UK: United Kingdom Tax Bulletin (October 2008)

Tax returns: 31 October Deadline

If you were not aware that 31 October was the deadline for hard copy tax returns, it is a bit late now. Well, not quite. Tax returns delivered by hand that are found in the HMRC letterbox when opened on Monday, 3 November, will be treated as delivered on Friday, 31 October, for all purposes and will not attract a nonfiling penalty. Furthermore, the enquiry window for that tax return will close on 31 October 2009.

Tax returns delivered by hand on that Monday (or that are found in the HMRC letterbox when first opened on Tuesday, 4 November) will not attract a penalty either. However, in these cases the enquiry window will not close until 31 January 2010.

There is still the opportunity to file tax returns online, and the deadline for electronic returns is 31 January 2009, but not once you have filed a hard copy. Unfortunately, once you have filed a hard copy late, you cannot avoid the penalty by then filing online before 31 January.

In all cases, the penalty will be reduced to zero when all the tax is paid by 31 January 2009.

Residence: IR20 Judicial Review

It is well known that Mr Gaines-Cooper is challenging the refusal by HMRC to apply the practice set out in their booklet IR20 on residence. Mr Gaines-Cooper had taken the trouble to make sure that his visits to the United Kingdom were below the 91-day limit contained in IR20 – the terms of which had remained pretty much unchanged for decades – and he therefore considered that he should be regarded as nonresident. He claimed that, whatever might be the strict legal position, the guidance contained in IR20 represented HMRC's assurance on how they would apply the rules. He had relied on their statement in organising his affairs, and he felt that HMRC should not be allowed to go back on it. He sought an order from the High Court to that effect.

HMRC disagreed and said that IR20 was not binding on them and taxpayers should not expect to rely on it. It merely sets out how HMRC might approach the taxpayer's position. Furthermore, HMRC cannot act outside the law, and if the terms of IR20 differ from the strict legal position, to that extent it would be ultra vires. Their duty is to collect tax, not to impose taxes or forgo them. Accordingly, the taxpayer could not have any legitimate expectation to rely on the terms of IR20. A taxpayer's residence position had to be determined by reference to the law, and the terms of IR20 were completely irrelevant. No matter how carefully Mr Gaines-Cooper may have counted his days to stay below the 91-day limit, that was not a concept enshrined in the law, so it did not avail him anything.

HMRC had another interesting argument. Even if they were bound to apply the terms of IR20, they could not make a decision on a person's residence before the matter had been to the Special Commissioners because, until that time, they would not know all the facts. The matter would first have to go to the fact-finding tribunal so that they could make their decision. It would, therefore, not be possible to apply for Judicial Review before the matter had been heard by the Special Commissioners. However, after the Special Commissioners have made a decision, the fact that they have ruled on the law means that you cannot then apply for Judicial Review. Neat.

We shall soon see how the Administrative Court views these matters. It does seem extraordinary for HMRC to claim that we cannot rely on their public statements, because the whole purpose of having IR20 and all the other statements of practice would be completely vitiated.

It is difficult to see how HMRC can possibly be right. Of course, it is simple to say that HMRC is bound by the law like everybody else and they cannot go outside it, but the whole purpose of a statement of practice is to provide a sensible framework for the administration of taxes; accordingly, there are bound to be elements within the statement that are extrastatutory or, to put it another way, go beyond the law. In the past, they have always justified this conclusion on the basis of the duty of care and management given to them under the Taxes Management Act 1970.

It is not enough to point to some paragraphs in IR20 and find legal authority for them. If HMRC are right, there should be nothing in IR20 that is unsupported by legal authority, but that is clearly not the case.

One example will suffice, although there are many. When somebody comes to the United Kingdom during a tax year, IR20 generally provides that he or she will be treated as resident in the United Kingdom from the date of arrival. There is a similar practice when somebody leaves. However, the law is clear. Residence is a status that applies for the whole year, and you cannot be resident for part of the year and nonresident for the remainder of the year. There is no doubt or any argument about that. However, that is exactly how HMRC say they will treat you, despite the fact that they know and acknowledge that this is contrary to the strict legal position. How can they possibly now claim that IR20 does not differ from the strict legal position, and how can they protest that they would never issue guidance that would cause them to act outside the law?

So, if somebody comes to the United Kingdom on 1 January and takes up residence in the United Kingdom from that date, he or she really ought to be paying tax on the whole of his or her income and gains since the previous 6 April. Why is he or she not paying that tax, and why are HMRC not trying to collect it? It is because IR20 sets out a sensible framework on which everybody can and does rely to deal with his or her tax affairs, and HMRC ought to be required to honour it.

The 91-day test and the way it is calculated are also Revenue inventions. Nothing wrong with that – it is a perfectly satisfactory rule – but it is certainly not in accordance with the law. But there is something seriously wrong in HMRC encouraging people to adopt a procedure that is convenient for them but claiming the right (retrospectively) not to apply it at their discretion on the grounds that it is only a practice and does not have the force of law.

