In England & Wales, the historic starting point for all parties seeking to mitigate their taxes was the House of Lords case of IRC v Duke of Westminster  AC1, in which Lord Tomlin, stated:
“Every man is entitled if he can to arrange his affairs so that the tax attaching under the appropriate Acts is less than it otherwise would be. If he succeeds in ordering them so as to secure that result, then, however unappreciative the Commissioners of Inland Revenue (now HMRC) or his fellow taxpayers may be of his ingenuity, he cannot be compelled to pay an increased tax”
This sanctioning of a ‘cat & mouse’ game between legislators, the courts and tax payers was effectively the position up to and until the 1st of April when the general anti-abuse rule (“GAAR”) was introduced.
The General Anti-Abuse Rule (“GAAR”)
From the 1st of April 2013 GAAR applies to income tax, national insurance contributions, corporation tax, capital gains tax inheritance tax and property stamp duty land tax (SDLT).
THE DECLARED AIM OF GAAR IS SIMPLY TO CREATE A DEFAULT POSITION WHERE-BY ANY DEEMED ‘ABUSIVE’ TAX PLANNING SCHEME CAN BE REVERSED EVEN IF NOT TECHNICALLY IN BREACH OF ANY SPECIFIC LEGISLATION OR HMRC RULES.
At first glance, this would seem to deny anyone the right to ‘arrange’ their affairs in a tax efficient manner and indeed give HMRC the right to impose their perception of what is a reasonable and/or acceptable rate of tax for every individual and company in the UK. However, whilst there is an undoubted ‘moral’ undertone within GAAR, the massively complex UK tax system means that whatever the intention the result is that there will still be many ‘non-abusive’ and highly variable tax rates. Indeed, the GAAR’s guidance notes clarify that “...it is in place in order to impose an overriding statutory limit on the ‘extent’ to which taxpayers can go in trying to reduce their tax bill, being the point beyond which actions could not ‘reasonably be regarded as reasonable”.
In short, what GAAR has done, which is laudable, is attack the aggressive tax planning schemes that professional tax planners and accountants would never have advocated in the first place.
The Continued Primacy of International Law and Treaties
Notwithstanding the introduction of GAAR, it should be noted that the primacy of international law and the tax treaties that the United Kingdom has signed with other countries around the world is still in place and cannot be usurped by domestic legislation such as GAAR. In other words, companies and indeed individuals who have legitimate international business can still plan their affairs in the most non-abusive but tax efficient manner possible. In particular, companies will still be at liberty to use European Union (EU), directives and regulations such as the Parent Subsidiary Directive 90/435 (which prevents withholding tax on dividend distributions from one member state to another), the Interest Directive 49/03 (which prevents withholding tax on loan interest payments from one member state to another) and of course the general double taxation treaties that exist between the UK and virtually every non tax haven jurisdiction in the world. Therefore, in general it is safe to say that provided there are legitimate business (and not simply tax) reasons for establishing a corporate presence abroad, then any tax savings, be they in respect to corporate tax, value added tax (VAT), local salary levels, taxes on dividends, royalties and interest will be valid.
The Importance of International Tax Treaties
In international tax planning and/or international accountancy, a practitioner must have in depth knowledge of international tax treaties, EU directives and regulations and in particular what is required to satisfy that a particular person and/or entity is (or is not) tax resident in a particular country. In such matters, the interpretations, rules and regulations of the Paris based Organization for Economic Co-Operation and Development (The O.E.C.D.) are paramount especially when a tax planner seeks to garner tax treaty provision protection.
Non-Domiciled Tax Benefits Continue
Notwithstanding the restrictions imposed by the Finance Act of 2008 (please see the section on domicile and residence) and subsequent amendments, the UK is still a remarkably attractive location for ‘foreign’ individuals to ordinarily reside for tax purposes. Of course, it could be argued that it is unfair that wealthy foreigners are in effect only taxed on (at worst) their remitted income to the UK for at least the first 7 years of being UK resident but it is this firm’s belief that to compromise these benefits any further would be against the collective interests of the UK and simply drive away the wealthy foreign diasporas, which are so vital to especially the City.
