PM-Tax Wednesday 11 February 2015 News and Views from the Pinsent Masons Tax team In this Issue Our Comment •HMRC ‘two-pronged’ attack on tax avoiders and avoidance scheme promoters by Fiona Fernie •US tax system could fuel M&A activity by US multinationals by Eloise Walker 2 •HMRC targets moderately wealthy by James Bullock Recent Articles •New diverted profits tax could apply to real estate structures by John Christian and Heather Self •The Chinese GAAR by Eloise Walker and Robbie Chen 5 •Office of Tax Simplification: Final report on partnership taxation by John Christian Our perspective on recent cases European Commission v United Kingdom (Case C-172/13) HMRC v National Exhibition Centre Limited [2015] UKUT 0023 (TCC) PricewaterhouseCoopers LLP & Another v HMRC [2015] UKFTT 0007 (TC) HMRC v Astral Construction Limited [2015] UKUT 0021 (TCC) Biffa (Jersey) Ltd & Another v HMRC [2015] UKFTT 0010 (TC) 11 People 16 NEXT @PM_Tax © Pinsent Masons LLP 2015 >continued from previous page PM-Tax | Our Comment HMRC ‘two-pronged’ attack on tax avoiders and avoidance scheme promoters by Fiona Fernie Planned new measures to tackle what HMRC has described as “persistent” use of avoidance schemes would target the promoters of these schemes, as well as taxpayers. HMRC is consulting on proposed additional financial and reporting burdens for those who have used multiple avoidance schemes, as well as looking at whether to introduce additional penalties in the most abusive tax avoidance cases. However, the most significant development is that the proposals do not just focus on taxpayers. The measures proposed in the new consultation would apply to a group of ‘serial’ users of tax avoidance schemes yet to be defined, but which could cover those who use the same avoidance scheme in more than one year or who use different avoidance schemes over a short period. These taxpayers could be required to pay a surcharge on the repeated or concurrent use of tax avoidance schemes that fail, or could become subject to special notification requirements. Those who enter these special measures could also have their names published by HMRC. These measures are a continuation of the government’s proposals to ‘close the tax gap’ and change the behaviours of recalcitrant taxpayers. The intention is to build on previously-announced measures which aimed to remove the economic benefit to the taxpayer of being part of a disputed tax avoidance scheme, thus discouraging the use of such schemes. The consultation also proposes strengthening the new Promoters of Tax Avoidance Schemes (POTAS) rules to catch promoters if a “significant proportion” of the schemes that they notify under DOTAS fail in the courts or tribunals. This new “threshold condition” would be set in such a way as to ensure that it does not catch tax advisors who conscientiously comply with the reporting regime and whose products are generally compliant with the law, according to the consultation document. The current proposals differ from previous measures, however, in that they do not only focus on taxpayer behaviour. Instead, the idea is that there should be a two-pronged attack, one aspect of which is a focus on the promoters of high-risk avoidance schemes. It will be interesting to see what effect the proposed measures in relation to the promoters of schemes – which include ‘naming and shaming’ and fines of up to £1 million – have on the number and efficacy of new schemes introduced to market. The consultation also considers whether to introduce additional penalties for cases where the general anti-abuse rule (GAAR) applies, and if so how to do this. The GAAR was introduced in July 2013 and is designed to prevent ‘artificial and abusive’ tax avoidance schemes that “cannot reasonably be regarded as a reasonable course of action”. This could take the form of a new penalty for cases where the GAAR applies, or the introduction of a surcharge in cases where the GAAR applies, according to the consultation. The government announced that it would consult on potential sanctions for repeat users of known avoidance schemes as part of the Autumn Statement in December. The new measures follow last year’s introduction of ‘accelerated payment notices’ (APNs) allowing HMRC to demand the payment of disputed tax associated with an avoidance scheme up front. APNs can be issued where schemes hit certain ‘avoidance hallmarks’, such as the scheme being subject to disclosure requirements under the Disclosure of Tax Avoidance Schemes (DOTAS) rules. The consultation closes on 12 March 2015. Fiona Fernie is a Partner (non-lawyer) leading our Tax Investigations team. She has over 25 years’ experience in assisting clients subject to investigations/enquiries by HMRC with particular focus on COP8 and COP9 (Contractual Disclosure Facility) cases and large complex investigations. She also assists clients who want to make a voluntary disclosure of tax irregularities to HMRC. According to