HMRC has published draft legislation for consultation aimed at ensuring that persons (whether companies or individuals) cannot benefit from double taxation agreements (DTA) entered into by the UK where the claim to benefit is part of a scheme, one of the main purposes of which is to reduce liability to UK taxation. The legislation is split into two - the first part dealing with UK residents (likely principally to be individuals) who seek to, for example, become treaty non-UK resident for a short period in order to avoid UK tax on income/gains realised - and the second part dealing with the more typical treaty-shopping arrangements whereby non-UK residents seek to access the benefits of a treaty between the UK and a third country. It is the latter which is more interesting and potentially more consequential as it applies to UK source income in the form of dividends, interest and royalties. In particular, the ability to avoid UK withholding tax on interest paid to treaty resident vehicles (typically SPVs in Luxembourg) will need careful scrutiny if the legislation is enacted as proposed.
A number of problems are immediately evident. First, the avoidance conditions are very widely drafted, so will apply to any scheme where the main purpose or one of the main purposes of any of the persons putting the scheme in place is to ensure that the DTA provision applies to the income (although as currently drafted it is not entirely clear that the person whose purpose is relevant has to be one who puts in place a scheme). "Scheme" is widely defined to mean any scheme, arrangement or understanding of any kind whatever including one that is not or not intended to be legally enforceable.
Second, the legislation is intended to apply to UK income arising after commencement, regardless of when the scheme was put in place. Not only is there no grandfathering of existing arrangements, but there is contemplated the unusual prospect that a scheme could be put into place to benefit from a DTA that at that time had not been entered into. Ascertaining the purposes of a person putting in place a scheme in such circumstances could be interesting.
Third, in practical terms in the context of loan financing, market practice has become comfortable with HMRC's guidance on Indofoods and its application to loans to UK borrowers by treaty vehicles (see our April 2011 newsletter), particularly where the treaty vehicle was itself financed by a loan that constituted a quoted Eurobond. One expects that this legislation will mean HMRC's guidance in this area is effectively overridden. Ashurst will accordingly be making representations to HMRC on the draft legislation so as to clarify the potential impact on debt funds, CDOs and on borrowers under vanilla LMA facility agreements who could potentially face substantial gross-up costs in relation to existing loans.
Comments on the draft legislation are required to be made by 22 September. One has the sense that there is a risk we could be heading down a similar road to the disguised remuneration legislation where a lack of clarity over the precise policy aims led to multiple carve-outs and much HMRC guidance being needed.
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