GENERAL ANTI-AVOIDANCE LEGISLATION: To curb the abuse of UK tax legislation, there is a vast array of anti-avoidance legislation. There are also a number of tax cases decided in the courts, which restrict the use of "artificial" schemes. Some of the anti-avoidance measures of particular interest are as follows:
Controlled Foreign Companies (CFCs):
S.747 - 756 & Schedules 24 - 26 of the Taxes Act, 1988
If a foreign company is deemed to be under the control of a UK company and the foreign company pays less than 75% of the tax which a UK company would pay, subject to double taxation treaties, and the UK company owns at least 10% of the foreign company, the Inland Revenue can direct that the UK company pays tax in respect of the foreign profits. However, the revenue will not make this direction if the company’s profits were less than £20,000.00 for 12 months, or it meets certain other criteria such as it has an acceptable distribution policy, or was engaged in exempt activities or it satisfies the “Motive” Test. In respect to the latter, it should be noted that bona fide investments made in fiscally beneficial jurisdictions, such as the Republic of Ireland or Portugal (especially Madeira), are very unlikely to be subject to this legislation. In addition, it should be remembered that certain other jurisdictions, such as Malta, can be subject to very similar taxation but nevertheless on distribution of dividends, benefit from very significant rebates. Therefore, provided one is careful to choose a “respectable” jurisdiction protected by treaties the CFC legislation should not apply
Sales at "Over" or "Undervalue"
S.770 - 773 of the Taxes Act, 1988
This is designed to catch transfer pricing between connected persons in the UK and overseas. For example, "X" a resident company makes a sale of goods for £50,000.00 to company "Z" in Cyprus. Companies "X" and "Z" are under common control and the true market value of the goods was £100,000.00. When calculating the tax liability of "X" the Inland Revenue may if known substitute the market value of £100,000.00 and thereby increasing the taxable profit by £50,000.00
Transfer of Assets Overseas
S.739 & S.740 of the Taxes Act, 1988
An individual who is ordinarily resident in the UK is prevented from avoiding income tax by transferring assets to non-UK residents. However, exemption is available from these provisions if the individual can demonstrate that the assets transferred and any associated operations were for bona fide commercial reasons and were not for the purpose of avoiding tax
Investment in the UK
Non-UK residents investing in the UK may wish to consider doing so through a non-resident UK company, i.e. a foreign company not legally deemed to have a permanent establishment, because of the inheritance tax implications. Such a company is not liable to capital gains tax on investments unless they are assets of a UK business. It is therefore essential to demonstrate that the company is not managed and controlled in the UK. There is one circumstance where a capital gain could arise (See S.13 taxation of Chargeable Gains Act, 1992). This allows a gain to be apportioned to a shareholder who is resident and ordinarily resident and domiciled in the UK. However, this could only arise if the non-resident company would come under the definition of a 'close' company if it was resident in the UK. The definition of a UK resident 'close' company being afforded by S.414 of the Taxes Act, 1988 - In simple terms, it is basically a company where the tax circumstances of the shareholders will or could influence the dividend distribution policy of the company. Therefore, companies with few shareholders (normally, though not necessarily, less than 5), some possibly holding company directorships in the undertaking, could find themselves unable to avoid capital gains tax.
Management & Control
There are a number of tax cases which are relevant (De Beers Consolidated Mines v. Howe, Bullock v. The Unit Construction Company, Noble (BW) v. Mitchell and the American Thread Company v. Joyce). Broadly, the central management and control is situated where a company is actually operated from i.e., where board and operational decisions are really made. It is not necessarily sufficient to assume that central management and control is where the directors hold board meetings. It is possible that hoard meetings are used to formalize decisions already made elsewhere and even by other individuals. Very often the directors do not actually exercise control. The Inland Revenue now looks very carefully at non-resident companies, particularly those established in known tax havens and at where decisions are made and how the company is operated. It is for this reason that professionally qualified tax advisers in the United Kingdom, and most other European countries, emphasize the need for genuine management and control. For active companies it is rarely sufficient that the 'real' owners do not have some physical and ongoing presence in the claimed place of management and control.
As in most developed countries, the fiscal authorities in the United Kingdom are aware of all the common, and in particular tax haven anti-avoidance and evasion schemes. In addition, the almost ubiquitous reverse burden of proof enjoyed by the Inland Revenue make it inadvisable not to try and secure a degree of confidentiality so as not to raise the proverbial 'red flag’. In no circumstance should the power and influence of the HMRC be under-estimated. Remember without tax revenue, no government can operate and for this reason tax enforcement legislation can often be more draconian than for many serious criminal offences. Thus, the objective of all tax mitigators should be to use but never break the law. In fact, in the UK there are so many tax advantages that few, especially non-domiciled, individuals cannot be helped. Some of the main powers enjoyed by the HMRC include:
Under the Finance Act 1976, the Inland Revenue has the ability, where reasonable suspicion exists, to search a private home or business premises without warning. Banks in the UK must declare particulars relating to interest payments made to an individual’s account. This provision normally only is used against non-employees. The Inland Revenue has the legal ability to pay third parties for information relating to tax matters. Other government divisions, such as Customs & Excise, often share information. Virtually all British tax treaties have exchange of information clauses. The HMRC will often examine estate agent and stockbroker records to try and identify potential tax avoiding/mitigating activities
The Operation of HMRC Inspectors
Inland Revenue Inspectors are instructed to collect as much tax as possible and therefore it should be noted that legitimate tax planning schemes are far less likely to be pursued, all things being equal, than their less legitimate counter-parts - The latter being far more likely to bear fruit. This pragmatism is further witnessed by the reluctance, even when there is proof of malfeasance, to pursue those without a known ongoing connection with the UK where UK assets no longer exist. In the case of company accounts, Inland Revenue Inspectors will examine about 3-4% of all submitted accounts each year. The aforementioned decision being based on a grading system; "A" for accepted, "R" for review and ME" for Examine. In general terms, a company's accounts will be reviewed if there exist large profits whilst examinations normally occur when:
Profits are low for the business sector, and/or; directors’ salaries appear artificially low and/or, large expenses exist in relation to profits and/or, dividend distributions are very high or low1 and/or, foreign goods and/or services are purchased when there exist similar goods and/or services available in the UK.
The UK Double Taxation Treaty Network
The United Kingdom has one of the World’s most extensive and sophisticated double taxation treaty networks with virtually every internationally recognised country. For an up to date list of current UK double taxation treaty networks please go to HMRC’s official website at http://www.hmrc.gov.uk/taxtreaties/in-force/index.htm
For more information on the UK Tax System please contact one of our tax planning consultants.