UK Tax Round Up – Tax

Welcome to November’s edition of the UK Tax Round
Up. This month has seen publication of the Finance Bill 2021-22
(what will become the Finance Act 2022) including draft legislation
for the basis period reform, UK asset holding company regime and
uncertain tax treatment reporting, as well as an interesting case
on the UK source nature of interest payments and withholding tax
and another victory for HMRC in a TV presenter IR35
case.

UK Case Law Development

Interest subject to UK withholding tax as UK source and
yearly

In Hargreaves Property Holdings Limited v HMRC,
the First-tier Tribunal (FTT) agreed with HMRC’s assessment
that interest paid by a UK resident tax company and derived from
real property assets in the UK had a UK source, despite provisions
in the loan agreement requiring that interest be paid outside the
UK and providing that the governing law was that of Gibraltar and
not the UK. The taxpayer also sought to argue that the interest was
not “yearly” interest and, failing this, that the
appellant was entitled to pay interest gross under the UK-Guernsey
double tax treaty (DTT) without a direction from HMRC. The FTT
rejected both of these arguments as well and held that the interest
should have been paid subject to UK withholding tax (WHT).

The taxpayer was the ultimate parent of a group of companies
engaged in property investment, development and construction.
Crucially, for the period to which the decision related all of the
properties held by the group were located in the UK. The group
funded many of its acquisitions using loans from various lenders
including both financial institutions and various other persons
connected with the group. This case related to two loans made by
two family Gibraltar resident trusts, settled by directors of the
company during the relevant period, and a loan from the sister of
one of those directors.

Before 2004, funding from these lenders was informal and
undocumented in some cases. In late 2004, the company took tax
advice and subsequently took the followings steps with a view to
excluding the interest payable on the relevant loans from UK
WHT:

• they changed various contractual terms of the loans (place of
  payment, governing law and jurisdiction of enforcement) so that
  they were not linked to the UK. This was done with a view to
  ensuring that the interest was not UK sourced; and




• they implemented of a cycle of interest-stripping and loan
  extensions under which the interest-payment rights were assigned
  for consideration to a Guernsey company (and, from 2012 onwards, to
  a UK resident company) shortly before the interest payment date and
  entered into a new loan at the time the existing loan matured (less
  than a year from its advance) using the new loan to repay the
  existing loan. The intention with this was to ensure that the
  interest was not “yearly” interest, and so not subject to
  UK WHT, and, additionally, that the recipients were entitled to
  gross payment by virtue of the UK-Guernsey DTT and the general UK
  corporate-to-corporate payment exception.

During the course of the hearing the company’s directors
admitted that the sole purpose of the restructuring of the loan
arrangements was to ensure that the interest would not be subject
to UK WHT, while preserving the company’s corporate tax
deduction for the interest paid, and that there was not a
commercial purpose other than obtaining this tax advantage.

The FTT’s finding that the contractual provisions mentioned
above did not deprive the interest of its UK source is not
surprising in light of the 2018 Court of Appeal (CA) judgment in
the Ardmore Construction  case. Applying the
multi-factorial test from that case, and following the
“underlying commercial reality” of the arrangements in
question, the UK residence of the borrower and UK situs of its
property investment assets from the money used to pay the interest
derived outweighed the other factors and it was held that the
interest clearly arose from sources in the UK. The FTT’s
decision on this point, again like Ardmore,
underlined how little weight is given to the residence of the
lender and the source of the funds used to advance the loan and
that the question of source focuses on the circumstances of the
borrower and how the interest payments are funded.

On the argument that the interest was not “yearly”,
the interest was found to be yearly, notwithstanding that in most
cases the duration of the loans was under a year, as the loans were
held to form part of long-term financing of the company provided by
the same lenders using sequential loans.

On the company’s point that the interest was not subject to
UK WHT under the UK-Guernsey DTT without the company having to
obtain a gross payment direction from HMRC, which was purely
voluntary, the FTT confirmed that, even if the DTT would fully
remove the UK WHT obligation, a claim for relief from UK WHT would
need to be made and a direction from HMRC authorising gross payment
would need to be received by the borrower, neither of which
happened in this case.

