The "management and control'' test of corporate residence is a significant connecting factor for tax purposes in many common law jurisdictions. The UK's central management and control test is certainly an important consideration for non-UK registered companies operating in the UK who wish to avoid worldwide liability to UK corporation tax as UK resident companies. The UK test arguably has an additional relevance today, linked to the economic substance legislation now in force in the zero tax offshore financial centres . For example, a BVI registered company that is "non-resident'' e.g. because it is tax resident in Hong Kong, is not required to demonstrate economic substance in the BVI, provided certain administrative requirements are met around evidencing tax residence in Hong Kong. In certain circumstances this may be very helpful. Under Hong Kong law the concept of corporate residence is a common law test of management and control, and UK case law is almost always cited in Hong Kong court cases where company residence in Hong Kong is being considered. UK case law is persuasive, though not necessarily binding on the Hong Kong courts. Given that many BVI and other offshore companies must now start to determine where they are actually resident as part of their compliance with the new economic substance legislation, and given the importance of the management and control test in most common law countries, an understanding of recent case law developments in the UK is likely to be relevant and helpful to a significant proportion of offshore companies, even if their beneficial ownership is unconnected with the UK and there is little or no UK activity .
Since the UK Court of Appeal judgement in Wood v Holden , the UK's central management and control test has been made much clearer in assessing the residence of offshore companies, including offshore special purpose vehicles (or SPVs). In brief, Wood v Holden is authority for the following propositions:
- that a company's directors exercise central management and control where they meet and decide business
- if the directors are "usurped" i.e. if central management and control of the business is exercised by parties other than the directors, then the usurpation displaces the meeting place of the board of directors as the company residence forum
- if the directors are subject to dictation by third parties such that the directors do not exercise independent consideration of the matters put before them for decision, then the dictating third parties displace the meeting place of the board of directors as the company residence forum
- where third parties advise or influence the directors in their decision-making, central management and control continues to rest with the directors in their board meetings and is located where these meetings are held. This remains the case even if the third-party advisors or influencers obliquely initiate corporate activity by making requests or proposals to the directors, provided that in the course of this process the directors are not usurped or dictated
In Development Securities PLC & Others v HMRC (Her Majesty's Revenue and Customs), the Upper Tribunal has reversed the controversial decision of the Fist-tier Tribunal , on the basis that the First-tier Tribunal ( FTT ) misapplied the law condensed in the propositions outlined above. At first instance, the FTT were clearly at pains to strike down or negate egregious offshore tax planning, but in doing so, they departed from all the UK authorities on this area of the law.
The facts of the case
Three wholly owned Jersey subsidiary companies were incorporated by Development Securities PLC (the parent company) in order to purchase UK property, or assets representing UK property, from various UK companies also in the Development Securities group. At the time of purchase these assets were standing at a loss for capital gains tax purposes.
No indexation relief is allowed on such capital losses, and so the purpose of the Jersey companies was to enter into a scheme whereby the capital losses could be increased by an indexation element.
The scheme required the Jersey companies to buy the property assets at a significant over-value whilst the companies were non-UK resident i.e. centrally managed and controlled in Jersey by Jersey professional directors. Once the assets had been purchased, the residence of the three Jersey companies was simultaneously migrated from Jersey to the UK. The period of Jersey residence of the Jersey companies was transitory. According to the taxpayer, Jersey tax residence commenced on incorporation (10/6/2004) and ended on or shortly after 20/7/2004, when for UK tax mitigation reasons alone, the companies migrated their tax residence to the UK.
To acquire the properties for well above market value, it was necessary that the Jersey companies were financed by the UK parent company, Development Securities PLC. Such funding was by way of share capital and separate capital contribution (i.e. gift).
The boards of the three Jersey companies were comprised of three Jersey resident professional directors, and the secretary of Development Securities Ltd, who was UK resident.
