.png)
.png)
MATTHEW HUTTON MA (Oxon), FTII, AIIT, TEP reports an IBC conference 'HINWIs 2002 - Essential Onshore and Offshore Tax Advice for Private Clients and their Advisers' which took place in London on 28 May 2002.
Sections 739 and 740: no remittance basis?
MATTHEW HUTTON MA (Oxon), FTII, AIIT, TEP reports an IBC conference 'HINWIs 2002 - Essential Onshore and Offshore Tax Advice for Private Clients and their Advisers' which took place in London on 28 May 2002.
Sections 739 and 740: no remittance basis?
Patrick Way put forward an interesting idea produced by Michael Flesch QC based on the proposition that the remittance rule applicable to section 739, Taxes Act 1988 operates in its own restrictive manner. Assume in a section 739 situation that a person sets up an overseas company which owns overseas land and therefore receives overseas rent. There is no United Kingdom tax charge on the receipt of rents given the rule which is in section 743(3). Assume that in a year after receipt of the rent the company is liquidated and the land and the monies comprising the rental income are distributed to the shareholder in the liquidation and he remits the money to the United Kingdom. The argument is that there is no United Kingdom tax liability. The position falls to be tested at the time of the receipt of the rent by the overseas company and there is nothing in section 739 or section 743(3) which says that a subsequent remittance of that income can affect the situation. In other words, the income has already been received abroad and that is the end of the matter.
Compare the position with section 660G(4), Taxes Act 1988 which was introduced in 1995 in relation to settlements (and note that in the above example the individual owns the shares direct and not via a settlement). The effect of the final paragraph of new section 660G(4) is that a subsequent remittance of the non-United Kingdom source settlement income will in principle trigger a liability to income tax, but there is nothing to mirror this in relation to section 739.
While the above conclusion on the non-remittance aspects of section 739 does not depend on the source closing rules, those can offer a further defence.
The final point is that the Inland Revenue is unlikely to agree with the above analysis!
A similar argument could apply in relation to section 740(5) where the individual is not the settlor. Here the argument is based upon the proposition that a benefit already received abroad in tax-free circumstances cannot be received again on remittance: receipt happens only once.
The judicial approach(es) to tax avoidance schemes
John Walters QC identified three distinct current judicial approaches. These are, in increasing order of present importance (though the balance may of course shift in future), as follows:
'Abus de droit' (Abuse of right)
This is a European concept, very much in the early days in the courts of this country. It was raised by Customs and Excise as an alternative argument in three recent VAT cases (Halifax, BUPA and WHA), though only in the BUPA case (see Taxation, 9 May 2002 at pages 150 to 153) was it considered at any length by the tribunal. The tribunal said, in effect, that there were no Community (as opposed to national) rights which the taxpayer had abused in claiming an input tax deduction. However, the right to a deduction of input tax is, in origin at least, a Community right and it is possible that the tribunal's response will not last very long. The Halifax case has been referred to the European Court of Justice, where the concept of abus de droit is likely to receive authoritative exposition in the context of VAT.
The Halifax no supply argument
In finding for Customs and Excise, in what was admittedly a VAT avoidance driven structure, the tribunal said that a transaction which was purely tax driven could not be a supply for VAT purposes. This was on the grounds that there was no commercial or business purpose at all, despite the important finding of fact that the transactions themselves were not shams.
The Ramsay 'approach'
In the Westmoreland case [2001] STC 237 the House of Lords' approach was designed to prevent Lord Brightman's formulation of Ramsay in Furniss v Dawson petrifying into a rule of law. Hence Lord Nicholls in Westmoreland referred to the 'Ramsay approach' rather than the 'Ramsay principle'. Lord Hoffmann made the distinction between words or phrases which were 'commercial concepts' (to which the Ramsay principle could apply) on the one hand and 'legally defined concepts' (when the business purpose was irrelevant) on the other. The difficulty is how this distinction is applied in practice. Indeed we have had a recent example: in the Westmoreland case, the word 'payment', in the context of charges on income, was held to connote a legal concept, whereas in DTE Financial Services v Wilson (a PAYE avoidance case - see [2001] STC 777) the word 'payment' was found to refer to a commercial concept. While Westmoreland is a key pointer to the approach taken by the present House of Lords, it is clear that different judges will adopt different approaches to tax avoidance.