Probably the most surprising element of the decision was the
FTT’s rejection of the company’s argument that where the
interest payments had been assigned to a UK tax resident company
for consideration and received by that company, the interest was
“beneficially owned” by it and so payment should not be
subject to UK WHT under section 933 of the Income Tax Act 2007,
which applies where a UK tax resident company is beneficially
entitled to the income. Applying a purposive construction of the
exemption to a realistic view of the facts, the FTT found that
assigning the right to interest to the UK tax resident company
shortly before interest was paid had no commercial purpose and,
therefore, that the UK company recipient of the interest was not
“beneficially entitled” to it to the extent that it paid
for the assignment. This was on the basis of a purposive
construction of beneficial entitlement under UK law and not
applying an “international fiscal meaning of the sort referred
to in the Indofood case.

The decision in relation to beneficial entitlement may appear to
be somewhat troubling from a taxpayer’s perspective as a rare
example of a non-fiduciary being deprived of beneficial
entitlement. However, it seems likely that this conclusion was
influenced by the extreme fact pattern in this specific case and
the recognition that the assignment of the interest to a UK
resident company for payment was to genuinely commercial
transactions. 

Another IR35 victory for HMRC

In Little Piece of Paradise Ltd v HMRC, the FTT
has continued the recent trend and held that Mr Clark, a Sky TV
sports presenter was a deemed employee of Sky TV for the purposes
of the IR35 intermediaries rule so that the taxpayer (his personal
service company or PSC) was liable for PAYE and national insurance
contributions on payments that it made to Mr Clark. This is the
latest in a number of recent IR35 victories for HMRC where TV and
radio presenters have been characterised as deemed employees of
their end client organisation.

The basic process required to determine whether IR35 applies to
the provision of services by an individual through their PSC is to
construct the “hypothetical contract” that would have
existed between the individual and end client had they contracted
for the work directly rather than through the PSC and determine
whether the individual would have been an employee or a
self-employed contractor under that hypothetical contract. As has
been discussed in those recent cases, in order for that
hypothetical relationship to be one of employment, there has to be
sufficient mutuality of obligation and control by the end client
and no other factors in the relationship that point to the
individual operating on a self-employed basis.

In this case, there were three contracts spanning a six-year
period and providing a fee each year for services to be performed.
These resulted in Little Piece of Paradise (the PSC) providing the
presenter to Sky as a lead presenter on professional darts
broadcasts. The coverage extended to only 64 days a year, and these
represented Mr Clark’s primary working days for the year.

The PSC asserted that there was no mutuality of obligation
between Mr Clark and Sky on the basis that if he did not perform
the services there was no obligation for Sky to make payment under
the contracts. However, this assertion was not supported by the
facts, since payments were made on a monthly basis, regardless of
whether an event was covered in the month in question. The FTT
found that in return for the promise of payment the presenter was
obliged to perform the services and that the mutuality of
obligation requirement was satisfied. The most significant finding
in this regard was that, although the actual contract allowed for
the PSC to provide an alternative if Mr Clark was not available,
the FTT held that this substitution clause would not be included in
the hypothetical contract between Mr Clark and Sky. A similar
position has recently been taken by the CA in upholding an
Employment Appeal Tribunal (EAT) decision that a courier was a
“worker” notwithstanding a substitution clause in his
contract because the clause was not unfettered and so did not
release the courier from his principal obligation to carry out the
work himself. These cases show that substitution clauses will be
considered sceptically by the courts when the end client, rather
than the individual worker, has effective control over whether or
not a substitute will be accepted.

The FTT also held that Sky had ultimate control over what events
would be covered and where and how Mr Clark was required to present
notwithstanding that it was actually the Professional Darts
Corporation (PDC) that decided where and when the events were held.
In this regard, the FTT, like previous tribunals, placed emphasis
on the fact that Mr Clark had to comply with Sky’s and
Ofcom’s general standards and editorial guidelines.

Having concluded that mutuality and control were indicative of a
hypothetical employment relation, the FTT went on to consider the
other relevant factors in that context, namely exclusivity, whether
the presenter was in business on his own account, lack of
entitlement to holiday and sick pay and the right to provide a
substitute. None of these factors led to a conclusion that the
relationship reflected a contract for services.

The case emphasises that it will be increasingly difficult for
individuals providing services over the medium to long term,
whether under a single contract or number of contracts, who are not
clearly taking financial risk commensurate with operating as a
self-employed contractor to resist HMRC’s view that they should
be treated as a de facto or deemed employee.