HMRC, it has issued APNs worth over £1 billion since the new regime came into force. However, HMRC was recently ordered not to enforce APNs in relation to a group of clients represented by Pinsent Masons, who are pursing a judicial review claim against the issue of the notices. The outcome of the review could have a significant impact on whether taxpayers are influenced to change their behaviours and steer away from using tax avoidance schemes. E: [email protected] T: +44 (0)20 7418 9589 CONTENTS BACK NEXT 7694 PM-Tax | Wednesday 11 February 2015 2 >continued from previous page PM-Tax | Our Comment US tax system could fuel M&A activity by US multinationals by Eloise Walker Cash reserves held outside the US for tax reasons by US multinationals are likely to fuel a big increase in M&A activity in Europe over the next year. Apple, the US technology company, has reported the biggest quarterly profit ever made by a public company. It reported a net profit of $18 billion in its fiscal first quarter. According to Standard and Poor’s, this topped the $15.9 billion profit made by ExxonMobil in the second quarter of 2012. Apple’s figures also show huge net cash reserves of £142 billion. the G20 asked the OECD to recommend possible solutions. However, such solutions are unlikely to impact the US position in the short term. In July 2013, the OECD published a 15 point Action Plan and the first formal proposals dealing with seven of the 15 specific actions were published in September 2014. The remaining actions are due to be published in September 2015. The reason why multinationals like Apple are sitting on so much cash may be because of the way the US tax system operates. The US is unusual in having a ‘worldwide’ tax system which taxes companies’ profits wherever they arise – even if they are earned overseas. If profits are earned overseas, the tax can be deferred, but only so long as the profits are kept out of the US. If the profits are repatriated to the US they will be taxed at the normal US rate – which at 35% is currently one of the highest rates of corporate tax around. The European Commission is also investigating the favourable tax rulings given by some EU countries to multinationals. In September 2014 the European Commission said that advance pricing arrangements (APAs) agreed between the Irish tax authorities and Apple may have given the company unfair advantages incompatible with EU state aid laws. So, although moves are afoot to change the international tax system and there is pressure in the US to stop multinationals avoiding US tax on their overseas profits, in the short term there is plenty of cash sloshing around in these multinationals looking for a home. That could therefore lead to increased European M&A activity in the technology sector in the near future. There is therefore a massive incentive for US multinationals to keep their foreign profits out of the US. This leads to the crazy situation where groups like Apple borrow money in the US to fund returns of value to their shareholders, despite having huge cash reserves elsewhere in the world. US multinationals will be looking for a home for these cash reserves and this could fuel an increase in European M&A activity, particularly in the technology sector, where many of these multinationals operate. Pinsent Masons, in association with Mergermarket, has surveyed more than 150 senior executives from both technology corporates and private equity firms to discover what the future holds for European technology M&A in 2015 and beyond for this exclusive report, Ahead of the curve: the growth of European technology M&A. The fact that the pound and the euro are both low against the dollar adds to the attractiveness of European investments for US companies; making UK and other European investments look cheaper than they were before. Eloise Walker is a Partner specialising in corporate tax, structured and asset finance and investment funds. Eloise’s focus is on advising corporate and financial institutions on UK and cross-border acquisitions and re-constructions, corporate finance, joint ventures and tax structuring for offshore funds. Her areas of expertise also include structured leasing transactions, where she enjoys finding commercial solutions to the challenges facing the players in today’s market. Although there are international moves afoot to clamp down on the avoidance of tax by multinationals, it is likely to be some time before there is a fundamental change in the international tax system. Any changes proposed are unlikely to have much practical effect in the foreseeable future on the cash mountains already held by US multinationals, which are currently available for investment. The Organisation for Economic Co-operation and Development (OECD) is looking at ways to prevent base erosion and profit shifting (BEPS). BEPS refers to the shifting of profits of multinational groups to low tax jurisdictions and the exploitation