Jersey board meetings
The three Jersey companies each held five board meetings in Jersey between 11 June and 20 July 2004. It was not contended that the meetings did not take place.
At the first board meeting held in Jersey on 11 June 2004, the tax planning scheme was outlined to the Jersey directors by the UK resident director, who attended the board meeting in person. It was envisaged that if the Jersey directors decided to enter into the scheme, the UK parent company would be likely to make a capital contribution and to subscribe for newly issued shares to assist in the purchase of the assets.
On 25 June 2004 the Jersey directors agreed to execute various call options over the UK property assets , having received a resolution from the UK parent company (via its nominee shareholder) approving the transaction and advising the Jersey boards that entering into the transaction was for the benefit of the 3 Jersey companies. This UK parent company approval was coupled with a letter of intent from the parent company, to the effect that it would consider making a capital contribution towards the purchase of the relevant UK property assets, although there was no obligation for it to do so.
A pre-condition for the implementation of the scheme was that the FTSE Real Estate Total Return Index would have to close at 2082 or above for at least five consecutive days in a specified period. Another pre-condition required final approval by the parent company (presumably these measures were designed to prevent the scheme being collapsed under the Ramsay principle: however, the likelihood that the chosen index would close above 2082 on five consecutive days was almost certain).
Further board meetings were than held on 28 June 2004 (to transfer the legal ownership of the Jersey companies' shares to Development Securities PLC, the parent company); on 12 July 2004 in order to exercise the options (the FTSE conditions having been met) and to request the funding from the parent company.
Finally, on 20 July 2004 the Jersey directors resigned, and UK resident directors were appointed. Shortly after the appointment of the UK directors, and when it was considered that the Jersey companies were all UK tax resident, the Jersey companies took steps to sell the property assets, thereby triggering a capital loss including the indexation element built in to the over-value paid by the Jersey companies.
The decision at first instance
The First-tier Tribunal decision that the Jersey companies were always UK resident i.e. centrally managed and controlled in the UK by the UK parent, seems to have been based on the assumption that the Jersey companies were acting contrary to their best interests by entering into a transaction to buy assets at more than their market value i.e. on uncommercial terms. This assumption then led to the conclusion that the Jersey directors had surrendered their discretion.
An obvious flaw in this reasoning was that although the Jersey companies paid over the odds for the assets, they suffered no loss in doing so, because the purchase price was fully funded by the parent company. Moreover, the transaction augmented a capital loss for the clear benefit of the parent company and its group, and therefore indirectly benefitted the Jersey companies as members of the group.
The other flaw in the First-tier Tribunal's finding that the Jersey companies were UK resident from the outset , was that the evidence showed that the Jersey directors were at pains to ensure that what they were agreeing to implement was lawful from a Jersey perspective, and that no stakeholders in the Jersey companies could be prejudiced by the Jersey companies paying over the odds for the property assets ( such stakeholders that the Jersey directors took into account included creditors , and employees). Only once the Jersey directors had satisfied themselves on these points and had also taken specific advice on both Jersey company law and UK taxation on behalf of the Jersey companies, did they feel able to agree to proceed with the transaction. In other words, the facts showed no evidence that the directors had surrendered their discretion or been dictated to. On the contrary they implemented the scheme because they, and they alone, decided to do so, after careful consideration.
This is a good win for the taxpayer, although the actions of Development Securities PLC do not inspire admiration when read today. The decision at first instance seems to have been an example of the maxim "hard cases make bad law". The tax planning undertaken by Development Securities PLC was conceived in 2004 and looks unconscionable today. If such contrived tax planning was implemented in 2019, it is reasonable to suppose it would be struck down by the General Anti-Avoidance Rule (or GAAR). However, HMRC were unable to invoke the GAAR, due to its transitional provisions. The First-tier Tribunal were understandably unhappy with the tax planning, but their efforts to stretch the laws of corporate residence to unravel the taxpayer's scheme has not found favour with the Upper Tribunal.
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The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.