Taper relief and personal representatives
Emma Chamberlain pointed to a significant difference in relation to qualification for business assets taper as between trustees and personal representatives. For the latter, the company must be a trading company and either unlisted or, if listed, the personal representatives have 5 per cent or more of the voting rights. In other words there is no extension to personal representative holdings of the case where the legatee is an employee of the company (as there is for trustees where an 'eligible beneficiary' is an employee): compare subparagraph 6(3) with subparagraph 6(2) of Schedule A1 to the Taxation of Chargeable Gains Act 1992.
While this point may not be an immediate problem for personal representatives, it could well present a difficulty for the legatee later on, if the initial holding period within the administration of the estate does not attract business assets taper. When the personal representatives assent the shares to the legatee, he is treated as though he had acquired the shares at the date of death at their then market value, thus extending his qualifying holding period. However, if, when he actually becomes the legal owner of the shares, the personal representatives would not have qualified for business assets taper in their own right if they had disposed of the asset, their period of ownership cannot increase the amount of business assets taper on a later disposal by the legatee. Therefore if an asset does not attract business assets taper in the hands of personal representatives but would so attract relief in the hands of the legatee, the personal representatives should consider transferring the assets to the beneficiary at the earliest opportunity. The classic case here is shares in a listed company (carrying less than 5 per cent of the voting rights) in which the legatee is an employee.
Employee benefit trusts: company loans
Andrew Thornhill QC suggested that the company might make a non-recourse loan to an employee benefit trust. The trust uses the loan to acquire shares in the employer company and appoints those shares to an employee absolutely 'subject to and charged with a portion of the loan'. The economic effect is the same as an option, though far preferable to an option. The anti-avoidance provisions of section 160, Taxes Act 1988 will not apply (the employee has not got a loan), nor will section 162 (all the employee gets is an equitable interest in shares worth just what he has paid, viz £1), nor indeed section 140A (the shares that are not conditional). As to section 78, Finance Act 1978, even if there is a cessation of a restriction on repayment, this does not increase the value of the shares. Finally, business assets taper will be available.
Employee benefit trusts: accounting principles
Important developments in accounting practices have culminated in new Urgent Issue Tax Force release 32, the essential principle of which is that making payments to an intermediary to satisfy future business liabilities is akin to a pre-payment. Assets of an employee benefit trust will therefore appear as fixed assets of the employer until they are vested in an employee or employees. There is a rebuttable presumption that a payment to an intermediary does result in an asset. The question arises: how can assets of the trust be assets of the company for tax purposes? The answer is that profits for tax purposes are computed on accountancy principles of which Urgent Issue Tax Force release 32 is one.
Andrew Thornhill QC advised that to get a deduction one must be able to show that the asset in the employee benefit trust is not a resource of the company: it must be possible (and there should be arm's length trustees) to distinguish the trust from the company.
Several situations can be identified:
Profit sharing
The employer promises his employees (on a non-binding basis) that he will contribute a proportion of the current year's profits to the trust, to be shared out among this year's employees. The promise creates a constructive liability (see Financial Reporting Standard 12) which will be shown properly as a deduction. The payments are not an asset of the employer because they cannot benefit future employees for future work. The assets are vested in the sense that they must be distributed.
Fund for current employees
In the current year, the employer makes a non-binding promise to create a fund to benefit this year's employees (possibly for future work) and the trustees of the existing trust use the funds to create the promised fund. Again, there is a constructive liability, the assets in the trust have vested and are no longer a resource of the company. A deduction is given.
Long term award scheme
The employer creates a long-term incentive award scheme paying out in, say, ten years' time on an increasing basis if performance targets are met. The analysis here is interesting. Under UITF 32, payments into an employee benefit trust which is funding the awards will be treated as assets of the employer which the company must accept. However, year by year there is a corresponding liability which grows each year and should achieve a deduction.
In conclusion Andrew Thornhill QC thought that Urgent Issue Tax Force release 32 does not represent a real threat to deductibility and is generally helpful to taxpayers.