of mismatches between different tax systems so that little or no tax is paid. Following international recognition that the international tax system needs to be reformed to prevent BEPS, E: [email protected] T: +44 (0)20 7490 6169 CONTENTS BACK NEXT 7694 PM-Tax | Wednesday 11 February 2015 3 >continued from previous page PM-Tax | Our Comment HMRC increasingly targeting the moderately wealthy by James Bullock A 60% jump in the amount of extra tax collected by HMRC from moderately wealthy taxpayers shows that the department is leaving no stone unturned in its efforts to target tax avoidance. Figures obtained by Pinsent Masons, showed that HMRC collected £137.2 million in additional tax as a result of investigations by its ‘affluent unit’ last year; up from £85.7 million in 2012/13. The figures show that HMRC is no longer focussing its compliance efforts solely on the super-rich. New powers that would give HMRC the ability to withdraw outstanding tax directly from the bank accounts of debtors, as announced in the 2014 Budget, are due to come into force this year. In November, the government announced that it would require HMRC to conduct face-to-face meetings with those with tax in dispute before it could use the new powers, following critical responses to a consultation on the proposals. People who would just consider themselves moderately successful professionals and businesspeople are now also coming under the scrutiny of HMRC’s specialist units. This unrelenting attitude is being backed up by new civil powers to pursue unpaid tax and a much more aggressive approach to prosecutions – targeted at professionals and entrepreneurs. The government also consulted last year on the introduction of a new ‘strict liability’ offence, carrying automatic criminal penalties, for those who failed to declare offshore taxable income. The new offence would have allowed HMRC to prosecute taxpayers that did not correctly declare income or gains, regardless of whether this was done with any intention to defraud. HMRC has not yet responded to its consultation despite having already legislated for other proposals announced at the same time, indicating that the plans may have been quietly shelved. Whilst the fact that more is being raised from compliance investigations should as a general principle be welcomed, HMRC needs to be vigilant that over-zealous use of some of its new powers does not end up being damaging to business. The diluting of the direct recovery of debt proposals in late November, and the apparent disappearance of the proposed strict liability offence of offshore tax evasion, are hopeful signs that HMRC is getting the message on this front. James Bullock is Head of our Litigation and Compliance Group. He is one of the UK’s leading tax practitioners and has been recognised as such in the leading legal directories for many years. James has over twenty years of experience advising in relation to large and complex disputes with HMRC for large corporates and high net worth individuals, including in particular leading negotiations and handling tax litigation at all levels from the Tax Tribunal to the Supreme Court and Court of Justice of the European Union. The figures relate to investigations carried out by HMRC’s ‘affluent unit’ into the tax affairs of approximately 500,000 UK residents with either annual income of over £150,000 or wealth over £1 million. It was set up in 2011 to target the group of taxpayers whose income means that they are not considered wealthy enough to be scrutinised by its ‘high net worth’ unit. In 2013, the affluent unit was doubled in size with the recruitment of an additional 100 inspectors. The private wealth threshold was also decreased to £1 million from £2.5 million, bringing more taxpayers into its remit. E: [email protected] T: +44 (0)20 7054 2726 HMRC has also run a number of voluntary disclosure campaigns targeting specific groups of professionals over the past few years. It is currently encouraging legal professionals to voluntarily declare any undisclosed income before a June 2015 deadline. HMRC’s new ‘Connect’ database system gathers real-time data from public and private sources including banks, local councils and social media to help it identify groups where tax avoidance may be an issue. CONTENTS BACK NEXT 7694 PM-Tax | Wednesday 11 February 2015 4 PM-Tax | Recent Articles New diverted profits tax could apply to real estate structures by John Christian and Heather Self Diverted profits tax (DPT) is a new tax aimed at multinationals operating in the UK which is due to apply from 1 April 2015. DPT is not targeted at structures for UK real estate investment or development, but it is so widely drafted there are concerns that it could it impact upon structures involving non-UK residents. This article is based on the draft legislation published for consultation on 10 December – this may change before the rules come into force. In outline the “effective tax