Unexpected infringement proceedings launched by the European Commission may force the UK to rescind tax rules on assets transferred abroad, and its treatment of the gains of non-UK resident companies, a move that strikes at the very heart of the country's anti-avoidance legislation with regards offshore asset protection arrangements
In a reasoned opinion, which requires the UK to respond within two months, the Commission said the provisions were “disproportionate, in the sense they go beyond what is reasonably necessary in order to prevent abuse of tax avoidance.”
The Commission's consideration is based on the fact that, when the rules are applied, domestic investments (in the UK), face lower tax than investments for instance within the EU. The case concerns UK tax law introduced to deter taxpayers from using offshore structures to minimize tax liability, combatted by allowing the tax authority to apply 'look through' taxation of foreign companies' income and capital gains.
David Kilshaw, of KPMG, said the ruling conjured, “a vision of a tidal wave of money moving offshore” if the Revenue were forced to draw the teeth of its anti-avoidance legislation. “This announcement shakes the very foundations of the UK tax system,” he said, adding:
“It is sections 720 and s13 which largely reduce the opportunity for taxpayers to shelter their income and gains from tax by the simple expedient of holding them via an offshore structure. The provisions, where they operate, pierce the veil of the offshore structures and essentially make the profits taxable in the UK.”
“These provisions are a key part of anti-avoidance legislation in the UK and any change could have a profound impact on the structure of UK tax legislation and how individuals operate their businesses and hold their investments,” he surmised.
“The Commission believes discrimination exists as, if the individual had invested assets in a UK company (rather than a company within the EU) the individual would not be subject to tax; only the UK company would be taxed on its income. The Commission’s alert implies that they are only interested in a transfer of assets to a foreign company; however the rules go further than this as they apply to transfers to any foreign persons. It is unclear at the current time whether the action will be taken against the rules in their totality or only on transfers to a non-UK but EU resident company.”
"At present, the UK tax system keeps some balance between incorporated and unincorporated business by allowing for a reduced rate of corporate tax (21%) for smaller profit levels compared to the income tax rate of 50% at its highest. If profits are distributed as dividends further income tax is paid so the overall tax rate on profits can be around the same as for an unincorporated business at between 21 and 50%."
“To extend these anti-avoidance rules to UK companies would add compliance costs for such small companies and accelerate or increase the income tax charge on their owners. This could have a major impact on small business in the UK. It therefore seems more likely that the UK government will look instead to dis-apply the current rules only where EU companies are used for genuine business purposes other than to accumulate income.“
“It is clear that we are entering a period of uncertainty. It is less clear how that uncertainty will be resolved – for example, might the UK government respond to any such challenge by imposing a similar tax charge on certain UK companies? However, this approach, while possibly addressing the Commission’s concern, could have a major effect on a key area of UK tax policy. “
“One thing above all does seem clear however. The landscape as we know it is set to change forever. All taxpayers need to reflect now on how to position themselves for change.”
Andrew Tailby-Faulkes, private client services partner at Ernst & Young, commented that these anti-avoidance rules have been very effective for many years at discouraging UK resident and domiciled taxpayers from sheltering tax by placing their assets in structures overseas.
"However," he said "if the UK is forced to accept the changes being recommended by the European Commission then both native tax payers and non-doms would have more opportunity to make use of lower tax countries within the EU to lower their tax burdens."
Tailby-Faulkes also noted that the ruling introduces some "significant complexities which will raise lots of question marks."
"These include, how will overseas trusts be impacted? What is the position if an EU-based company owned by a UK taxpayer in turn has a non-EU subsidiary that holds the investments?," he observed.
“Until the position is clarified, particularly as the government is also expected to make further announcements on tax residence and domicile status imminently, there is unlikely to be a rush by wealthy taxpayers to review their asset-holding arrangements just yet," Tailby-Faulkes said.
In a reasoned opinion, which requires the UK to respond within two months, the Commission said the provisions were “disproportionate, in the sense they go beyond what is reasonably necessary in order to prevent abuse of tax avoidance.”
The Commission's consideration is based on the fact that, when the rules are applied, domestic investments (in the UK), face lower tax than investments for instance within the EU. The case concerns UK tax law introduced to deter taxpayers from using offshore structures to minimize tax liability, combatted by allowing the tax authority to apply 'look through' taxation of foreign companies' income and capital gains.
David Kilshaw, of KPMG, said the ruling conjured, “a vision of a tidal wave of money moving offshore” if the Revenue were forced to draw the teeth of its anti-avoidance legislation. “This announcement shakes the very foundations of the UK tax system,” he said, adding:
“It is sections 720 and s13 which largely reduce the opportunity for taxpayers to shelter their income and gains from tax by the simple expedient of holding them via an offshore structure. The provisions, where they operate, pierce the veil of the offshore structures and essentially make the profits taxable in the UK.”
“These provisions are a key part of anti-avoidance legislation in the UK and any change could have a profound impact on the structure of UK tax legislation and how individuals operate their businesses and hold their investments,” he surmised.
“The Commission believes discrimination exists as, if the individual had invested assets in a UK company (rather than a company within the EU) the individual would not be subject to tax; only the UK company would be taxed on its income. The Commission’s alert implies that they are only interested in a transfer of assets to a foreign company; however the rules go further than this as they apply to transfers to any foreign persons. It is unclear at the current time whether the action will be taken against the rules in their totality or only on transfers to a non-UK but EU resident company.”
"At present, the UK tax system keeps some balance between incorporated and unincorporated business by allowing for a reduced rate of corporate tax (21%) for smaller profit levels compared to the income tax rate of 50% at its highest. If profits are distributed as dividends further income tax is paid so the overall tax rate on profits can be around the same as for an unincorporated business at between 21 and 50%."
“To extend these anti-avoidance rules to UK companies would add compliance costs for such small companies and accelerate or increase the income tax charge on their owners. This could have a major impact on small business in the UK. It therefore seems more likely that the UK government will look instead to dis-apply the current rules only where EU companies are used for genuine business purposes other than to accumulate income.“
“It is clear that we are entering a period of uncertainty. It is less clear how that uncertainty will be resolved – for example, might the UK government respond to any such challenge by imposing a similar tax charge on certain UK companies? However, this approach, while possibly addressing the Commission’s concern, could have a major effect on a key area of UK tax policy. “
“One thing above all does seem clear however. The landscape as we know it is set to change forever. All taxpayers need to reflect now on how to position themselves for change.”
Andrew Tailby-Faulkes, private client services partner at Ernst & Young, commented that these anti-avoidance rules have been very effective for many years at discouraging UK resident and domiciled taxpayers from sheltering tax by placing their assets in structures overseas.
"However," he said "if the UK is forced to accept the changes being recommended by the European Commission then both native tax payers and non-doms would have more opportunity to make use of lower tax countries within the EU to lower their tax burdens."
Tailby-Faulkes also noted that the ruling introduces some "significant complexities which will raise lots of question marks."
"These include, how will overseas trusts be impacted? What is the position if an EU-based company owned by a UK taxpayer in turn has a non-EU subsidiary that holds the investments?," he observed.
“Until the position is clarified, particularly as the government is also expected to make further announcements on tax residence and domicile status imminently, there is unlikely to be a rush by wealthy taxpayers to review their asset-holding arrangements just yet," Tailby-Faulkes said.
