Article by Verfides
A common question put to tax advisors by UK resident clients is "is there any way I can legitimately use an offshore company or trust to hold assets and reduce my UK tax bill?" It is a natural enough question for those not overly familiar with UK tax law, the questioner's starting point often being why would income and gains made by a company or trust resident in an offshore location be subject to UK tax?
The reality for many years for UK taxpayers is that a number of very widely-drawn anti-avoidance rules have prevented just that. Here we look more closely at those rules, but also at some proposed changes, in effect forced on the Government by the EU Commission, which may make such planning more achievable.
This article focuses on the use of offshore companies with only a brief consideration of the position for offshore trusts.
From a UK standpoint, the term "offshore company" simply describes a company which is not incorporated in the UK and, provided managed and controlled abroad, is therefore not UK resident for tax purposes. Such a company is commonly incorporated in a low or zero tax jurisdiction. For this reason many such companies have been used historically for tax planning by taxpayers all round the world.
The ostensible reason for the use of such companies is that income and gains accruing to the company are not subject to tax in the UK by virtue of being non-resident for tax purposes. Providing those income and gains are not paid out to the UK-resident shareholder, the inference is that the company can be used as a "money box" to generate tax-free income and gains over the course of its life.
Unfortunately for the taxpayer but fortunately for the UK Exchequer, such use of offshore companies by most UK-resident taxpayers will not result in such tax savings, due to long-standing anti-avoidance legislation which effectively "looks through" such arrangements to the ultimate shareholder or beneficiary of the income or gains.
Capital Gains: Attribution to Shareholders
Section 13 TCGA 1992 seeks to allocate the gains of a non-resident company directly to its UK-resident shareholders or "participators". This is designed to stop assets being transferred to non-resident companies only to be sold at a later date without a charge to UK tax.
Section 13 operates such that any UK-resident shareholder holding over 10% of the shares of the company will have the relevant proportion of the non-resident company's gains attributed directly to them and taxed at the point the gain is made by the company. When considering whether the 10% threshold is met, the shareholdings of certain persons connected to one another will be amalgamated (for instance spouse, close family members and connected companies).
UK-resident but non-domiciled shareholders retain an advantage of being able to elect for such attributed gains to be taxed on the remittance basis, such that they will not be subject to UK taxation unless the proceeds are brought into the UK. However, this treatment is only available in respect of non-UK situs assets (and not, for instance, in respect of gains realised on the disposal of UK real estate; however, use of an offshore trust as shareholder may solve this problem in certain circumstances). There will be a number of issues to consider for such individuals, not least the remittance basis charge (where applicable).
Income: Transfer of Assets Abroad
A separate set of anti-avoidance provisions exists to stop income being rolled up in a non-resident structure where a UK-resident still retains the ability to benefit in some way from the income. The provisions are contained at Sections 714 to 751 ITA 2007. The rules relate to both non-resident companies and non-resident trusts and are very widely drawn.
The rules bite where:
- There is a transfer of assets by a UK resident (or ordinarily resident) individual
- As a result of which, income becomes payable to a person abroad (this is typically a non-resident company or trust); and
- A UK resident
- has the power to enjoy the income of the person abroad; or
- receives a capital sum as a result of the transfer; or
- receives a benefit as a result of a transfer made by another UK resident
Even where a benefit is not immediately received, the provisions can bite where one will be available in the future: for instance a transferor as beneficiary of a non-resident transferee trust may be caught even though there is no absolute right at any point to benefit from trust distributions. It would also catch a situation where a third party UK resident becomes entitled to benefits as a result of another's transfer of assets, which demonstrates the scope of the legislation.
The transfer of assets legislation is very much framed in terms of intention or motive. The so-called "motive test" exempts a transaction if it can be demonstrated that there is no tax avoidance motive, or if a tax avoidance motive is purely incidental in a fully commercial transaction. In practice it has been notoriously difficult to meet this motive test.
Again an exemption is available under certain circumstances to users of the remittance basis of taxation.
It can be seen from both the capital gains and income provisions that the use of offshore structures by UK resident domiciled individuals is heavily circumscribed under current law.
Proposed Changes: A Window of Opportunity?
Whilst the UK Government would be more than happy to keep these rules as they are, the EU Commission released a formal opinion some time ago that they are not compliant with EU Law.
Whilst EU law (as developed by rulings of the ECJ) recognises that each EU state has the right to protect its own tax revenues by the imposition of anti-avoidance rules, those rules must not go beyond what is reasonable in achieving those aims. Any rule which does more than prevent only "wholly artificial arrangements" has been found by the ECJ to be disproportionate and therefore unlawful. The Commission believes that both anti-avoidance laws outlined above are unlawful as they catch legitimate commercial transactions (for instance, the bona fide transfer of assets to a company in a low tax EU state in order to establish a commercial business there) as well as those with a pure tax avoidance motive.
In response to this, the UK Government published a Consultation Document on 30 July 2012 setting out its planned changes to the rules, which it intends to bring into law in Finance Act 2013. The changes are intended to continue to prevent avoidance but to exempt legitimate commercial transactions.
The proposed amendments are not restricted to transfers within the EU but also to "third countries", which is a clear indication that the Government believes that the current rules offend not only the Freedom of Establishment but also the Freedom of Movement of Capital, the latter of which is applicable to movements outside the EU.
Proposed Changes to s.13 – Capital Gains
The intention is to introduce an exemption for assets transferred to a company which is carrying on a "genuine economic enterprise" – the "business establishment test". Sale of such assets at a gain would be outside the scope of the s. 13 charge.
It is intended that a "genuine economic enterprise" would be one where the company is engaged in an overseas trade in goods or services rendered on a commercial basis on arm's length terms, with a second requirement that sufficient competent employees, agents or contractors are used such as would be commensurate with the generation of profits of that level. There must be a genuine local establishment pursuing these activities. This gives scope for planning in the form of choosing a jurisdiction in which to establish a bona fide trading business through the transfer of money or assets out of the UK even where there is a tax avoidance motive.
The draft legislation specifically excludes a business or part of a business consisting of the making of investments from the proposed exemption. This seems to be going beyond the scope of preventing purely artificial arrangements (can an investment portfolio not be managed commercially from another jurisdiction?) and limits somewhat the planning opportunities. Like other amendments to the tax legislation forced on the UK by the EU (for instance the amendments to the CFC rules), it seems like the proposals may not go far enough to make the law fully EU compliant.
Proposed Changes to Transfer of Income Abroad Rules
Very similar changes are proposed. The draft legislation aims to introduce a further exemption for what are termed "arm's length transactions". The first leg of this test is that, again, the transaction or transfer must be effected "for the purposes of economically significant activities carried on (or to be carried on) outside the United Kingdom". Again these activities are described in terms of active provision of goods and services with commensurate input from employees or contractors, and investment holding activities are specifically excluded.
The second arm of the "arm's length test" must also be met: the transfer must be one which would be made by unconnected persons, and if so must be made according to terms which would have been agreed by such unconnected parties. The new exemption therefore supposedly disregards motive (which may be tax avoidance) but instead relies on "objective tests" in determining legitimate commercial activity.
Again there is an argument that this very strict exemption is not enough to satisfy EU law although it does nevertheless open up new planning opportunities for UK businesses.
We await the outcome of the consultation process to see what form the final amendments will take.
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