mismatch” test will apply if the foreign tax (ignoring the offset of losses, but taking account of all other provisions of the foreign legislation) is less than 80% of the equivalent UK corporation tax (20% from 1 April 2015). When will DPT apply? DPT will apply in two circumstances: The “insufficient economic substance” condition will apply where the tax benefit of the transactions is greater than any other financial benefit, and it is reasonable to assume that the transactions were designed to secure the tax reduction. Alternatively, it will apply where a person is a party to one or more of the transactions, and the contribution of economic value by that person is less than the tax benefit, and it is reasonable to assume that the person’s involvement was designed to secure the tax reduction. •where a non-UK resident company is carrying on activity in the UK in connection with supplies of goods and services to UK customers and it is reasonable to assume that any of the activity is “designed so as to ensure” that the foreign company is not carrying on a trade in the UK through a permanent establishment; (this is referred to as the “avoided PE”), or •where a group has a UK subsidiary or permanent establishment and there are arrangements between connected parties which “lack economic substance”. One example of this would be if profits are taken out of a UK subsidiary by way of the payment of royalties to an associated entity in a tax haven. What happens if DPT applies? Taxpayers will have to notify HMRC if it is reasonable to assume that taxable diverted profits “might” arise to the company. HMRC have accepted that this notification obligation is too wide, but it is not clear how the draft legislation will be amended to address this concern. DPT will not apply to small and medium-sized entities and in the case of an avoided PE, DPT will only apply where UK sales are at least £10 million. If HMRC believes that there is a liability to DPT, it will issue a preliminary notice setting out the grounds on which DPT is payable, and calculating the DPT based on certain simplified assumptions. In particular, HMRC can disallow 30% of “relevant expenses” which would otherwise reduce the liability of the company. In determining whether a tax liability arises in respect of an avoided PE, two further tests are applied. If either test is failed, then DPT will be charged: •The first test is that in connection with the supplies of goods or services to UK residents, arrangements are in place the main purpose or one of the main purposes of which is to avoid a charge to corporation tax The company can correct obvious errors in the preliminary notice, but cannot appeal at this stage and must pay the DPT that HMRC says is payable, prior to entering into detailed discussions with HMRC. During the review period, which lasts up to 12 months, the company and HMRC will attempt to reach agreement on the amount of DPT due. If agreement cannot be reached, HMRC will issue a final notice. At this stage, the profits will be calculated on OECD transfer pricing principles, but with the ability for HMRC to recharacterise arrangements based on what they consider to be the most likely alternative transaction. •The second test applies to both the avoided PE and the “arrangements which lack economic substance” situations. It is intended to be an objective test, which will be satisfied if two conditions are met: there is an “effective tax mismatch outcome” and “insufficient economic substance”. CONTENTS BACK NEXT 7694 PM-Tax | Wednesday 11 February 2015 5 >continued from previous page PM-Tax | Recent Articles New diverted profits tax could apply to real estate structures (continued) The company can appeal to the Tax Tribunal, but only at the end of the review period. This will result in a significant cash flow disadvantage for the company. •development projects involving offshore owned UK property are usually structured to minimise the risk of a UK PE in respect of a property development trade. These structures should be reviewed against the DPT proposals, in particular the “avoided PE” test. DPT is chargeable at 25% – significantly in excess of the rate of corporation tax which is due to reduce to 20% in April 2015. What should you do? In our view the legislation is not designed to catch this sort of transaction and should be amended so that it is clear that it does not apply. We have responded to the consultation on the draft legislation asking that the scope of the rules be narrowed. DPT applies for periods beginning on or after 1 April 2015 and there is no grandfathering of profits from structures already in place. How could DPT apply to real estate transactions? In theory the tax could apply in some circumstances where a non UK resident company (for example an offshore SPV) has been used in a transaction involving UK land or where there is a UK presence and profits are extracted to offshore owners based in low tax