It’s fair to say that the UK tax base has come in for something of a battering recently. Recent media spotlight has focused on the low rates of UK tax paid by multinationals on UK sales and on tax avoidance through offshore structures. The UK has a number of tax regimes which seek to deter UK residents from sheltering profits offshore but these have proved increasingly difficult to reconcile with the EU fundamental freedoms of establishment and movement of capital. The CFC rules have been comprehensively revamped, partly in response to EU concerns, and the European Commission has also requested the UK to amend its provisions dealing with transfer of assets abroad, attribution of capital gains of non-UK companies and the corporate exit charge. The draft Finance Bill legislation published this month contains clauses which seek to bring these regimes into compliance with EU law. 

Attribution of capital gains to members of non-resident companies

Section 13 Taxation of Chargeable Gains Act 1992 is an anti-avoidance provision designed to prevent UK residents avoiding tax on capital gains by sheltering them in closely-held overseas companies.  The section operates by attributing the gains realised by the overseas company to UK resident participators in proportion to their interests in the company and charging them to tax on the gains even though they may not receive any income or proceeds from their shares in the company to fund the tax liability. There is a limited credit for the section 13 tax against tax liability on subsequent dividends or liquidation proceeds from the company in the following three years; otherwise the section 13 tax can only be treated as a deduction from the proceeds of sale. At best therefore section 13 accelerates payment of capital gains tax; at worst it results in additional tax over and above what is payable on the UK resident’s actual returns from the investment.

While the section was intended to prevent individuals setting up offshore vehicles to hold assets which they would otherwise have held directly, the section currently has much wider application and potentially applies to any closely held non-UK resident investment company, even if its non-UK investments are commercially driven and not motivated by tax avoidance.  Several of the UK’s double tax treaties protect against this section 13 charge, but in the absence of treaty protection section 13 can operate harshly and discourage foreign investment. Not surprisingly, the European Commission concluded that section 13 was a disproportionate infringement of the EU freedom of establishment and free movement of capital.  The amendments now proposed are designed to bring section 13 into conformity with EU law. The main changes are as follows:

  • Introduction of a new exemption which excludes gains from “economically significant” activity carried on outside the UK, broadly the provisions of goods or services on a commercial basis involving the use of staff, premises, equipment and addition of economic value commensurate with the size and nature of those activities.
  • A general motive exemption for gains on disposals where neither the disposal of the asset nor the acquisition or holding of the asset by the non-UK company formed part of a scheme or arrangements to avoid capital gains tax or corporation tax. This exemption is not restricted to trading companies so should protect investment holding companies set up for reasons other than UK tax avoidance, for example a local company set up to acquire foreign real estate.
  • The participation threshold for attribution of gains will be increased from over 10% to over 25%. This will be welcomed but will not assist those investing through partnerships if partners continue to be regarded as associated with each other and aggregated together for the purpose of this threshold. This concern was noted in the Response Document and will be considered further.

The changes will take effect from Royal Assent to Finance Bill 2013 but with retrospective effect from 6 April 2012. It remains to be seen whether the new exemptions will be wide enough to satisfy the European Commission.  The Government has indicated that it is open to further suggestions provided they do not undermine the effectiveness of these anti-avoidance provisions.

Transfer of assets abroad

The transfer of assets abroad provisions are designed to prevent individuals using overseas structures to shelter income from UK tax. They are broadly the income equivalent of the section 13 capital gains attribution provisions.  The legislation applies where there has been a transfer of assets (which is very broadly defined) and as a result of that transfer (and any associated operations) income becomes payable to a non-UK resident person but the UK transferor can still enjoy the income or a UK individual receives the benefit of it in capital form.  An example would be an individual who subscribes for shares in an offshore company, arranges for that company to acquire an income-producing asset and accumulate the income from that asset so that the individual can sell his shares in the company realising a capital gain instead of receiving the income.

The legislation charges the UK individual to tax on the income received by the non-resident.  There is a general motive exemption which prevents liability arising in circumstances where the transactions were not motivated by tax avoidance or were commercial transactions only incidentally motivated by tax avoidance, but the exemption is relatively narrow and the European Commission have argued that the provisions breach the EU freedoms of establishment and movement of capital.

The draft legislation seeks to bring the legislation into compliance with EU law and also to provide clarity in some areas of practical application of the provisions.  The main changes are as follows:

  • A new exemption for situations where the imposition of UK tax liability would constitute an unjustified and disproportionate restriction of the individual’s freedom of establishment or movement of capital in EU law. The exemption is restricted to genuine commercial business activities overseas and also transactions which do not involve commercial activities but are nevertheless genuine transactions protected by the single market.  Business transactions will not be regarded as “genuine” unless they are on arm’s length terms and give rise to income attributable to economically significant activity that takes place overseas. “Brass plate” companies would not be regarded as economically significant for this purpose.
  • It will be made clearer that double tax agreements do not override these provisions.
  • Other changes will clarify the way in which income is matched with benefits received by an individual in circumstances where an individual other than the original transferor is the chargeable person.
  • The double charging provisions will be clarified to ensure that the same income is not taxed  both under the transfer of assets provisions and also other tax provisions.
  • Companies incorporated outside the UK but resident in the UK will no longer be treated as offshore persons for the purposes of this regime.  This was an anomaly of the current provisions.

These changes take effect from Royal Assent to Finance Bill 2013 but with retrospective effect from 6 April 2012. The new exemption is clearly broader than the existing commercial transactions exemption as it applies even where transactions are motivated by tax avoidance, provided they are genuine.  However it is not yet clear whether the new exemption, restricted to commercial or genuine transactions, will go quite far enough to satisfy the European Commission; the ECJ has previously indicated that only arrangements which are wholly artificial can be counteracted.

The corporate exit charge

Following recent ECJ decisions, the European Commission requested the UK to amend its exit charge for companies moving their tax residence outside the UK. The current provisions deem an emigrating company to dispose of, and immediately reacquire, its assets at market value at the time it ceases to be UK resident. This gives rise to liability to corporation tax on the accrued gains, but because there is no actual sale, the exit charge can cause cashflow problems, which the ECJ regards as a restriction on EU freedom of establishment.  The ECJ does not regard the quantum of the exit charge as disproportionate, as the UK only charges corporation tax on gains accruing during the period of UK residence, but it requires payment to be deferred, ideally until  the subsequent realisation of the assets. The UK legislation already contains provisions for deferral but they are relatively restrictive.

The draft legislation will apply where a company incorporated in the UK or another EEA state moves its place of residence from the UK to another EEA state and carries on business there. The company will be able to enter into one of the following exit charge payment plans:

  • The standard instalment method, broadly payment of the tax in six annual instalments; or
  • The realisation method, under which the company pays the tax on the eventual realisation of the relevant asset, with a backstop date of 10 years after emigration; in the case of intangible assets, loan relationships and derivatives, the tax is paid over the useful economic lives of the assets.

The changes will come into effect on Royal Assent to the Finance Bill 2013 but retrospectively to the publication of the draft legislation on 11th December 2012.