Judge Harriet Morgan decided that although the directors of the Jersey companies had approved the relevant transactions at board meetings in Jersey and taken company law advice, it was the UK parent company which decided to undertake the planning and engaged the board to perform these specific actions, and was in effect exercising central management and control of the Jersey companies.
"It was not a case of the Jersey board considering and exercising their discretion as directors at the board meetings of the company as and when the proposals for the option and exercise of the options were put to them," the judge said.
"From the outset there was no prospect that the actions would not be taken, barring any legal impediment, because in reality that was what the Jersey board were engaged by DS Plc to do, namely, to enter into the formal approvals required subject to checking the legality. Checking the legality does not in these circumstances … amount to exercising [central management and control]" she said.
"The problem with this case is that it focuses on parental influence rather than finding that the companies were UK resident on more usual grounds – say, because the UK director had undue influence, or that UK residence occurred earlier than first seemed," said tax expert Eloise Walker at Pinsent Masons, the law firm behind Out-Law.com. "This leaves the door open for HMRC to argue in other cases that the influence of a UK parent over an overseas subsidiary changes residence – a step they have thitherto been reluctant to take."
"This will not be welcomed by overseas tax authorities who already have trouble with HMRC's central management and control test in applying residence tests under double tax treaties, and will not help resolve issues where companies become (sometimes accidentally) dual tax resident," she said.
The case concerned the Development Securities property development and investment group of companies (DSG). The group had assets standing at a loss and decided to enter into a scheme designed by PwC to increase the capital losses by including the indexation element. Indexation allowance is designed to reduce a capital gain to counter the effect of inflation, but it does not increase a capital loss.
The scheme involved the DSG companies which held the assets granting call options to the Jersey companies. The price payable by the Jersey companies on exercise of the option was the historic base cost in the relevant asset plus indexation accrued to that time. This meant that the price was considerably in excess of the then market value of the asset. The UK DSG companies would not realise any tax charge on the sale of the assets to the Jersey companies and if the Jersey companies were non-UK resident, they would acquire the assets for capital gains purposes for the actual amount paid rather than by reference to market value. This meant that when the Jersey companies later sold the assets, they would be standing at a larger loss, as increased by the indexation element. The group stood to save around £8 million from the planning. The Jersey companies became UK resident shortly after the transaction.
It was critical to the success of the scheme that the Jersey companies were non-UK resident at the time the assets were acquired. HMRC argued that the companies were in fact UK resident.
Where a company is not incorporated in the UK, it is tax resident where its central management and control is carried out. The Jersey companies had three Jersey based and tax resident directors provided by a trust and corporate services company and one UK resident director who was also the company secretary of DSG. Board meetings authorising the transactions were all held in Jersey.
DSG argued that it is the directors who exercise central management and control at board meetings unless control has been exercised independently of, or without regard to them or their decisions are essentially dictated by another party. They argued that a person, such as a parent company or adviser, who merely proposes, advises on, and influences decisions of the directors is not thereby dictating to the directors or usurping their role.
Judge Harriet Morgan said that it does not necessarily follow that central management and control of an overseas group company, which has been formed for a specific purpose is in the UK if it falls in with the plan of the parent of the group and does what is expected, provided that proper consideration is given to the proposal and the directors are in fact exercising their discretion to exercise central management and control of the company.
However, in this case the judge pointed out that there were unusual features such as that the Jersey companies were set up on the basis that the only transaction to be undertaken whilst the Jersey board was intended to be exercising central management and control over them was an inherently uncommercial one from their perspective. This inherent lack of commerciality meant that the only basis on which it was valid as a matter of corporate law for the Jersey companies to enter into the transaction was that their parent specifically approved the transaction and funded them. In addition the Jersey companies become UK resident shortly after the transaction.
"It is clear from the evidence of what occurred at the board meetings that, as regards the key matter of entering into the options and acquiring the assets on exercise, the Jersey directors were acting on the basis of what was, in effect, an instruction from the parent which included the parent’s confirmation that the transaction was for the parent’s benefit, subject only to checking there was no bar to them complying with the instruction as a matter of legality," she said.
"This was not a case where the board considered a proposal and, having taken appropriate advice, decided that it was in the best interests of the companies to enter into it. Given that the transaction was clearly not in the interests of the companies and indeed could only take place with parental approval, the inescapable conclusion is that the board was simply doing what the parent, DS Plc, wanted it to do and in effect instructed it to do," she said.
"In the circumstances, the line was crossed from the parent influencing and giving strategic or policy direction to the parent giving an instruction. The Jersey board were simply administering a decision they were instructed to undertake by DS Plc, in checking the legality of the plan and then administering the other consequent actions prior to handing over completely to the UK group," she said.
"It is to be hoped that the case will be appealed, and the courts at a higher level overturn the First-tier Tribunal's decision," said tax expert Eloise Walker. "Despite reaching arguably the "right" result, the court is setting a dangerous precedent that blurs the distinction between central management and control and shareholder control, which every majority shareholder ultimately has over its subsidiary's board of directors."