jurisdictions. If the legislation is passed without significant amendment, investors and developers should review their structures and transfer pricing arrangements, and may wish to consider seeking an Advance Pricing Agreement (APA) to confirm that DPT does not apply in their circumstances. The avoided PE rules could be relevant to development activities. For other real estate activities, the main risk is that the offshore SPV has “insufficient economic substance”. Where the local tax rate is less than 16%, a DPT charge could arise John Christian is head of our corporate tax team. He specialises in corporate and business tax, and advises on the tax aspects of UK and international mergers and acquisitions, joint ventures and partnering arrangements, private equity transactions, treasury and funding issues, property taxation, transactions under the Private Finance Initiative and VAT. Unfortunately the draft legislation is not very well drafted so it is not at all clear at present whether it will apply, but the following observations can be made: •straightforward investment structures are probably not intended to be subject to DPT but some commentators have noted that bona fide commercial arrangements could technically be argued to be caught E: [email protected] T: +44 (0)113 294 5296 •in particular, investments using a propco/opco involve a trading activity being carried on through the opco and structures should be reviewed against the “economic substance” test Heather Self is a Partner (non-lawyer) with almost 30 years of experience in tax. She has been Group Tax Director at Scottish Power, where she advised on numerous corporate transactions, including the $5bn disposal of the regulated US energy business. She also worked at HMRC on complex disputes with FTSE 100 companies, and was a specialist adviser to the utilities sector, where she was involved in policy issues on energy generation and renewables. •the avoided PE rules require someone in the UK to be carrying on an activity in the UK in connection with “supplies of goods or services” made by the non-UK company to customers in the UK. This is VAT, rather than direct tax terminology, and it is not clear what it means in connection with transactions involving land. Until clarification emerges, it should be assumed that it may be viewed purposively as referring to all supplies and therefore could apply to land supplies E: [email protected] T: +44 (0)161 662 8066 CONTENTS BACK NEXT 7694 PM-Tax | Wednesday 11 February 2015 6 PM-Tax | Recent Articles The Chinese GAAR by Eloise Walker and Robbie Chen The introduction of new administrative measures for the general anti-avoidance rule in the People’s Republic of China will be the envy of HMRC, with its tight timescales, the burden of proof being laid firmly on the taxpayer, and its failure to address double taxation. However, greater control by the State Administration of Taxation over local tax authorities and the GAAR’s wide ambit (it should catch Circular 698 issues) will be welcome to those who meet its stringent background information and data retention requirements. HMRC brought in the UK’s general anti abuse rule (UK GAAR) after much heated consultation. The end result was unappetising for all concerned, with taxpayers scratching their heads over the double reasonableness test and the unsatisfactory guidance. By contrast, the administrative measures published in December 2014 for the application of the general anti-avoidance rule in the People’s Republic of China (PRC GAAR) are short and to the point. HMRC can only look upon them with envy. The same must be true for taxpayers: as a taxpayer, you do not want to have to apply the GAAR; but if you do have to, at least in China you will know where you stand. In contrast, under the UK GAAR the tax advantage has to be only one of the main purposes. The test is objective (whether it would be reasonable to conclude that a tax advantage was a main purpose of the arrangement). The purpose test is therefore a lower bar for HMRC to pass, allowing it to focus on whether the arrangements are in fact abusive. At the discussion draft stage, the PRC’s State Administration of Taxation (SAT) – the highest tax authority in China – did consider following the UK’s approach and adopting the wider ‘one of the main purposes’ test. Fortunately, this was abandoned for the higher hurdle of ‘sole or main purpose’, which benefits taxpayers by narrowing the scope of the PRC GAAR. How the PRC GAAR works The PRC GAAR first appeared in the Enterprise Income Tax (EIT) Law in 2008. It empowers the tax authorities to make reasonable adjustments to any enterprise’s arrangement if it does not have a reasonable commercial purpose and if it leads to a reduction of taxable income. A transaction ‘without reasonable commercial purpose’ is defined as a transaction with the main purpose of reducing, exempting or deferring the payment of tax. How is a GAAR case investigated