all of the income earned by the partnership and claimed only those reliefs to which the partnership was properly entitled. There was no suggestion by Mrs Bellingall to the contrary. Equally it is accepted by the Respondents that the partners in the business completed and submitted self assessment returns in respect of their individual earnings from the partnership business which were complete and accurate. There was therefore nothing in any of these returns for the Respondents to "discover". It is clear that as a first step in the process of raising a discovery assessment the officer of the Revenue must first decide whether a "discovery" within the meaning of sub-s(1) made by him warrants the making of an assessment. Only when this step is satisfactorily taken must he then go on to consider whether either of the two conditions referred to in sub-s (3) is fulfilled (see Derek William Hankinson v The Commissioners for Her Majesty's Revenue and Customs [2010] UKUT 361 (TCC). In the present appeal there was no "discovery" within sub-s (1) as any such discovery is required by the terms of that sub-s to be "as regards any person (the taxpayer) and a year of assessment" In the years of assessment with which this appeal is concerned the taxpayer's returns fully met his obligations and he is entitled not to have the assessments opened up or the subject of further assessment. We accept the contentions advanced by Mr Maultby in this respect. Again referring to the judgment of Stanley Burnton J in R (Johnson) v Branigan ([2006] EWCH 885 (Admin)):

"In my opinion the test has to be a two-stage one to fit in with the underlying purpose of the scheme [of s.29]. The officer has to discover something new otherwise the underlying purpose of early finality of assessment would be defeated. His assertion of the newly discovered insufficiency is then tested against the adequacy of the disclosure by the taxpayer. It is only if the taxpayer has made a return which has clearly alerted the officer to the insufficiency that it will be considered adequate and will shut out a s. 29 discovery assessment"

25. We find therefore that there was no "discovery" within sub-s (1) of s.29 in relation to any of the years in respect of which the discovery assessments have been raised. For that reason alone we would find the assessments to be invalid. The fact that the Revenue became alerted to a receipt of monies in 2006/07 which had (at least to the Revenue) the aspect of revenue income cannot in our view be canvassed as a "discovery" within sub-s (1). so as to bring into charge income which was not received in those years but which arose after the period within which the Revenue might properly re-open the taxpayer's assessments. It is quite clear that the Revenue received the tax properly due from each of the partners in the business for each of the years in question. An additional charge to tax arising out of a quite different set of circumstances occurring after the periods concerned would have the effect of providing the Revenue with tax receipts in excess of that justified by the income actually received by the partners. This cannot in our judgment be right.

26. As indicated above a two stage process is required. The second stage involves an enquiry as to the satisfaction or otherwise of either or both of the conditions referred to in sub-s (4) and/or (5) of s.29. When Mrs Bellingall was asked by the tribunal to explain the grounds asserted by the Revenue so as to support the discovery assessments we were told that the Respondents relied on the negligent failure of the Appellant to include revenue income in his 2006/07 tax return. That reply of course rather begs the question concerning the nature of the receipt under the Tomlin Order. If the receipt was of a capital nature, as the Appellant says, then his return for that year has been dealt with, in our view, perfectly correctly. This was not contested. If, however, as claimed by the Respondents, some or all of the monies received were in the nature of revenue income arising only in the tax year 2006/07 then it is difficult to understand how the Respondents could rely on some "negligence" in his return for that year having conducted an enquiry into that return and having subsequently written on 11 March 2009 to the Appellant that:

" I am pleased to tell you that no amendment to the 2006/07 Return is needed as a result of my enquiry."

It seems clear to the tribunal that the question of negligence in the context of the returns for the years covered by the discovery assessments had not been properly thought through. Negligence cannot in our judgment be established so that at least the condition in sub-s (4) cannot be met by the Respondents and for this reason too we have no hesitation in finding the discovery assessments for each of the years 1996/97 to 2003/04 invalid. No argument was advanced by the Respondents that the condition in sub-s (5) might apply nor do we consider it credible that this could be argued."

Capital or revenue

Because HMRC failed on the discovery point the Tribunal did not need to decide whether the payment of £35,000 was capital or income. However for completeness the Tribunal found that:

"the whole of these monies were in the nature of capital representing the sum payable by Mr Wood for the assignment to him of his former partner's share in the partnership. We accept the principle urged on us by Mrs Bellingall that "What you ask for is what you got". In this case what was asked for by Mr Howell was a sum of money payable under the Partnership Deed on the retirement of a partner. He also asked for the sum of £20,000 being capital introduced by him into the partnership to be credited to his capital account...... Interestingly whilst Mr Howell asserted breaches of both contract and fiduciary duty in his Statement of Claim the claim did not specifically include an allegation that Mr Howell had not been paid the correct share of profits from the partnership. ........ The whole thrust of Mr Howell's claim was that he was entitled to a sum of money on retirement which included the £20,000 capital together with such further sum as might stand to the credit of his capital account. That is what he wanted. What he got was set out in the schedule to the Tomlin Order, namely £55,000 in return for which he agreed to "transfer any share of his in the Partnership to the First Defendant (Mr Wood) in consideration of the agreement contained in this schedule and for no other consideration (i.e. payment of the sum of £55,000). That this was a capital payment is further supported by the schedule to the Statement of Claim. This does not set out any unpaid income as the Respondents might expect but instead details year by year the adjusted balances to the Appellant's capital account for which he contended in the litigation."

