Modern tax treaties for Guernsey, Jersey and IOM

On Monday 2 July Financial Secretary Mel Stride and ministers from Guernsey, Jersey and the isle of Man signed new double tax treaties. 

Signing new treaties at HM Treasury

The treaties need parliamentary approval in the UK and the Crown Dependencies before they enter into force. 

The new treaties are a simplified form of the UK’s current model treaty, which offer modern protections to investors and equally modern protection against abuse.   There’s a principal purpose test, which aims to ensure that treaty benefits only go to those investors intended to benefit by the treaty partners. It has an interesting sub-clause, which may allow taxpayers to claim different (presumably lower) benefits, where they can show that they would have been granted absent the disqualified arrangements.     The Crown Dependencies will collect UK tax, if necessary – and the UK will do the same.  There are better dispute resolution provisions, including arbitration if necessary.  Interestingly, despite the UK liking arbitration provisions in treaties, it has not yet been involved in one.  Perhaps this demonstrates that countries really do try harder to resolve disputes where there is the potential to hand it over to a third party for adjudication.

Crown Dependency residents will be pleased that they may escape UK withholding tax on interest and royalties, where the recipient is an individual, or a company where 75% or more is owned by resident individuals.  Banks and financial institutions may also benefit, as can any other person where the establishment, acquisition or maintenance of that person, or the conduct of its operations, does not have as its principal purpose or one of its principal purposes to secure the treaty benefit.  Similar provisions cover royalties.

The Opposition has on occasion challenged new UK tax treaties as part of the approval process in the House of Commons and may ask questions about these ones.  However, the new treaties do have significant provisions to prevent abuse – and should otherwise help the flow of investment from the Crown Dependencies to the UK. 

BEPS Update

Work on the Base Erosion and Profit Shifting project continues to move forward.   The BEPS Inclusive Framework met in Peru on 27-28 June, with representatives from over 80 countries. 

The Inclusive Framework delegates

The Inclusive Framework now includes 116 countries and jurisdictions, with others expected to join.  The EU’s Non-cooperative jurisdictions measures have certainly acted as an encouragement, since a requirement to stay off that list is adoption of the four BEPS minimum standards.

More countries have signed the BEPS Multilateral Convention, bringing the participants to 82.  Peru, together with Kazakhstan and the UAE, naturally signed during the framework meeting.  The last remaining EU state, Estonia, has also signed.  Nine countries have now ratified the Convention, including the UK.  The key start date for these countries, and others which ratify by 30 September, will be 1 January 2019 when the anti-treaty abuse rules kick in, which will stop some funds and holding companies within multinational groups from claiming reduced withholding taxes on interest, royalties and dividends.  The vastly-improved dispute resolution provisions will take effect from the start of the 2019 tax year (1 April for the UK and 1 January in most other countries).  A smaller number of countries will see changes to the definition of taxable presence for companies, since there is less agreement on how best to change those rules.  The Working Party on Tax Treaties is working on additional guidance on when taxpayers may claim the benefit of treaties, to improve global consistency in defining treaty abuse.   

The OECD secretariat released on 21 June final transfer pricing guidance on of the profit-split method and the application of principles to hard-to-value intangibles.  Still to come is the controversial first draft of new guidance on financial transactions.

Update: the draft guidance on financial transactions was released on 3 July for comment. 

The door opens for a late claim

The Upper Tribunal has opened the door for Robert Ames’ late claim for Enterprise Investment Scheme relief.  The case is a perfect example of a quite unnecessary restriction in the law – which provides that an individual may only claim exemption from capital gains tax on the sale of shares where income tax relief has previously been claimed on the share subscription.  HMRC thus refused Mr Ames capital gains tax relief on his later sale of the shares.  There’s no good reason for linking the claims, but the Upper Tribunal found it was the law.  Mr Ames hadn’t claimed income tax relief on his share subscription, as his income that year was only £42. This was well below the personal allowance, which was given automatically in HMRC’s online Self Assessment system, as his counsel Keith Gordon pointed out.  

It was suggested at the First Tier Tribunal hearing that Mr Ames could have submitted a late claim for income tax relief -so he did.  HMRC turned him down, though. 