in China? When the local tax authority starts a general anti-avoidance audit, it sends a ‘notice on tax audit’ to the enterprise that is to be investigated. Within 60 days of receiving a notice, the enterprise has to provide documents to prove that its arrangement has a reasonable commercial purpose. The tax authority then reviews the documents provided, holding a subsequent round of meetings with the taxpayer for further information and clarification. Which transactions are under the spotlight? An arrangement can be labelled as a tax avoidance scheme if its sole or main purpose is to obtain tax benefits (referred to as any deduction, exemption or deferral of EIT payable); or if tax benefits are obtained under a disguised arrangement that is in effect inconsistent with the transaction’s economic substance. If the local tax authority believes that the documents cannot prove the arrangement has a reasonable commercial purpose, it should consult internally with the SAT. If the SAT concurs with its opinion, the local tax authority may send a ‘special tax audit adjustment notice’ to the enterprise and make a tax adjustment based on the information already acquired. Common types of such tax avoidance schemes are: The purpose of involving the SAT in the final decision is designed to ensure that all GAAR investigations are conducted in a consistent manner and that technical criteria are properly applied. •abuse of tax incentives •tax treaty shopping •abuse of a company’s legal form According to a question and answer session with a SAT official, an expert committee will be formed from within the SAT for each individual GAAR hearing. A GAAR investigation will normally be closed within nine months from the date when the local tax authority formally initiates the investigation. •transactions with companies registered in a tax haven to avoid tax •other business arrangements without reasonable commercial purposes. CONTENTS BACK NEXT 7694 PM-Tax | Wednesday 11 February 2015 7 >continued from previous page PM-Tax | Recent Articles The Chinese GAAR (continued) The PRC GAAR is likely to be a source of envy for HMRC. It appears to put the burden of proof firmly on the taxpayer to show that their arrangements are not tax avoidance; and there is a long list of information in article 11 that the taxpayer has to produce (including, ominously, a general reference to such ‘other information as the tax authority deems necessary’). The tax authority can also require the scheme promoter to provide information under article 13, which must be bad news indeed for some of the large global accountancy firms. •The burden of proof lies with the taxpayer. •If the taxpayer fails to provide supporting documents, the tax authorities can deem the tax to be payable. It remains to be seen how this process will actually work in practice •If, after review by the SAT, the tax authority rules against the taxpayer and issues a preliminary adjustment notice, the taxpayer has only seven days to appeal •With the expansion of the PRC’s double tax treaty network and the signing of tax information exchange treaties with major tax havens, it is likely the PRC tax authorities could have more ways to find out, from their overseas counterparts, information on overseas parties involved in a transaction. Contrast this with the UK GAAR, where (at least in theory) the burden of proof under FA 2013 s 211(1) rests firmly with HMRC to show, on the balance of probabilities, that the tax arrangements are abusive. The good news However, it is not all bad news. Those with business interests in the PRC (especially those who have tangled with the tax authorities before and suffered from cumbersome processes and a lack of consistency) may welcome some clarity: What are the tests and adjustments? The PRC tax authorities adopt a ‘substance over form’ test and a ‘reasonable commercial purpose’ test when examining possible GAAR cases. When those requirements are met, the Chinese tax authorities can: •The procedures and process of a GAAR investigation should now be more standardised than in the past •recharacterise the arrangement in whole or in part •The PRC GAAR only targets cross-border transactions •disregard the existence of a transaction party for tax purposes, or treat such a transaction party and other transaction parties as a single entity •A PRC GAAR investigation is the last resort of the tax authorities and it appears it will only be used when other remedies cannot secure the PRC’s taxing rights •recharacterise the relevant income, deductions, tax incentives, foreign tax credits, etc., or reallocate these items among transaction parties •The final decision on a PRC GAAR investigation lies with the SAT. This should help to prevent inconsistent treatments between taxpayers in similar circumstances •employ any other appropriate means to adjust the position. •A PRC GAAR case should be closed within nine months. Interestingly, the PRC tax authorities