3.3. Review of small business administration

The Coalition Government set up the Office of Tax Simplification last year and set it two initial tasks, firstly to review over 1,000 tax reliefs and secondly to review the taxation of small businesses and recommend priority areas for simplification. The OTS' small business report was published in March 2011 and recommended that Government should consider two long-term reforms, namely the integration of income tax and NICs and the introduction of a radical new way of taxing the smallest businesses.

The Government has now confirmed that it will not be proceeding with the suggestion of a full merger of income tax and NIC and the two will therefore remain separate.

The OTS report recognised that any major reforms would take some years to deal with and it recommended that in the meantime there could be some 'quick fixes' that would make life easier for small businesses. One of these recommendations was to improve elements of HMRC's administration with the aim of improving its relationship with the small business community. The report highlighted the following areas of concern:

  • HMRC sees the small business area as a source of tax leakage and as a result of its robust approach it was feared by many small businesses;
  • Small businesses and their advisers spend too much time sorting out HMRC errors;
  • HMRC needs to communicate better with taxpayers;
  • HMRC staff need to be well trained;
  • The tax legislation is over complicated;
  • What businesses want more than anything else is certainty and that is not helped by HMRC pushing the boundaries in the area of "discovery" which means that HMRC can choose to issue an assessment several years after the tax year which the taxpayer then has to try to defend.

The OTS recommended that Government should consider various means of improving the relationship:

  • Providing a rulings service in certain difficult areas like the employed/self-employed divide.
  • Improving the quality of information provided by HMRC staff and clarifying when that guidance can be relied on by taxpayers.
  • Defining areas that will be more likely to attract HMRC scrutiny.
  • HMRC should rely more on the work done by agents.
  • HMRC should be held accountable where it is found to have behaved unreasonably.
  • Faster working of tax enquiries.

The Government has now asked the OTS to look more closely at the above issues, focusing on all aspects of the interaction between small businesses and HMRC, and to make concrete recommendations for improvements. In particular OTS has been asked to closely examine small business contact with HMRC at key stages in the tax cycle, particularly when starting and growing a new business.

The starting point here must surely be the need to simplify the tax code generally. It is universally recognised that the UK tax system is now totally out of control and needs radical reform. The OTS review of tax reliefs led to the chopping of 100 pages of redundant legislation, but that small saving was immediately swamped by the extra 400 pages resulting from the 2011 Finance Bill.

The next major aim must be to do something to improve HMRC's performance. As is the case with many mergers over history, the combination of the old Inland Revenue and HM Customs and Excise seems to have back-fired spectacularly. The merger promised to provide significant operational efficiencies, but in reality it has merely provided an excuse for major job cuts, which in turn has led on to a spiralling vicious circle of poor customer service and falling staff morale which now seems to have hit rock-bottom.

HMRC is currently recognised for providing a good service for large businesses and it is endeavouring to improve the service provided to the wealthiest taxpayers, but this seems to have been at the expense of its service levels to the rest of the population within the charge to tax. HMRC now needs to get back to basics with regard to its service levels to the vast majority of taxpayers who don't fall into one of those specialist areas.

Firstly it needs to provide good technical training across the whole range of taxes so that its staff can advise on the whole range of issues that a small businessman has to contend with in the areas of business tax, PAYE, VAT, National Minimum Wages, Statutory Maternity Pay etc.

Secondly it needs to provide its staff with some good customer service training which recognises taxpayers as customers. This is not rocket science – it's all about ensuring the telephone is answered with a helpful and patient attitude, and post is opened on receipt and dealt with fully and correctly within a short time-frame (i.e. all those simple things which HMRC currently finds so difficult to do).

3.4. Local Compliance (LC) SME Single Compliance Process

HMRC has written to us regarding the Single Compliance Process (SCP) which we understand relates to the way that they handle tax investigations into SME businesses:

"Introduction

Relieving the burden on our customers and their agents is one of HMRC's top priorities. Feedback from customers suggest that some current compliance practices are long and drawn out, not to mention costly to all parties.

Within LC SME we are currently looking at a new approach to compliance checks; the Single Compliance Process (SCP) will focus solely on the risks and behaviours identified in cases as they come to us and throughout the life of the compliance check, irrespective of the head of duty involved.

