For many year’s now the EU have been pushing the UK government to review the income tax and capital gains tax anti-avoidance rules relating to the transfer of assets overseas and the attribution of offshore company capital gains to UK resident shareholders. The EU claim that rules are excessive in their application and are contrary to EU law relating to the free movement of capital. Until now HMRC and the Treasury have resisted any relaxation of the rules but in the 2013 Budget the Chancellor announced that changes would be made to these rules with retrospective effect from 6 April 2012.
A consultation document was issued on 30 July 2012 outlining the proposed changes to both rules. The changes are most welcome and should offer some relief from these otherwise draconian rules.
Capital Gains Tax
The changes relating to the capital gains tax rules in section 13 TCGA 1992 will introduce a new test, the business establishment test, to exempt foreign company gains. This will effectively extend the current exemption for assets used in a trade by an offshore company to look at the whole activity in the round. The business establishment test will look at the activities being conducted by the offshore company and determine if a genuine economic activity is being conducted. To determine this, such matters as staffing, physical presence in the offshore jurisdiction and third party transactional activity will be examined. Any pure investment activity is unlikely to pass this test unless the offshore company can demonstrate that it is actively managing the portfolio and not using agents. The proposed test will therefore protect companies that carry out genuine economic activities but will not assist those offshore companies that are merely being used to envelope assets.
An alternative motive test to avoid a section 13 charge has been suggested. Section 13 will not apply if it is demonstrated that tax avoidance is not the main or only reason for structuring the transaction in the manner prescribed. This test however is likely to be far more subjective.
The consultation document has also addressed changes in the anti-avoidance rules relating to the transfer of assets overseas. Currently the anti-avoidance rules apply where the following conditions are met:
- There is a transfer of assets overseas to a person not resident in the UK, and
- Income becomes payable to the transferee, and
- The transferor has the power to enjoy the income either now or in the future.
If all three conditions are met then the income arising is treated as the transferor’s income and is taxed accordingly. The conditions above are extremely wide in their application such that most situations are usually caught. There currently is a commercial defence test against the rules but one must satisfy HMRC that the transfer of the assets was for purely commercial reasons and that any tax avoidance is incidental.
In addition to the existing exemption a new exemption is to be introduced. The new exemption will look at the economic circumstances surrounding the transfer in an objective manner and try to identify transactions carried out on an arms-length basis for genuinely commercial purposes. To meet this test there will be two conditions to satisfy:
- Condition 1is that the transaction is truly arms-length in character. This does not mean that it cannot be between connected parties, but it must be on the same terms as would be undertaken between independent third parties.
- Condition 2requires that the transaction is undertaken for significant economic activities that are carried on outside the UK. This broadly follows the section 13 exemption and will require the overseas activity to be for the provision of goods or services on a commercial basis and with a view to making a profit through employees, agents and contractors that are required to generate profits on that scale The Consultation Document states that the making of investments will not normally be considered as being an “economically significant activity” and therefore is unlikely to satisfy this test.
One final change to the current rules relates to foreign companies resident in the UK for corporation tax purposes. Under the existing rules such companies are deemed to be persons overseas for the purposes of the transfer of assets abroad legislation and therefore lead to anomalies arising. It is proposed that such companies will be outside the legislation and therefore transfers of assets to such companies will no longer be caught within this particular anti-avoidance provision. This is to apply retrospectively from 6 April 2012.
Generally these changes are extremely welcome. It should mean that going forward commercial transactions are outside the scope of the anti-avoidance rules if the conditions are satisfied. The objectivity of the tests should also mean that any claim for relief should be easily identifiable. However, only time will tell as to HMRC’s approach to this relief.