need not have much regard to the international tax position in making their adjustments. Article 21 makes it clear that when an adjustment in the PRC results in international double taxation or in abrogation of the protections in a double tax treaty, the taxpayer has to file an application for the relevant tax authorities to sort it out under the mutual agreement procedures in that tax treaty. If specific other anti-avoidance rules also apply (such as transfer pricing, thin capitalisation and controlled foreign enterprises, treaty limitation of benefits or beneficial ownership issues), then those rules take priority over the PRC GAAR. (In contrast, the UK GAAR takes priority over everything else.) Currently, the most frequent GAAR investigations in the PRC are related to offshore indirect share transfers under a circular 698 filing, especially where the offshore holding company to be transferred is located in a tax haven. Those facing circular 698 investigations will especially welcome a more regimented process with fixed deadlines. Applying mutual agreement procedures is a notoriously difficult, expensive and lengthy affair, with no certainty of outcome. This is much more favourable to the tax authorities than the requirement on HMRC to show in court proceedings that its proposed counteracting adjustments are just and reasonable before they can alter the tax treatment of a transaction under the UK GAAR. What should I do now? Although most normal commercial arrangements should not fall foul of the PRC GAAR, any international group involved in transactions in or with the PRC needs to be mindful of the potential for a GAAR investigation (or of being dragged into someone else’s). The bad news From the preceding paragraphs, the taxpayer might be forgiven for thinking it was all bad news. Indeed, certain aspects of the PRC GAAR are less than desirable: •The taxpayer only has 60 days (or at most 90 days if an extension is granted) to provide all the documents needed to prove that their transaction is not for the purpose of avoiding PRC taxes and has a reasonable commercial purpose CONTENTS BACK NEXT 7694 PM-Tax | Wednesday 11 February 2015 8 >continued from previous page PM-Tax | Recent Articles The Chinese GAAR (continued) The key point is to have the supporting data ready to send. Remember that the deadline is only 60 days. Article 11 has a list of what may be needed, but note that it is wide and includes: internal management data (board resolutions, memos and emails); contracts, supplementary agreements and payment receipts; and correspondence with other parties. For emails in particular, it will be important to avoid casual references to tax savings in the correspondence between the parties. Particular care may also be needed around confidentiality undertakings and non-disclosure agreements, with exclusions inserted to allow for GAAR disclosure, as such restrictions may not be a sufficient excuse for failure to supply information to the PRC tax authorities. Watch out for further developments. If the SAT decides a transaction is taxable due to a GAAR adjustment, the taxpayer still needs to negotiate with the local tax authority how the tax is calculated – how to determine the tax basis, what is the deemed income, etc. These areas do not yet have clear guidelines and will be subject to further negotiation with the tax authority. Lastly, if you are unfortunate enough to suffer a PRC GAAR adjustment, then good luck with avoiding double taxation at the international level. Unless further guidance emerges in the future, or the OECD manages to pull off a multi-jurisdictional agreement under its BEPS project (action point 15) and persuade the PRC to be a party, you are going to need it. Eloise Walker is a Partner specialising in corporate tax, structured and asset finance and investment funds. Eloise’s focus is on advising corporate and financial institutions on UK and cross-border acquisitions and re-constructions, corporate finance, joint ventures and tax structuring for offshore funds. Her areas of expertise also include structured leasing transactions, where she enjoys finding commercial solutions to the challenges facing the players in today’s market. E: [email protected] T: +44 (0)20 7490 6169 Robbie Chen is a Senior Associate in our Shanghai office. Robbie provides tax services on foreign direct investment, corporate restructuring, cross border M&A, and tax planning for companies and individuals. Robbie also gives VAT and customs advice in relation to import/export, bonded areas, and processing trades. E: [email protected] T: +86 21 6138 2527 CONTENTS BACK NEXT 7694 PM-Tax | Wednesday 11 February 2015 9 PM-Tax | Recent Articles Office of Tax Simplification: Final report on partnerships by John Christian The Office of Tax Simplification’s (OTS) final report on its review of the taxation of partnerships has recently been issued. Although the report is a “final report”, the OTS