It is envisaged that the framework will be used initially by LC SME, but other Customer Groups within HMRC will be watching the development and trial with interest.

The Single Compliance Process

The Single Compliance Process will provide caseworkers with a new framework for working compliance checks. The idea is to have a compliance check comprising of four different levels of intensity:

  1. The first level will provide a new approach to working cases remotely, as we currently do with ITSA and CT aspect cases and VAT Pre-Credibility desk clearance cases.
  2. The second level will look at a simplified and faster route for those cases where there are not many risks, but a face to face intervention approach is required; similar to VAT assurance or Employer Compliance visits
  3. The third level will address cases showing more in depth risks and address behaviours short of evasion.
  4. The fourth level will tackle cases indicating evasion characteristics.

The intention is that as a case is worked it should be able to move between each of the four levels depending on what is encountered as the case progresses. This will avoid any perceived "fishing expeditions" and will help to reduce the emotional burden to the customer in that the check will only take as long as the risks or behaviours dictate.

As part of the process we have looked at current practices for areas we can improve the service that we provide and help to reduce unnecessary delay.

Timelines

Design complete by 31st May 2011.

Trial across 12 locations between mid May and December 2011.

Implementation i.e. rollout across LC SME from January to June 2012 – subject to the results of the trial."

3.5. Customer Co-Coordinator role for large partnerships

The Large and Complex Business Directorate within HM Revenue & Customs (HMRC) introduced the new role of Customer Co-Coordinator in June 2010 for the department's large businesses that didn't have a dedicated Customer Relationship Manager (CRM). CRMs are senior tax specialists who work with HMRC's largest businesses to deliver departmental objectives and commitments. They also help their customers ensure they pay the right amount of tax at the right time.

HMRC has a dedicated Large Partnership Unit, and a number of large partnerships already have CRMs. From June 2011 onwards, HMRC's Customer Co-Coordinator service will be extended to many of their large partnership customers who don't already have a CRM. For a business to qualify as a large partnership, it must have ten or more partners, or five or more partners if the turnover is £5 million or above, or the turnover exceeds £15 million.

Customer Co-Coordinators will provide a professional, joined-up service for large partnerships. The Co-Coordinator will be a single named point of contact for their customers, overseeing their tax issues and directing them towards appropriate specialists and published information. They will follow up issues within HMRC to ensure they are concluded within an agreed timeframe and will also maintain a single up-to-date overview of their customers and their issues and risks.

Customer Co-Coordinators will be sending introductory letters to their new large partnership customers by 30 June 2011.

3.6. Corporation tax statistics

HMRC has released reports on various corporation tax statistics:

www.hmrc.gov.uk/stats/corporate_tax/menu.htm

www.hmrc.gov.uk/stats/corporate_tax/corporation-tax-statistics.pdf

3.7. New SDLT forms from 4 July 2011

New SDLT forms (SDLT1, SDLT3 and SDLT4) will be in use from 4 July 2011 that require a unique identifier for lead purchasers.

www.hmrc.gov.uk/sdlt/get-ready-for-change.htm

3.8. Updates to HMRC manuals

HMRC's company tax manual has been updated to reflect (amongst other things) changes to the time limit for claiming under s 419(4) of ICTA88, the default time limit for claiming relief under CTSA, and the time limit for assessments under Para 46 of Sch 18 of FA98 (including discovery determination, applied by Para 49).

http://www.hmrc.gov.uk/manuals/ctmanual/updates/ctmupdate180511.htm

3.9. EU requests UK to amend its CFC rules

The EU has formally requested the UK to further amend its legislation on controlled foreign companies (CFC). The request takes the form of a reasoned opinion for which the UK has two months to respond satisfactorily before possibly being referred to the EU's Court of Justice.

The EU refers to measures put in place by the UK as a result of the EU's decision in Cadbury Schweppes (case C-196/04) and the Test Claimants in the CFC and Dividend GLO (case C-201/05). These were introduced in Finance Act 2007 amending ICTA88 part 18 chapter 4 and in particular introducing s751A and s751B. The new provisions enable a company to apply to HMRC to exclude from CFC anti-avoidance apportionment of overseas company profits, the permitted element of profits where the CFC meets the following conditions throughout the relevant period:

  • the CFC has a business establishment in an EEA territory;
  • there are individuals who work for the controlled foreign company in that territory.

The amount that HMRC can exclude from CFC apportionment under these rules is the amount representing net economic value arising to the CFC from qualifying work. Qualifying work is work done in an EEA territory by individuals working (employed by the CFC or directed to perform duties on its behalf) for the CFC there.

