Accounting standards are not law

The Upper Tribunal, in Ball UK  Holdings has upheld the decison of the First Tier Tribunal that the company was not entitled under accounting standards to switch its financial statements to US dollars.  The company was an intermediate holding company, ultimately owned by a US parent.  By switching to dollars from sterling, the company claimed to crystallise a large tax-deductible loss on loans.

Mrs Justice Falk and Judge Jonathan Cannan had to consider whether accounting standards were a matter of law – such that an appeal lay to the Upper Tribunal.  They ruled that “findings about the meaning as well as the practical application of FRS 23 are properly matters of fact”.  As such, their interpretation was to be determined by the First Tier Tribunal, relying upon expert evidence. 

Accounting standards “are documents written by accountants for accountants, and are intended to identify proper accounting practice, not law. No accountant would consider turning to a lawyer for assistance in their interpretation, and nor should they.”

The judges agreed that the findings of fact by the lower tribunal were conclusions it was entitled to reach – and the company’s appeal was rejected. 

“ ’in respect of’ tax avoidance”

The Upper Tribunal has upheld the First Tier Tribunal’s decision to strike out the taxpayers’ appeal on the basis it had no reasonable prospect of succeeding.   The case, The First De Sales Limited Partnership (2) Twofold First Services LLP (3) Trident First Services LLP (4) Trident Second Services LLP v HMRC, concerned a tax avoidance scheme.  The judgement notes “Each Appellant carried on a modest business for the purposes of which it employed one or more individuals. In implementation of the schemes, each Appellant entered into a Deed of Restrictive Undertakings with an employee and a third party. Under each Deed, the employee agreed to be bound by certain restrictive undertakings as part of entering into a contract of employment and the Appellant made payments to the third party pursuant to the Deed. The schemes were intended to generate losses that could be utilised by individual partners/members…” 

The employees were paid £60,000 and £80,000 in total – yet the partnerships each agreed to pay £970 million “solely in consideration of [the employee] giving the restrictive undertakings”, which were broadly a six-month non-compete provision. 

It is thus one of those cases where reality fails to coincide with the written agreements.  The judges held that:

“The payments were not in respect of, or for, the giving of, the restrictive undertakings. The memoranda supported the obvious conclusion that any relationship between the commercial value of the undertakings and the amount of the payments was irrelevant to these schemes, which were entered into solely for the purpose of tax avoidance.”

No escape

Mr Justice Henry Carr and Judge Greg Sinfield indulged in  a spot of judicial wit, by referring to Lord Reed’s judgment in UBS:

“In our society, a great deal of intellectual effort is devoted to tax avoidance. The most sophisticated attempts of the Houdini taxpayer to escape from the manacles of tax (to borrow a phrase from the judgment of Templeman LJ in W T Ramsay Ltd v Inland Revenue Comrs generally take the form described in Barclays Mercantile Business Finance Ltd v Mawson:

“…structuring transactions in a form which will have the same or nearly the same economic effect as a taxable transaction but which it is hoped will fall outside the terms of the taxing statute. It is characteristic of these composite transactions that they will include elements which have been inserted without any business or commercial purpose but are intended to have the effect of removing the transaction from the scope of the charge.”

That paragraph is apt to describe the schemes which are the subject of this appeal, save in one respect. Houdini always allowed himself a reasonable prospect of escape from the handcuffs in which he was bound. These schemes do not have any reasonable prospect of enabling taxpayers who invested in them to escape from the manacles of tax.

Expectation created

HMRC have just lost a judicial review in relation to their guidance on VAT.  Vacation Rentals provided credit card handling services and argued that they complied with the guidance set out in HMRC’s Business Brief 18/06 on when such services should be treated as exempt from VAT.  HMRC later issued assessments, claiming that the services should be standard-rated.  The company sought judicial review of HMRC’s decision, contending that “the policy is expressed in a way that is clear, unambiguous and devoid of relevant qualification”.  The Upper Tribunal agreed.  The judges further ruled against HMRC’s  contention that “it would not be unfair or an abuse of power to resile from the guidance in that the Claimant was a “very sophisticated taxpayer”, with access to high quality advice”.

The Office of Tax Simplification recently recommended in their report on HMRC Guidance that “HMRC should undertake a consultation on the circumstances in which a taxpayer can rely on published guidance”.  The decision reinforces that recommendation.

Loose language

As impetus builds behind the BEPS Multilateral Convention, with more and more countries signing and ratifying, the question to consider is when will the new provisions apply?

There are two different issues: withholding taxes on the payment of interest, dividends and royalties and provisions affecting the taxable presence, overall profit or dispute resolution rights of companies and individuals. 