Other UK Tax Developments

New Asset Holding Company Regime

One of the more significant developments for the private funds
industry this year is the introduction of the new UK asset holding
company (UKAHC) regime that will become effective on 1 April 2022.
The (nearly) final draft legislation for the regime were included
in the Finance Bill 2021-2022 published on 4 November.

The regime is intended to increase the UK competitiveness as a
jurisdiction for the establishment, operation and administration of
private funds and their investment holding structures following a
trend in recent years whereby an increasing number of private funds
have been established in Luxembourg or the Channel Islands. The
rules aim to establish a more favourable tax regime for UKAHCs
where certain eligibility criteria are satisfied.

The rules have been subject to considerable consultation between
HMRC and interested representative bodies over the past few months,
which is reflected in the draft rules which provide the basis for a
reasonably simple and certain regime that should prove attractive
to certain fund managers investing in shares, debt and non-UK real
estate.

In order to qualify for the regime, the UKAHC must satisfy
certain eligibility requirements:

i the UKAHC’s main activity must be carrying on an
investment business with any other (e.g. trading) activities being
ancillary to the investment business and insubstantial in relation
to it;

ii the investment business must not include acquiring listed
securities other than with a view to delisting the relevant
company;

iii the UKAHC must be owned at to at least 70% by “category
A investors”, which include widely held funds and certain
other investors such as local authorities, sovereign entities,
pension schemes, UK REITs and their non-UK equivalents and
charities; and

iv the UKAHC elects to be within the regime.

There are rules relating to the tax consequences of a company
entering the regime (broadly, being treated as selling its relevant
assets for market value with a relaxation of the holding period
required to claim substantial shareholding exemption (SSE) on the
deemed disposal of shares), breaching the qualifying requirements
and curing them and leaving the regime (broadly, selling its
relevant assets for market value).

While in the regime the UKAHC will benefit from:

1. no corporation tax on sale of shares that it
holds for its investment business with no conditions of the sort
required for the SSE to apply;

2. no corporation tax on profits from overseas
real property to the extent that the property is subject to tax
overseas;

3. no withholding tax on payments of interest
on the UKAHC’s debt instruments;

4. no application of certain of the
distribution rules that can convert deductible interest into
non-deductible distributions, such as results dependent interest
and interest being more than a reasonable commercial return;
and

5. no application of the income distribution
rules to repurchases or redemptions of the UKAHC’s shares for
more than their original subscription price, although this rule is
not applicable to individuals holding employment-related securities
other than individuals involved in providing investment management
services to a fund owning the UKAHC (e.g., carried interest
holders).

There are other tax simplification rules in relation to the
hybrid mismatch rules and corporate interest restriction rules and
also rules to treat certain returns from the UKAHC as non-UK source
income or capital gains for remittance user purposes.

All in all the rules are clear and comprehensive, if a little
long and detailed, and it will be interesting to see how successful
the regime is and whether it gets used immediately or funds allow
it to bed in for a while before considering the UK as an
alternative to other holding company jurisdictions.

Basis Period Reform Consultation

HM Revenue & Customs (HMRC) have released their
“Consultation outcome: Basis period reform” and published
draft legislation for the new rules. The consultation and draft
rules reflect the changes made following discussion and
representations, the main change being the delay to the
introduction of the rules for 12 months so that they will now
become effective in tax year 2024-25 with the transitional year
being 2023-24. The rules are expected to be included in Finance Act
2022.

Basis periods are relevant to all individuals carrying on
trading activities, whether as sole traders or through a
partnership (including an LLP) and are the method by which taxable
profits or allowable losses are allocated from a business’s
accounts to a specific tax year. Broadly, they seek to align
profits of a tax year with the accounting period that ends in the
tax year, but this process gives rise to complications and what are
known as “overlap profits” in the first year or two years
that an individual commences a trade. The proposal to repeal basis
periods and align taxable profits with the tax year is intended to
simplify the current rules for small businesses, helping them to
spend less time filing their tax returns and making the rules
fairer, more logical and easier to understand.