HMRC have applied this legislation with a focus on work done by labour. HMRC's reference to the ECJ guidance in Cadbury Schweppes is in INTM210510:

"The ECJ decided that controlled foreign companies' rules pursue a legitimate aim and are compatible with European law - so long as they are not applied to the profits of genuine economic activities undertaken in an actual establishment in another Member State."

However, they appear to have interpreted 'genuine economic activities' rather narrowly. The ECJ made no distinction between capital and labour profits, yet the UK rules and HMRC's guidance are focused on only exempting profits from labour. HMRCs guidance at INTM210530 states that for the purpose of the UK rules:

"genuine economic activities" undertaken in another Member State are those created directly by the work of the individuals working for the controlled foreign company in its EEA business establishment(s).

Profits from holding assets are not profits created by the work of individuals working for the controlled foreign company. Profits from holding assets includes any amount of profits arising in a controlled foreign company as a consequence of locating non-essential equity capital in the controlled foreign company, for example where a group chooses to use equity rather than debt to finance the activities of the controlled foreign company."

This reluctance by HMRC to extend the exemption to capital profits has been evident during the current consultation on CFC reform with the sticking points being profits generated from financing activities and intangible assets. However there has been a big shift in HMRC's attitude to financing arrangements and the current proposals for CFC reform in Finance Bill 2012 are for partial finance exemption potentially subject to debt equity ratios, which by 2014 could result in a tax rate on those profits of as little as 5.75%.

It remains to be seen how the UK will respond to the EU's latest request, what attitude they will take to outstanding enquiries and disputes in this area, and whether the legislation for the new rules will fully comply with the UK's EU obligations. Unfortunately the continuing reluctance of the UK to fully embrace EU treaty requirements and the resulting uncertainty for tax in this area does little to restore the UK's reputation for a competitive tax regime.

http://europa.eu/rapid/pressReleasesAction.do?reference=IP/11/606&format=HTML&aged=0&language=EN&guiLanguage=en

4. VAT

4.1. Accounting for acquisition VAT on intra-EU supplies – changes to the 'fallback' position

HMRC has announced a change in VAT treatment where a business uses a UK VAT registration number (other than for triangulation purposes - see below) to secure zero-rating of goods sent from one EU Member State to another, without arriving in the UK.

Under what is often referred to as the 'fallback' provision, use of a UK VAT registration number in these circumstances makes the customer liable to account for acquisition VAT in the UK. Significantly this does not cancel any liability to account for acquisition VAT in the Member State to which the goods are sent ('the Member State of arrival'). However, the UK VAT can be adjusted if VAT is accounted for correctly in the Member State of arrival.

The fallback rule is explained in paragraph 7.7 of Notice 725 (The Single Market). The change follows the judgement of the Court of Justice of the European Union (CJEU) in the joined cases of X (C-536/08) and Facet BV (C-539/08).

In its decision the CJEU held that there could be no right to deduct acquisition VAT where it falls due under the fallback arrangements as the goods did not actually enter the Member State. In arriving at its decision the Court noted that if there were a right to deduct in these circumstances, it could jeopardise the operation of the normal rules as it would remove the incentive for the acquisition to be taxed in the Member State of arrival.

The liability to account for acquisition VAT where a UK VAT registration number is used in the course of an intra-EU supply of goods not involving removal to the UK remains unchanged. However, it is now clear that there is no right to recover the acquisition VAT as input tax. The only basis on which the UK VAT may be adjusted is where it can be demonstrated that acquisition VAT has been accounted for in the Member State of arrival.

Impact on acquisitions of yachts in the UK

In 1997 Customs & Excise agreed to arrangements under which a UK VAT registered business could account for acquisition VAT in the UK on a yacht purchased from a supplier in another Member State without the yacht arriving in the UK. This was announced in Business Brief 12/97 which also permitted input tax deduction subject to the normal rules.

Following the CJEU decision the UK acquirer may now no longer recover the UK acquisition VAT as input tax. For this reason the agreement will cease to have effect and so is to be withdrawn from 1 June 2011. After that date UK acquisition VAT accounted for on a yacht that does not arrive in the UK will no longer be recoverable as input tax. However, as a transitional measure, any UK VAT registered business who, before 1 June 2011, entered into a contract for the purchase of a yacht and who intended to adopt the procedure as agreed in Business Brief 12/97, may continue to rely on those arrangements (including recovery of the acquisition VAT as input tax, subject to the normal rules) when the yacht is eventually delivered. But this is subject their holding satisfactory evidence of the contract and the date that it was agreed.

http://customs.hmrc.gov.uk/channelsPortalWebApp/channelsPortalWebApp.portal?_nfpb=true&_pageLabel=pageLibrary_PublicNoticesAndInfoSheets&propertyType=document&columns=1&id=HMCE_PROD1_031284

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