Another Case on Corporate Tax Residence: Why Does It Matter?
Corporate tax residence is an area of enduring enquiry and focus for HM Revenue & Customs (HMRC) in the UK. Development Securities (No.9) vs. HMRC  provides a reminder of the steps that should be taken to ensure that a foreign company does not unintentionally become UK tax resident. As such, the case is relevant to a wide range of transactions and structures, including corporate, private equity, finance, asset management and real estate, among others.
Where Were the Decisions Made?
In Development Securities, three Jersey companies had been incorporated for the purpose of implementing arrangements for crystallizing latent capital losses in certain property assets and, thereby, obtaining capital loss relief in respect of the same. Importantly, the effectiveness of the arrangements relied on the Jersey companies being tax resident in Jersey (and not in the UK) during the relevant period. As non-UK incorporated companies, this required the "central management and control" (CMC) of each subsidiary to be located in Jersey. The CMC test generally looks to where high-level executive decisions are made (including policy and strategy). It was accepted that the only issue in dispute, which fell to be considered by the First Tier Tribunal (FTT), was whether the subsidiaries were, in fact, Jersey tax resident or UK tax resident under the CMC test.
While certain factors were supportive of Jersey tax residence (for example, board meetings comprising experienced, professional directors had been held in Jersey), the FTT found that the UK parent had given instructions to the Jersey directors to make the necessary executive decisions (specifically, approving the capital loss transactions), which were followed. Based on the facts, therefore, the FTT concluded that CMC was located in the UK, and the Jersey subsidiaries were held to be UK tax resident.
Development Securities might be viewed as having been decided on its particular facts (given the tax planning involved), and there will inevitably be discussion among observers (and possibly also in Development Securities, if appealed) about whether or not the case should be distinguished from previous case law on CMC, especially the Court of Appeal decision in Wood vs. Holden (2006). However, the case provides an opportunity to restate some important points in relation to CMC.
What Lessons Can Be Learned?
- In order to support non-UK CMC of a foreign company, the foreign-located board should consider any recommendations made to it by a parent company or other third parties, and it should then exercise its executive authority by making decisions as to whether to act upon or implement any such advice received. In order to mitigate the risk of unintentionally bringing its CMC into the UK, the foreign company should ensure that recommendations from external sources, such as UK-based investment or asset managers, advisers and finance parties, among others, do not grow to the level of board level decision-making on behalf of the foreign company.
- Evidential support for the fact that executive decisions are made outside the UK should be retained. By way of illustration, in Development Securities, the FTT's lengthy judgment included a detailed appraisal of the documentary evidence, while noting that the directors were inevitably unable to recall all of the details of the transactions that took place in 2004. Therefore, the FTT focused on the transaction documents, the timing and content of board meetings (including related minutes and notes, both typed and handwritten), the tax planning paper provided by the group's tax advisers, and relevant correspondence (including certain correspondence between the group and its tax advisers).
- In characterizing the parent-subsidiary relationship, the FTT also focused on certain aspects of the evidence, such as a reference in the subsidiary's board papers to an "instruction" from the parent company to implement the transactions. The FTT felt that the directors did not sufficiently engage in the decision to implement the transactions, especially given what it viewed as the inherently "uncommercial" nature of the transactions from the perspective of the subsidiary (i.e., the purchase of assets at a price above market value, so as to create a latent capital loss). The FTT also attached some weight to the fact that the tax planning involved the Jersey subsidiary relocating its CMC to the UK after around six weeks. Therefore, the FTT concluded overall that at no stage was CMC exercised in Jersey, and instead CMC had always resided in the UK by virtue of parent company control. Importantly, the FTT explicitly stated that it was not criticizing the directors and that they had not acted improperly. In fact, it was noted that the directors were very mindful to ensure that the transaction was lawful (which, according to Jersey corporate law advice they had received, required the parent to confirm that the transaction would benefit the parent).
- With respect to special purpose companies more generally, the FTT acknowledged that it is common for foreign subsidiaries to be established for a specific or limited function that might serve the wider purposes of the group. However, the FTT sought to draw a distinction (which, again, some observers may question) between, say, a group finance company, which might review and respond to proposals put to it by its parent company for the benefit of the group and the Jersey subsidiary in Development Securities, which followed the "order" from its parent company to implement the "single act" for which it was established.
Development Securities is yet another case where the CMC of a non-UK company is closely examined. As the CMC question is highly fact-sensitive, the best answer to an HMRC challenge is usually to be able to demonstrate that executive decisions have been made by a suitably qualified foreign board that exercises CMC, and for the decision making process and outcome to be supported by appropriate documentary evidence.