Offshore structures to hold United Kingdom house
Patrick Way considered that, following the House of Lords' decision in R v Dimsey [2001] STC 1250; R v Allen [2001] STC 1537, the traditional structure of an excluded property trust owning shares in a foreign company which owned a house was dangerous in the context of the employee benefits exposure under sections 145 and 146, Taxes Act 1988. He advised that the standard structure should be terminated. It may be possible to do so by arranging for the offshore company to sell the property to the trust and to leave the consideration outstanding by way of debt (which in certain circumstances could reduce the value of the individual's chargeable estate for inheritance tax purposes). There can be no Schedule E charge if the house is owned by the trust.
Second, the company could grant a lease to the trustees for a short period of time. The trustees would allow the individual to occupy the property pursuant to the rights of the trustees as lessees. Patrick Way does not consider that such an arrangement would produce a section 145 or 146 benefit.
Third, given a future acquisition of the property in the individual's own name, he could take out a policy of term assurance written in trust to cover the inheritance tax risk of his dying while residing in the United Kingdom.
Fourth, the individual could borrow in the United Kingdom, so that under sections 5 and 162, Inheritance Tax Act 1984 the loan at the date of his death would be deducted from his United Kingdom situs assets. While a foreign loan could also be taken out, this would have to be charged on the United Kingdom situated property.
Assuming that the United Kingdom property had already been acquired, a fresh loan could be taken out and charged on the asset to reduce its value. The loan proceeds would then be invested in excluded property which would fall outside the individual's estate. On taking out a loan, it is essential to avoid having to withhold lower rate income tax for interest paid on borrowings from an overseas lender, which will be the case where the loan has a United Kingdom source (see Inland Revenue Tax Bulletin, November 1993).
Employee benefit trusts
Andrew Thornhill QC extolled the use of employee benefit trusts, in principle at least, in setting up and running share schemes as being extremely tax efficient in providing rewards and incentives to employees.
That said, he sounded a note of warning for people who tried to take the advantages of such trusts too far, as a result of which they had been attacked by the Revenue, in the main by challenges to the deductibility of contributions by the company. On the matter of deductibility, it has been established by several cases (including Heather v PE Consulting 48 TC 693), that contributions to the trust are deductible even where it is going to acquire and retain shares in the employing company.
Further, to satisfy the 'wholly and exclusively' condition, it must be clear that the object of the company's expenditure is to benefit the employees not (as happened in Mawsley Machinery v Robinson [1998] STC (SCD) 236) to benefit the shareholders by providing a market for their shares.
Domicile - different province trap
Patrick Way emphasised the importance of remembering that with certain countries (e.g. the United States of America, Canada and Australia), a person is domiciled not in the country as a whole but in a particular province. Consider a person who has a domicile of origin in one Canadian province and comes to the United Kingdom for a period of years before returning to a different province. He might unintentionally find himself acquiring an independent United Kingdom domicile of choice.
Taper relief and loan notes
Assume that a taxpayer has sold his shares in his family's trading company in consideration for loan notes issued by a listed purchaser. The sale took place before 6 April 2002 and, to ensure continuing taper, it was important to ensure that the loan notes were non-qualifying corporate bonds. (For disposals on or after April 2002, it may well be advantageous by contrast to receive qualifying corporate bonds which will effectively crystallise taper relief at ideally the maximum 75 per cent to be given on redemption of the loan notes, i.e. intervening events following the exchange have no effect on business assets taper.)
One possible problem discussed by Emma Chamberlain is presented by the provisions of paragraph 10 of Schedule A1 to the Taxation of Chargeable Gains Act 1992: where, for part of the period during which an asset is held its owner is not exposed to any substantial extent to fluctuations in value, the period of limited exposure does not count towards the ownership period for taper purposes. The taxpayer will want loan notes to be guaranteed: will this cause a problem? The Revenue has said that paragraph 10 will not be invoked even where there are guaranteed loan notes 'provided they are issued as part of normal commercial arrangements and not to exploit the operation of taper relief'.
The difficulty is the wide wording of paragraph 10 and Emma Chamberlain has seen the Revenue take the paragraph 10 point in certain circumstances. 'Limited exposure' means that the individual is not at risk if the value of the asset goes down and cannot benefit if the value goes up. Perhaps the ambit of paragraph 10 could be avoided by making the loan notes marketable in some way and by giving the taxpayer the prospect of gain (even if he cannot lose).