The OECD secretariat has just published a note on the effective date for withholding tax – which is 1 January.  The question put is which 1 January?  Was it the one immediately following the expiration of the three months after the second country ratified – or was there a further year’s grace?  The note sets out the legal advice from OECD Directorate for Legal Affairs, which states that it’s the first date – and there is no extra year.  The problem arose because of slightly loose language in the English version of the Convention.  Naturally the Vienna Convention on Treaties was considered.

A similar question arose in the UK, at least, on the effective date of the taxable period changes. Some argued that the changes took effect by reference to a company’s accounting period – not the country’s overall financial year.  HMRC disagreed and clearly state that changes apply from 1 or 6 April, as appropriate. 

Buying off plan means gain taxable

The Upper Tribunal’s decision in Higgins illustrates one of the pitfalls of buying flats before they are ready for occupation.    

Mr Higgins agreed to buy a flat before it was constructed, signing an agreement in 2006.  Building work took longer than anticipated and completion took place only in January 2010, when Mr Higgins moved into the flat.  He occupied it as his main residence until he sold it in 2012. 

He claimed that the sale was exempt from capital gains tax, on the basis the flat had been his main residence throughout his period of ownership.  However, HMRC disagreed, noting that he started occupation only in 2010 – and that the capital gains tax rules allocated the gain on a time basis, over the full period of ownership.  Sadly for Mr Higgins, the Upper Tribunal has agreed with HMRC, overruling the First Tier Tribunal. 

Effectively, buying off plan means that any gain is likely to have an investment element, now taxed at 28%.

Commission finds mismatch in US and European laws isn’t state aid

There will be a collective sigh of relief from many UK and US multinationals at the European Commission’s ruling in favour of Luxembourg and McDonald’s.  The US-parented group held intellectual property rights in a Luxembourg company, which assigned them to a US branch.  The Luxembourg tax authority agreed that the income from the rights (intragroup royalties) should be allocated to the US, under the Luxembourg-US tax treaty.  However, as the branch’s presence did not amount to a taxable presence under US law, no actual tax arose. 

The Commission finally agreed that the US presence did amount to a foreign branch or permanent establishment, as defined in Luxembourg law.   In this case (and many others like it) the effective non-taxation of almost all the profits arose from the US definition of taxable presence, which does not follow the OECD standard.

Luxembourg, like many other countries, is taking steps under the BEPS project to modify its law, such that non-taxation may not arise in the future.  The US has a new model treaty, which would do the same thing – although the Senate has not ratified any US Double Tax Treaties for many years.

The ruling may cause the UK to be more optimistic about the outcome of its own state aid enquiry into the finance company exemption, under controlled foreign companies’ legislation.  For the first time in recent years, the Commission has acknowledged that low, or even no, taxation isn’t necessarily state aid.

Paying tax on profits

Amazon has just filed 2017 accounts for two UK businesses:  Amazon UK Services, which runs its distribution centres and delivery business in the UK, and Amazon Web Services, which provides consultancy and marketing services in relation to cloud computing.  The major part of Amazon’s global business is in selling goods and services; its cloud computing arm, AWS, accounts for about 10% of global sales.

Amazon Inc filed its 2017 financial statements in April – and they showed a 2% net profit before tax on the group’s $177 billion sales.  The group has always made low profits – in the range 0-3% over the last decade.  Interestingly, the group’s CEO, Jeff Bezos focused not on profits but on customers in his annual report to shareholders. He noted that Amazon UK has ranked No 1 in the UK’s Customer Satisfaction Index from the Institute of Customer Service for the last five years (and 8 years in the equivalent US index).  The letter never refers to profit – and makes only passing reference to sales in one unit. 

The group’s financial statements reflect a 20% tax charge, which has halved due to US tax reform and is also substantially reduced by tax deductions for employee share payments.  They also note that $11.3 billion of its sales are attributed to the UK – about 6% of total group sales. 

The Amazon UK Services accounts do not include UK sales, as its role is to provide services only to the main UK retailer, Amazon EU Sarl.  This Luxembourg company has a sales branch in the UK, as Amazon buyers may have noticed on their invoices.  However, it doesn’t publish accounts solely for the branch.  UK company law requires that the accounts of the whole company be published. 

The UK distribution company makes a net profit of 4% on its sales – twice the group profit.  Its tax charge is just 2%, though, well below the statutory rate of 19%.  The accounts explain the difference – which is mainly due to corporation tax deductions for paying employees in shares, partly offset by non-allowable costs.  The expected tax charge would be nearly £14 million, but it’s reduced by £17.5 million due to tax relief for employee shares (and increased by £5.8 million for non-allowable costs).