And where does this leave extrastatutory concessions? We know they are extrastatutory, which means they are outside the law, but people rely on them, which is the whole idea. Some sense has to be brought to bear here so that everybody can acknowledge the wide practical benefit of having statements from HMRC that are good for the administration of the tax system and on which the taxpayer is entitled to rely.

I think that the issue here is tolerably clear. I hope that the Court will see it the same way – otherwise, chaos will ensue, and there will be a very long queue of further appeals for those who consider themselves unjustly treated.

Capital Allowances

The recent case of Tower MCashback LLP v HMRC [2008] EW8C 2387 was, in many ways, a surprising success for the taxpayer who claimed capital allowances on software. The software was related to a marketing incentive plan that provided rewards for shoppers who claimed their rewards by mobile phone. The LLP paid a certain amount to acquire the right to use the software and claimed capital allowances on the amount paid. The purchase price was financed to the tune of 75 percent by a bank loan that was effectively guaranteed by the vendor. The loan was reduced by the profits generated by the LLP from the software. We are not talking small potatoes here. This was a serious commercial deal, and the purchase price was £143 million.

However, HMRC denied capital allowances on the grounds that the LLP had not really incurred expenditure on the software licence.

You can see their point – or at least their grievance. If the LLP was at risk for only 25 percent of the purchase price but entitled to capital allowances on the whole of the purchase price (not immediately, perhaps, but over a period) they were bound to win, even if the whole project bombed. However, this does conveniently overlook the fact that the vendor had sale proceeds of £143 million, so HMRC should not have been out of pocket. I do not know where the vendor was resident, and they may not have been within the charge to UK tax, but that is hardly a matter that should affect the relief available to the purchaser.

HMRC argued that only 25 percent of the expenditure should be eligible for capital allowances, as the balance was just financing. ("Financing for what?" one might ask – for the purchase of the software, perhaps.) It was acknowledged that the agreement was not a sham and could not be set aside, but the Special Commissioner sought to recategorise the whole transaction because he felt the purchase price was artificially inflated.

The High Court said that the agreement could not be recategorised in this way. The terms of the deal were negotiated at arm's length between unconnected persons, and even though the funds borrowed went back to the lending bank, that did not mean that the expenditure had not been incurred in purchasing the software. The circular flow of funds did not affect the reality of the expenditure, and the House of Lords' decision in BMBF v Mawson was clear authority for this conclusion.

Remittances: Payment of Professional Fees

My enthusiasm in August for the relaxation introduced into Section 809W Income Tax Act 2007 was perhaps not entirely justified. This was a late amendment to provide the opportunity for resident but foreign-domiciled individuals to pay the fees of their UK advisers out of their foreign income without triggering a remittance. From 6 April 2008, the definition of a remittance has been widened considerably so that in the absence of this relief, the use of foreign income to discharge professional fees (even if paid outside the United Kingdom) would be a remittance if those services were rendered in the United Kingdom.

The exemption provides that when foreign income or capital gains are used to pay UK advisers for services relating wholly or mainly to assets situated outside the United Kingdom (including fees paid by offshore trustees to UK advisers for advice about managing or considering the acquisition of non-UK assets), this will not be regarded as a remittance provided the payment is paid to a foreign bank account.

Jo Summers of Penningtons has drawn my attention to the fact that it may never be possible to qualify for this exemption in the context of an offshore trust. This is because the exemption is specifically disapplied where the advice is "to any extent" in respect of the provision in the United Kingdom of benefits under Section 735 ITA 2007 or Section 87B TCGA 1992 – that is to say the remittance of benefits from the foreign trust that would otherwise be chargeable to tax. The problem is if we tell clients that the fees for our advice in respect of their foreign property can be paid to our foreign bank account without being a taxable remittance, this will deprive them of the exemption. This is because, by doing so, we would necessarily be advising in respect of the provision in the United Kingdom of benefits under Section 735 or Section 87B.

How can we inform clients about this exemption without destroying their entitlement to the exemption? We could hope that they come across the information by chance . . . I suppose we could advise clients specifically about this opportunity and charge them for it, ensuring that the fee for this advice is paid separately. In the future, we could then, perhaps, assume that they will know what to do without having to be told.

It is to be hoped that this absurdity is one of the issues to be resolved by the recently formed stakeholder committee of HMRC, who are enquiring into difficulties arising from the application of the new legislation.

Interest: Deduction of Tax

HMRC has issued a Brief 47/08 that sets out their policy towards deduction of tax at source from interest, which is treated as a distribution under Section 209(2) Taxes Act 1988.

When a company pays yearly interest, it is necessary for them to deduct tax at source. A concern has arisen that the rewriting of the rules in Section 874 Income Tax Act 2007 affected the position. However, HMRC has confirmed that Section 874, like its predecessor, requires income tax to be deducted from payments that have the character of interest. If a payment is a distribution under Section 209 (2), it does not have that character, and no tax deduction is required.

There is nothing dramatic here – merely welcome confirmation from HMRC that there is no requirement to deduct tax at source from interest which is treated as a distribution.

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