Post-Melville clause 116 of the Finance Bill 2002
Clause 116 of the Finance Bill is precisely targeted at the scheme adopted in Melville v Commissioners of Inland Revenue [2001] STC 1297 and does not affect other similar arrangements.
Consider a trust, suggested Andrew Thornhill QC, with a discretion over income for one year followed by a reversion to the settlor (Trust 1). Hold-over relief under section 260, Taxation of Chargeable Gains Act 1992 is available on putting assets into the trust. The settlor could simply give away his reversionary interest to a separate life interest or accumulation and maintenance trust (Trust 2), from which he is excluded from benefit. Again hold-over under section 260 would be available on the assets leaving Trust 1 entering Trust 2.
There is also an interesting unintended result of clause 116. The death-bed scheme (see Taxation, 31 January 2002 at page 412), whereby a person acquires for value an interest in an excluded property settlement, may well now be effectively stopped, because such a purchase of a 'settlement power' is made a transfer of value!
Foreign situs assets - loan notes and shares
In the context of maximising non-United Kingdom situs assets for a non-United Kingdom domiciled individual, Patrick Way considered the advantages of loan notes. A loan note is situated where the company's loan register exists. If the loan notes are in a United Kingdom company, the individual could request the company to move its loan note register to outside the United Kingdom. Once this has happened, he could then redeem or dispose of the loan notes: provided that the proceeds are received outside the United Kingdom (and he remains non-United Kingdom domiciled), no capital gains tax liability will arise until such time (if ever) as there is a remittance of the proceeds.
Annual capital gains tax exemption for trusts
Beware the rule under Schedule 1 to the Taxation of Chargeable Gains Act 1992 that the annual exemption for trusts will be cut down where the settlor has made more than one 'qualifying settlement' since 6 June 1978. Emma Chamberlain warned that an offshore trust which had been brought back to the United Kingdom following Finance Act 1998 will be such a qualifying settlement (even if settlor-interested). This is a point to be remembered for compliance purposes.
Homes for non-domiciliaries
Michael Hayes produced the following idea for consideration (subject, however, to extreme caution). An individual would form a trust which incorporates Newco as an offshore company. The individual contracts personally with the vendor to buy the property. He then contracts with Newco to assign the property to Newco and to pay the full costs of purchase, on condition that Newco grants him and his family the right to occupy the property rent-free for as long as they wish, subject to payment of outgoings.
The argument is that there is no benefits liability under section 146, Taxes Act 1988, since the benefit was not provided by Newco (the company having no choice). Even if this argument were wrong, Newco would have incurred no expenditure in acquiring the property and there is therefore no figure on which a section 146 liability can be based.
As with all post-Dimsey planning, corporate vehicles should be employed for home ownership only when absolutely necessary. The structure proposed above was used in circumstances where a leasehold interest was being purchased, the freeholder insisting on corporate ownership so as to preclude the possibility of leasehold enfranchisement.
New Ingram arrangements
The 1998 decision by the House of Lords in Ingram v Commissioners of Inland Revenue [1999] STC 37 confirmed the effectiveness, under English law, of leases to a nominee. Mark Herbert QC suggested a neo-Ingram arrangement which would not be affected by the Finance Act 1999 anti-avoidance rules. Assume that a residential property is already held in a settlement or will trust with an interest in possession subject to a wide power of appointment. The trustees could grant a rent-free lease of the property to a nominee for themselves (effectively dividing the freehold from the leasehold interest), before appointing the reversion on interest in possession or accumulation and maintenance trusts for the intended donees. There is a capital gains tax advantage over the traditional lease carve-out (where there is a problem with the appreciating freehold reversion), because the whole combined interest is a single trust asset, thus potentially attracting the exemption under section 225, Taxation of Chargeable Gains Act 1992.
If the property is not already held in trust, the creation of a new settlement might be attacked as a gift with reservation of benefit. However, this could be solved by including an initial interest in possession for the settlor's spouse on the basis of the Special Commissioners' decision in Essex v Commissioners of Inland Revenue [2002] STC (SCD) 39, subject to appeal. Might it be attacked as a disposition by associated operations within section 268, Inheritance Tax Act 1984? (See Rysaffe Trustee Co (CI) Ltd v Commissioners of Inland Revenue [2002] STC 872 which may now lead to some optimism on the last point.)