Mr Ames sought judicial review of HMRC’s decision.  Mr Justice Fancourt and Judge Greg Sinfield decided to quash the original decision. 

Please reconsider, say judges

HMRC’s care and management powers under section  5(1) of  the Commissioners for Revenue and Customs Act 2005 allow it to accept late claims.  The HMRC officer who refused the late claim did not consider whether this was one of those “…exceptional cases that do not meet these conditions and are not covered by guidance concerning the particular claim or election, where it may still be unreasonable for HMRC to refuse a late claim or election.” 

The judges ordered HMRC to remake its decision, with a broad hint that this case was likely to be sufficiently exceptional to allow a late claim.

Another state aid case

On 20 June, the European Commission announced it had found Luxembourg had granted unlawful state aid to French energy giant Engie, worth about €120 million.  As is usual in these cases, Luxembourg must recover this amount from the company even if Luxembourg and the company appeals the decision to the European General Court.   

The problem, in the Commission’s view, is that Luxembourg allowed Engie to use a domestic hybrid instrument to reduce its Lux tax bill.  Essentially the same instrument gave one group member a tax deduction for financing costs, whilst the equivalent income received by another group member was tax-exempt.  The result, said the Commission, was that “LNG Supply only paid taxes on about 1% of its profits”. 

Which side is the tax liablity?

It may sound remarkable that Luxembourg gave rulings from 2008 to permit this treatment.  In the UK, HMRC has challenged vigorously similar structures put in place by companies, winning almost all cases.  The dispassionate observer may think that this does indeed sounds like a case of unlawful state aid.

However, the company may feel rather hard done by, as Luxembourg commonly allowed multinationals to use financing structures leaving profits of 1% taxed in the Grand Duchy.   The logic behind this approach is that most of the risks are borne outside the country, with the result that a 1% profit offers a fair return.  No doubt this will form part of the argument put forward at the General Court. 

Comply, or face the consequences

The Supreme Court’s decision in JP Whitter (Water Well Engineers) Limited highlights the need for those in the construction sector to comply fully with all the requirements of the Construction Industry sub-contractor Scheme.  Under the CIS, payments made to a sub-contractor are subject to 20% withholding tax, unless the contractor benefits from gross payment status.  Given that margins in the sector are low, a 20% withholding has a big impact – not least because main contractors may be concerned that sub-contractors do not have HMRC approval. 

The company had been registered under the CIS for 25 years before a string of compliance failures in 2009-11.  HMRC at first allowed the company’s appeal against loss of gross payment status but after PAYE failures for seven months decided to cancel CIS registration.  The company’s evidence was accepted by the First Tier Tribunal – that loss of status would cost it 60% of turnover and 80% of its employees.  However, the Supreme Court held that HMRC’s discretion in allowing continuing registration had to be exercised in the context of the CIS – and ignore wider factors, such as the impact on the business.  The whole point of the CIS is to reduce tax evasion, which is why the rules are strict. 

Employment rights may be different from tax treatment

The Supreme Court’s decision in Pimlico Plumbers tells us one important thing about taxation of the gig economy.  The tax treatment of an individual is assessed separately from the rights of a worker under employment legislation.  Mr Smith, a heating and plumbing engineer, claimed before the Employment Tribunal that he was an employee of Pimlico Plumbers under a contract of service and alternatively that he was a ‘worker’.  The Tribunal dismissed his employment claim but concluded he was a ‘worker’.  Pimlico appealed this finding to the Supreme Court.  Lord Wilson, delivering the judgement of the court, said:

“From   1970   onwards Parliament has   taken   the   view   that, while only employees under a contract of service should have full statutory protection against various  forms  of  abuse  by  employers  of  their  stronger  economic  position  in  the relationship,  there  were  self-employed  people  whose  services  were  so  largely encompassed  within  the  business  of  others  that  they  should  also  have  limited protection,  in  particular  against  discrimination  but  also  against  certain  forms  of exploitation  on  the  part  of  those  others;  and  for  that  purpose  Parliament  has borrowed and developed the extended definition of a “workman” first adopted in 1875.”

Later, Lord Wilson notes “Mr Smith correctly presented himself as self-employed for the purposes of income tax and VAT.” 

