Legislation in the Finance Bill 2019 introduces targeted rules to tax arrangements through which individuals carrying on a trade or profession transfer a disproportionate part of their profits to offshore entities in low-tax jurisdictions. Following consultation on the draft legislation published on 6 July the UK government has decided to remove the requirement for the individual to notify HM Revenue & Customs (HMRC) where the rules apply.
Following the consultation on tax avoidance involving profit fragmentation in July 2018 the government seems to have taken on board some of the responses from stakeholders with resulting changes in the Finance Bill 2019 (FB 2019).
The proposed legislation, which is set out in Schedule 4 of FB 2019, seeks to prevent UK individuals, partners, or participators in a company from arranging their affairs in such a way that their business profits accrue to an offshore territory resulting in significantly less tax being paid. The rules can apply if the UK individual or someone connected to them is then able to enjoy the benefit of the transfers.
An 80% payment test has been introduced to compare the real rates of tax suffered on the alienated profits against that due in the UK. Broadly, where the tax paid offshore is less than 80% of that which would be due in the UK, there will be a ‘tax mismatch’ and an adjustment will be required in the UK.
Changes to the rules since publication in July
A number of amendments have been made, in particular the welcome removal of the requirement to notify HMRC that the legislation may apply, which the respondents to the consultation document had thought was a disproportionate and onerous obligation.
Another criticism was that the legislation was so wide that it would catch individuals legitimately carrying on a trade and would increase the burden of compliance. This has been taken into account in FB 2019, Sch 4, para 2(2) so that transactions will not be affected if they have not caused an actual tax mismatch, or if it was not reasonable to conclude that the main purpose or one of the main purposes of the transfer was to obtain a tax advantage.
Other amendments increase the scope of the rules so that, when reviewing a transfer of value from a business, such value may now be traced through any number of individuals—not only companies, partnerships, trusts or other entities—and all value will be reviewed, not simply income. When determining the value of any arrangements made, such arrangements must be treated as being distributed to partners or members on a just and reasonable basis, so that all are taxed equally.
The enjoyment conditions found at FB 2019, Sch 4, para 4 have now been modified to include a test that it is ‘reasonable to conclude’ that an individual procured the transfer in order that they may avoid being treated as making a taxable transfer under the legislation.
If the rules apply, adjustments must be made to counteract the tax advantage which arises from the arrangements. FB 2019, Sch 4, para 7 details the adjustments which have to be considered when reviewing any arrangements. These arrangements now relate to expenses claimed as well as income, profits or losses of the UK resident. The adjustments must be just and reasonable and must be compared to transfers between independent parties while acting at arm’s length.
Protected foreign source income
Comfort can be taken from the statement in the explanatory notes that "A 'transfer of value' for the purposes of this paragraph will not include protected foreign source income chargeable in the UK under section 731 of the Income Tax Act 2007 (ITA 2007), provided that the income has no connection with a UK business"
The proposed provisions do not prevent individuals who are UK resident but non-domiciled (non-doms), who have a foreign source income not connected to a UK business activity, from using an offshore entity such as a company to receive their non-UK business income, provided that they are claiming the remittance basis of taxation.
Following the changes to the tax treatment of long term resident non-doms introduced from April 2017, it is most helpful that the explanatory notes have reminded us that, where a trust established while an individual was non-dom is a protected trust which has not been tainted, then income accruing to an underlying company will not be taxable on the settlor unless a benefit is paid to them.
What concerns remain?
The test of whether there is a tax mismatch looks partly at whether it is ‘reasonable to conclude’ that profits are excessive. This is very subjective and will not afford the certainty demanded by business. However, now tempered by an independent third-party test, this will assist in moderating the actual transfers falling under this legislation, as it is a more helpful measure.
Even though the government has listened and addressed some of the concerns about the new rules, it will continue to increase the compliance burden on individuals carrying on a business.
Anne Healy-McAdam is a private client tax expert at Pinsent Masons, the law firm behind Out-law.com. This analysis piece was first published on LexisPSL (£).