The First-tier Tribunal has ruled that a Jersey incorporated company was resident in the UK for tax purposes. The Jersey company entered into an uncommercial transaction and then shortly afterwards its residence was moved back to the UK.
The Development Securities plc (DS) group had a number of properties held at a loss and a structure was implemented to enable the capital loss on eventual disposal to be enhanced by indexation which would not otherwise be taken into account. The structure involved a wholly owned Jersey subsidiary (Jerseyco) being formed which entered into a call option to acquire the properties from the DS group at a price equal to the indexed base cost. Jerseyco was funded by the DS group to exercise the call options and the properties were acquired.
Jerseyco was intended to be tax resident in Jersey at the time the properties were acquired. UK directors of Jerseyco were subsequently appointed and the properties were later sold by Jerseyco to third parties at market value generating a capital loss. Jerseyco claimed the capital loss was based on its actual acquisition cost, including indexation. HM Revenue & Customs (HMRC) argued that Jerseyco was in fact UK resident at the time it acquired the properties and therefore the base cost remained the historic group base cost and had not been uplifted by the indexation within the price paid by Jerseyco.
HMRC accepted that if Jerseyco were tax resident in Jersey, the structuring was effective to 'step up' the chargeable gains base cost.
The First-tier Tribunal decided that this was a case where the central management of control (CMC) of Jerseyco was not on the facts exercised by the Jersey based directors at the board meetings held in Jersey to implement the transactions.
The Tribunal held that the key acts of CMC were the decisions to enter into and exercise the call option, and then to move the residence of Jerseyco back to the UK. The Jersey directors approved the call options and related matters, but the Tribunal held that they were acting on the basis of what was in effect an instruction from the UK parent company and that the Jersey board did not actively engage in that decision. CMC was therefore in reality exercised in the UK. Factors which led to this conclusion included that the transaction, acquiring an asset at materially above market value, was in itself uncommercial and that there was no evidence of the directors considering the benefit to Jerseyco of the transaction.
In relation to the transfer of residence to the UK, the Tribunal concluded that the Jersey board did not engage at all with that exercise of CMC.
The decision, extending to 99 pages, is a valuable insight into how HMRC challenges corporate residence in practice and how evidence is tested before a Tribunal.
The decision does not change or develop the law on company residence. This is established in leading cases such as Wood v Holden and De Beers Consolidated. The Tribunal were however able to distinguish the facts from those in Wood v Holden where the Court of Appeal held that the directors of a non-UK resident company taking steps in a tax planning scheme did in reality exercise CMC in the decisions to enter into the transactions.
A key feature of the case was the inherently uncommercial terms of the transaction which meant that the Tribunal could distinguish the facts from Wood v Holden and conclude the Jersey directors were in reality acting on instructions from the DS group. Further, there was no evidence from the minutes that the commercial reasons for the transaction were actually considered. This contrasted with evidence that the lawfulness of the transaction was considered in detail, leading to the conclusion that the directors would act on DS group instructions subject to them only being lawful. References to "instructions" from the DS group in documents was unhelpful. The absence of evidence that the Jersey directors considered the steps taken to appoint UK directors led to the Tribunal describing that that was a decision taken by DS which was "rubberstamped" by the Jersey directors
The way in which the Tribunal dissected the written and oral evidence emphasises the importance of having a consistent and thorough record of decisions and the process. The oral evidence of directors was given much less weight than the written evidence and the contemporaneous notes.
Unusually, a UK employee of the DS group was one of the Jerseyco directors. This did not appear to be a material factor in the decision. HMRC argued that the facts were similar to those in the Laerstarte case where it was held that central management and control was usurped by a UK director who in effect took the key decisions rather than obtaining the agreement of the other non-UK director. The Tribunal concluded that the UK director had not acted in that way, although it remains unusual, and generally inadvisable, for a UK employee of the group to be on the board of a non- resident company.
An interesting part of the case is the discussion of the Smallwood decision. This was a case on the place of an effective management of an offshore trust, rather than on company residence. The Court of Appeal decided in Smallwood that the export of the trust to Mauritius and subsequent return to the UK meant that there was a "scheme of management of the trust" which was exercised from the UK. HMRC sought to apply the "scheme of management" argument in this case, possibly as a way around the high threshold suggested by Wood v Holden for CMC to be regarded as usurped from the Jerseyco board. The Tribunal decided that it was not appropriate to apply that concept, but it serves as a reminder that the test for trusts is different and that HMRC may continue to seek to introduce this wider concept into challenges on corporate residence.
There has been comment as to whether the case is an indication of increased HMRC focus on residence. The reality is that there has always been a high degree of scrutiny on residence in tax based structures although the relatively high burden of proof evident from cases such as Wood v Holden means that HMRC prefers to find additional lines of challenge rather than routinely litigate residence. The uncommerciality of the transaction and the limited period of non- residence here made it an easier matter to focus on the residence issue. The setting up of the Offshore Developer Task Force will lead HMRC to review an increased number of non-resident property structures and it is expected that patterns will emerge where residence can be more easily challenged and these may come to be applied more widely.
In terms of practical implications, the case does not as such require changes to group operational guidelines which have been developed with advisers. It does however serve as a warning that guidelines must be fully observed and that the reality behind the reaching of a decision will be scrutinised intensely if HMRC challenge the position.
John Christian is a corporate tax expert at Pinsent Masons, the law firm behind Out-Law.com.