Many companies offer employees part of their income in shares or share options.  The difference with many technology-based groups is the scale and value of the awards.  As technology company share prices climb, employees do very well.  We must always remember, though, that employee tax charges are much higher than corporation tax.  Employees will pay income tax at 20%/40%/45%.  Most will also pay national insurance at 2%, alongside employer national insurance at 13.8%.  The effective rate of tax will be 32-61% – considerably more than 19% corporation tax.

Making higher profits – and thus paying more tax – would mean increasing margins and putting up prices to customers.



More than £4 billion saved

Supreme Court
Judges rule against compound interest claims

The Treasury should be pleased by the Supreme Court’s decision in the Prudential case. The case is one of the long-running claims that the UK’s tax treatment of foreign dividends broke EU free movement of capital rules.  The UK changed the law in 2009 – but there’s still plenty of money involved in claims for back years.

This particular case is about portfolio dividends, typically held by investment funds, where the shareholding is less than 10% and usually much less.  The UK used to levy corporation tax on such dividends, whereas equivalent dividends from UK investments were exempt.  The European Court of Justice decided this was unlawful many years’ ago – but this case was about the exact method of allowing relief for overseas tax.  The Supreme Court has decided that relief should be given by reference to the foreign nominal rate, irrespective of whether this was actually paid by the underlying company.  It’s a sensible, pragmatic answer.

The element of the case which has the biggest impact is the Court’s ruling on compound interest.  Prudential – and many other claimants – have argued that they should be given compound interest on their tax refunds, which could easily double or triple the value of a claim.  HMRC have estimated that paying compound interest on all claims could cost the Exchequer some £4-5 billion.

However, the Supreme Court ruled that a 2007 case, Sempra Metals, had been wrongly decided by the House of Lords.  The Supreme Court has followed its recent decision in Littlewoods and decided that the EU principle of effectiveness (requiring an effective remedy for breach of EU law) did not require compound interest. 

UK law similarly does not require the payment of compound interest.  The Supreme Court noted that there is symmetry between taxpayers and the Exchequer, with tax law setting simple interest for both.   

The result is that the Exchequer will save over £4 billion, which will no doubt come as a relief in these times of deficits.

HMRC loses another EIS case

HMRC have just lost another tax case about their management of the Enterprise Investment Scheme.  Following their loss in Ames, the First Tier Tribunal has ruled in favour of the taxpayers in Oxbotica Ltd.  This is a case about the Seed EIS scheme, designed to help start-ups.  Oxbotica was founded to spin out technology from Oxford University, developed by several academics.  Four individuals and Oxford University subscribed for shares in the company and the university made a loan to the company of £110,000.  The company sought authority to issue an SEIS compliance certificate to three individuals, who had subscribed £316 for shares.  HMRC turned down the application, asserting that the Department did not consider Parliament would have intended granting relief where the share subscription was just £316.  HMRC also said that “in circumstances where the company had already secured funding from the University, HMRC considered that the purpose of the share issue was an attempt to secure capital gains tax relief.”

The Tribunal faced little difficulty in dismissing HMRC’s arguments.  The SEIS legislation did not set out a minimum subscription level and there was no basis to add one in. On the facts, it was clear that the money raised had been spent on the company’s qualifying business activity.   HMRC’s argument about the purpose being to obtain capital gains tax relief also failed, not least because HMRC had not claimed there was a tax avoidance purpose.  It would surely have been impossible to show there was a tax avoidance purpose here, where the shares were subscribed for by the people working on the project and the company’s chairman.

It’s disappointing to find this case (and Ames) going before the Tribunal.  Surely Parliament intended supporting start-up businesses with both income tax and capital gains tax reliefs – since that was what was enacted?  

Let us hope HMRC reviews its approach to operating the reliefs. 

New roles

After a career in private practice, I’ve just joined the Office of Tax Simplification, as a part-time policy adviser.  OTS locker

The OTS is an independent part of the Treasury.  I work in a building I’ve often visited – and now have the opportunity to get lost in.  The Horse Guards Road/Parliament Street building was one of Gordon Brown’s PFI projects, which broadly coincided with bringing together Treasury and HMRC policy specialists.  It resonates with history – but modernity too, as atriums and water features have been added, hot-desking is common and the technology looks just like any up-to-date private business.   The OTS conducts a mixture of its own reviews and reviews requested by the Chancellor.  Details of current and closed reviews are online and the annual report will be published shortly.  I’m now part of teams conducting two reviews. 

 I’ve also just been appointed by the HMRC Commissioners to the Advisory Panel for the UK General Anti-Abuse rule.  The Panel is required to offer one or more opinions on arrangements before HMRC is permitted to counteract them by applying the GAAR. The initial permanent panel didn’t see any cases in its first two years, so panel members were offered extended terms.  It’s now the time for three panel members to retire from duties – and three new members commenced their three-years terms from 1 June.  Details of the Panel’s membership and opinions are online.