The case of Development Securities (No. 9) Ltd and other v HMRC  UKFTT 0565 is the latest in a line of cases concerning the UK corporate tax residence of offshore companies. The case once again highlights the difficulties in preserving an offshore company's non-UK tax resident status, whilst giving a useful insight into the factors and evidence that HRMC will examine when considering whether the decisions of an offshore company are, in fact, being taken from the UK.
Companies that are UK tax resident are subject to UK corporation tax on their worldwide profits, regardless of where they arise. A company will be UK tax resident if it is incorporated in the UK or if it is centrally managed and controlled from the UK. This latter test evolved from a line of cases on corporate residence spanning the past 100 years, starting with De Beers Consolidated Mines v Howe  AC 445. In De Beers, it was held that a company is resident 'where its real business is carried on…and its real business is carried on where its central management and control actually abides'. De Beers and subsequent cases made it clear that where central management and control resides is a question of fact in each case. For example, in Unit Construction Co Ltd v Bullock  38 TC 712, a South African company's articles of association made it unconstitutional for any company decisions to be taken from the UK. The reality, however, was that all decisions were being taken by the parent company in the UK, and the provisions in the subsidiary's articles were not sufficient to prevent the company from becoming UK tax resident under the central management and control test.
HMRC's Statement of Practice 1/90 sets out HMRC's view on assessing central management and control. Broadly speaking, they will look to the highest level of control, which will typically be the board of directors (though it is possible for control to rest in the hands of a single person) and determine where decisions are taken. If the directors are not responsible for decision-making, HMRC will seek to establish who does exercise central management and control, and where. Furthermore, HMRC has stated that it will examine closely cases where a 'major objective' of the underlying arrangement is to obtain tax benefits, and there is an attempt to create the appearance of central management and control without the reality. Therefore, in such cases, HMRC will look to substance of the arrangements rather than mere form.
Where an outside party is found to be influencing the board, HMRC will assess the level of influence to determine whether the board is truly in control. The case of Wood v Holden  STC 443 made the distinction between a person involved in "proposing, advising and influencing" the decisions of the company and a person "who dictates the decisions which are to be taken". Where it is found that the latter exists, the board will have been usurped and the central management and control of the company will be wherever that person is resident.
In Development Securities, tax advisers for a UK plc (a property development group) devised a plan to use certain latent capital losses on assets held within the group to reduce the tax on the potential capital gains that the group anticipated it would make in that accounting period. The plan involved selling assets to newly incorporated Jersey subsidiaries for a price in excess of their market value. Directors of the subsidiaries would be Jersey-based, and all board meetings would take place in Jersey. No tax charge would arise on the disposal of the assets for the UK plc, and the UK plc would fund the purchase by way of capital contribution/subscription for shares. Later, the Jersey subsidiaries would become UK tax resident, with the assets standing at a larger loss, thereby providing an intended saving of approximately £8 million.
Under Jersey law, the decision for the subsidiaries to enter into the transaction required shareholder approval i.e. approval from the UK plc, which the tax advisers appreciated could give rise to UK central management and control issues. The advisers were confident that HMRC would "almost certainly" enquire into the returns of the companies involved with the plan, so the implementation was executed "meticulously" in an attempt to avoid any suggestions that central management and control had left Jersey.
Despite the careful execution of the plan, HMRC did make the forewarned enquiries, ultimately assessing the Jersey subsidiaries as being centrally managed and controlled from the UK. The UK plc appealed to the first-tier tax tribunal.
The tribunal concluded that central management and control was located in the UK, and as such, the Jersey subsidiaries were UK resident companies. In its 127 page decision, the tribunal focused on the following "unusual" features:
- The acquisition of the assets at an overvalue by the Jersey subsidiaries was inherently uncommercial; the Jersey directors produced no evidence that they had considered the merits of entering into the agreements to acquire the assets from the UK plc;
- The strategic decisions of the Jersey companies i.e. to acquire the assets and then move the control of the Jersey companies back to the UK, were taken in the UK. The tribunal found that these decisions were decided by the UK plc immediately before the incorporation of the Jersey companies; and
- The Jersey directors were following the UK parent's instructions, which meant the UK plc was doing far more than "proposing, advising and influencing" the decision. The tribunal held that the Jersey directors were "simply administering a decision they were instructed to undertake". In making this assessment, the tribunal conducted a thorough examination of the contemporaneous documents and correspondence detailing the transactions, and scrutinised the differences between the final board minutes and the handwritten notes of an employee present at the board meetings. It held that the language used in the notes suggested that it was inevitable that the plan was to be implemented by the subsidiaries, with the directors failing to apply their minds to the commerciality and merits of the decision to implement the plan.
The real business of the subsidiaries was therefore not property investment, but of implementing the plan formulated by the UK plc for the purposes of maximising tax losses.
Although the tribunal confirmed the continued relevance of the De Beers test i.e. that a company is resident where its central management and control abides, it extended the test so that where central management and control abides is determined on a "scrutiny of the course of the business… informed by what had taken place immediately prior to incorporation" i.e. the tax planning arrangements of the UK plc. This aspect of the test has not featured in previous cases on corporate residence, yet featured heavily in the tribunal's decision in agreeing with HMRC. Commentators have been quick to point this out as the basis of a potential appeal.
Whilst we anticipate an appeal, Development Securities sets out a number of important points for taxpayers and advisers which should be considered when seeking to mitigate the risk of a future residence challenge from HMRC. Of course, it is not uncommon for a subsidiary to receive guidance from its parent in making commercial decisions, and the fact a subsidiary does so should not mean that the subsidiary has relinquished its autonomy in making decisions. In these situations, it is more important than ever that all strategic and commercial decisions of the subsidiary are properly considered by the board, including an assessment of merits and benefits for the company and/or the wider group. Accurate contemporaneous board minutes must be produced to evidence these considerations (especially if there is a risk that the decision could disadvantage the company). Finally, it seems that HMRC will now examine the entire course of a business when assessing where central management and control resides, including periods prior to the company's incorporation. This may be problematic for offshore companies set up for one-off purposes, though it is unlikely to be an issue for offshore companies established to serve a single, yet long-term, function for a group.
In an environment which is seeing increasing numbers of challenges from HMRC on tax residence, groups with offshore entities keen to preserve their non-UK resident status should be encouraged to review their current arrangements in light of the points raised in Development Securities.
The article first appeared in our Real Estate Bulletin - Janaury 2018.