There has been much debate on employment rights and tax treatment of individuals engaged in the so-called gig economy.  The Supreme Court demonstrates that the issue goes back to 1875 – and that in some cases self-employed individuals do have additional rights, but below those of employees engaged under a contract of service. 

Mr Smith was entitled to protections due to a ‘worker’ primarily because his contract with Pimlico Plumbers was one of personal service – and the company was not a client or customer of his.

Who will disclose?

The EU’s Mandatory Disclosure Rules will take effect on 25 June 2018, following political agreement in March and final approval on 25 May.  The Directive must be transposed into national law by 31 December 2019, to take effect from 1 July 2020.  The ‘gotcha’ built into the Directive, though, is that arrangements from 25 June 2018 must be disclosed to national tax authorities in August 2020.  Cue a certain amount of concern amongst the adviser and taxpayer communities, which suddenly find themselves potentially liable to collect data based on rather unclear rules, before they have sight of local law. The UK is expected to introduce an enabling provision into Finance Act 2019 – and then introduce the rules as regulations – with a draft only available in 2019.

The UK introduced disclosure rules in 2004, when the emphasis was very much on making sure that tax authorities understood what planning was being undertaken.  Today, though, most taxpayers will not enter into arrangements requiring early disclosure.

The EU’s Directive seems to be mainly about information.  Several of the hallmarks cover arrangements where the tax implications look straightforward.  For example, a transfer of more than half the business of a company from one state to another needs to be disclosed.  Similarly, the transfer of a ‘hard to value’ intangible asset must be notified.

The Directive starts by presuming that an adviser or facilitator will be the prime discloser of information.  However, there’s an exemption for advice covered by legal privilege, as defined in each Member State. Initial comment suggests that German French, Italian and Spanish advisers expect to qualify for exemption.  This will leave the burden on taxpayers, as well as on UK advisers.   Quite how taxpayers – corporate and individual – will feel about making disclosures remains to be seen.  UK advisers find their customers prefer the adviser to manage the process.

Understanding Funds platforms

HMRC have filed for leave to appeal against the decision of the First Tier Tax Tribunal in the Hargreaves Lansdown case.  The case is about the tax treatment of payments made by the online investment platform to individual investors.  Hargreaves Lansdown wanted to offer its investors lower costs, which it negotiated with fund managers.  Initially most fund managers rebated monies to HL, which passed part of it on to investors, either in the form of additional units, or through cash payments.  The regulatory regime changed in 2014, such that platform providers were required to pass the whole of rebates to investors and then make separate charges to cover their own costs. 

In 2013 HMRC issued a Technical bulletin in which it set out its view that platform rebates were in fact annual payments to investors, subject to 20% withholding tax and higher/additional rate income tax where relevant.  Hargreaves Lansdown have challenged that view.

HMRC have fundamentally misunderstood what is going on.  Investors didn’t receive income from their investments – rather, they benefited from lower costs.  Judge Tom Scott ruled that the nature and quality of the loyalty bonus was that it was not a ‘profit’ to an investor, but a reduction of the net cost.

Whilst its disappointing that HMRC have appealed against this decision, let us hope that the Upper Tribunal will follow Judge Scott and help HMRC to a better understanding of the commercial – and thus tax – position.   Reducing investment costs is a good thing – and it shouldn’t be interpreted by HMRC as substituting income tax charges for capital gain tax.

Testing taxpayer reaction

Over 685,000 Self Assessment taxpayers who accessed their 2015/16 SA Return via their Personal Tax Account between August 2016 and March 2017 had their returns pre-populated. The worry was whether pre-population would lead to less accurate tax returns, as taxpayers simply assumed online figures were correct.

HMRC looked at a sample to see how they reacted.  17% overwrote a pre-populated income figure and 15% overwrote an employment benefit figure.  Comparing pre-population to those without showed improved accuracy of income reporting, with some over-writing with higher amounts and some with lower amounts. However, it cost money, due to improved accuracy, since taxpayers reducing overpayments outweighed the reduction in small underpayments.  The full results are in a letter from HMRC chief executive Jon Thompson to the Public Accounts Committee