The proposed rules will operate so that:

• in the tax year 2023-24 individuals will be taxed on the
  current basis period basis plus the profits from the end of that
  period until 5 April 2024. They will also bring any current
  “overlap relief” into account as a loss in that
  period;




• if there is an excess profit in the transition year, the tax on
  it can be spread over 5 years (or can be accelerated in whole or in
  part at any time);




• if there is an additional loss as a result of the overlap
  relief it can be carried back for 3 years; and




• from 5 April 2024 the taxable profits will be those arising in
  each tax year.

Where businesses have an accounting period of 31 March (or 1-5
April) these changes will have no effect. Where they do not there
will be some sort of additional profit and overlap relief in the
transition year.

The main complications that are likely to arise in the future
are around misalignment of accounting years and tax years where a
business can’t use a 31 March accounting date, because, for
instance, it has a seasonal business or is part of a wider
international business with a different required accounting date.
These businesses are likely to have to apportion profits from two
part accounting periods to each tax year and, depending on when in
the tax year their accounting period ends, the individuals might
have to file their tax returns with provisional numbers and then
amend them later.

There are also likely to be complications for individuals
subject to tax in the UK and another jurisdiction (particularly the
US) and seeking to claim double tax relief.

HMRC has recognised that there are still some issues to consider
in introducing the rules and, hopefully, changes will be made to
try to minimise the practical and operational complexities that the
rules will lead to in these specific circumstances.

Uncertain Tax Treatment

Finance Bill 2021-2022 includes proposed legislation for the
implementation of new notification rules relating to the uncertain
tax treatment (UTT) regime applicable to large businesses.

The new UTT rules will only apply to businesses, including
partnerships and LLPs with either, or both, a turnover above
£200 million and a balance sheet total of more than
£2bn. This will include all businesses handled by HMRC’s
large business division as well as the larger groups in its
mid-sized business division. Notably, and importantly, collective
investment schemes are excluded from the new regime, although their
portfolio companies will, on an individual basis, be subject to
them if they qualify as “large”.

Large businesses within the scope of the rules will be required
to notify HMRC of “uncertain amounts” in respect of
corporation tax, VAT or income tax (including PAYE), subject to a
threshold test and specific exemptions. A treatment is defined as
being “uncertain” if it falls within one (or more) of the
two specified conditions: (i) a provision has been recognised in
the accounts of the company (or members of the partnership) in
respect of the treatment; or (ii) the treatment relies on an
interpretation which is contrary to HMRC’s known interpretation
of the law. HMRC’s position is “known” for these
purposes if it is apparent from published HMRC documents or from
“dealings” with HMRC. “Dealings” in this
context means direct interaction between the taxpayer and HMRC, but
is not limited to discussions regarding the specific transaction or
treatment concerned.

A third condition, which was contained in an earlier iteration
of the draft legislation, would have required notification where
there was a “substantial possibility” that a court or
tribunal would find the treatment to be incorrect. This has now
been removed following consultation. The removal of this third
condition is a welcome change, as it was a completely novel and
untested concept which HMRC’s initial guidance said would fall
somewhere below a more than 50% likelihood applicable to a
taxpayer’s tax filing position. It was also not aligned with
any accounting measure that might result in a provision. Having
said this, the government has indicated that it remains committed
to further consideration of a third trigger, so it is possible that
a modified version of this trigger will be introduced before the
rules receive Royal Assent, or at some time after if HMR is unhappy
with the level of reports that it receives. Notwithstanding the
removal of this “substantial possibility” test, it is
concerning that HMRC considered that such a test should be included
in the original proposals.

Notification of an uncertain amount will only be required where
the “tax advantage” arising from a treatment exceeds a
£5m threshold. Where the financial year in respect of which
notification may be required is more or less than 12 months, then
the £5m threshold will be adjusted proportionately. The
threshold applies separately for corporation tax, VAT and income
tax. The draft legislation also sets out detailed rules for
quantifying tax advantages for these purposes.

The rules provide a number of specific exceptions which, where
applicable, mean that an “uncertain amount” will not need
to be notified. A “general exemption” will apply where it
is reasonable to conclude that all, or substantially all, of the
information which would otherwise be required to be notified has
already been made available to HMRC.

As the draft rules currently provide, the notification
requirement will apply to tax treatments included in “relevant
returns” which must be filed on or after 1 April 2022. This
means that notification is potentially relevant to transactions and
uncertain treatments arising now. As such, affected businesses
should begin preparing at the earliest opportunity for the
implementation of the regime.

UK Tax Round Up

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