notes that further updates are likely to be issued – which reflects the sense in the report that progress still needs to be made in a number of areas. The key recommendations identified in the report are: •International: the report confirms a number of challenges for international partnerships around unclear application of double tax treaty provisions to partnerships/LLPs. The report acknowledges that these issues are only capable of resolution through treaty renegotiation but the issues may at least have been put on the agenda for current and future treaty negotiations. Other areas identified can more easily be addressed through changes in HMRC practice. These include certification of residence of LLPs and partnerships for double tax treaty purposes, the suggested use of a single composite tax return for international partnerships (rather than individual returns) and extension of the Double Tax Treaty Passport Scheme (DTTP) to partnerships (it is currently limited to UK companies). A number of other difficult areas are noted including foreign exchange (where there are no income tax rules equivalent to the corporation tax foreign regime), application of the remittance basis to partners and the rules applying to short term visitors. •Group Structures: the OTS notes the unclear legislation and lack of HMRC guidance in relation to group structures which include LLPs for corporation tax, CGT and IHT purposes. The OTS notes that the position in relation to IHT business property relief may need to be dealt with in legislation but that guidance from HMRC as to how they interpret group relief and entrepreneurs’ relief provisions would be helpful. •CGT: Statement of Practice D12: D12 sets out a number of important points of practice in relation to the chargeable gains treatment of partnerships. It is heavily relied on in practice as the underlying legislation is brief. Whilst the OTS interim report noted that it cannot be right for a key area of CGT to be largely governed by a statement of practice, the way forward agreed with HMRC (and the consensus of those the OTS consulted) is for D12 to be updated to reflect changes in business ownership and operation, rather than for the statement to be legislated. HMRC has agreed to produce an updated statement. •Entrepreneurs’ Relief: the application of entrepreneurs’ relief to partnership businesses and structures involving partnerships is unclear in a number of areas. The report recommends that technical questions raised by professional bodies in 2011 be addressed in the Partnership Manual and HMRC are understood to be dealing with this. •Operational and Other Issues: the report notes a number of technical areas where HMRC do not accept the need for change including the position on Gift Aid, VAT registration process, simplifying basis periods and allowing deduction of expenses from partners’ profit share. The report repeats the recommendation that HMRC create a “Head of Partnership” role and that an industry/HMRC liaison group focussing on partnerships be set up but to date HMRC has not accepted the need for these. The OTS process has been valuable in highlighting the numerous areas in which the tax treatment of partnerships is unclear and in achieving clarification and publication of HMRC practice in a number of areas, particularly the publication of the Partnership Manual. The reaction from HMRC to date in relation to the Head of Partnerships and liaison group recommendations is disappointing and until HMRC are more aware of the practical issues facing partnerships, they are likely to remain as an after thought in the tax regime. To take one example, it is difficult to see the policy reason for the DTTP process not to be available to partnerships with UK corporate partners. John Christian is head of our corporate tax team. He specialises in corporate and business tax, and advises on the tax aspects of UK and international mergers and acquisitions, joint ventures and partnering arrangements, private equity transactions, treasury and funding issues, property taxation, transactions under the Private Finance Initiative and VAT. E: [email protected] T: +44 (0)113 294 5296 CONTENTS BACK NEXT 7694 PM-Tax | Wednesday 11 February 2015 10 >continued from previous page PM-Tax |PM-Tax Our Comment | Cases Cases European Commission v United Kingdom (Case C-172/13) The UK’s cross-border group relief rules are compatible with EU law. The European Commission brought treaty infringement proceedings against the UK claiming that the UK’s cross border group relief rules make it “virtually impossible” for companies to claim tax relief on losses made by non-resident subsidiaries. The CJEU pointed out that losses sustained by a non-resident subsidiary may be characterised as definitive only if that subsidiary no longer has any income in its Member State of residence. It said that “so long as that subsidiary continues to be in receipt of even minimal income, there is a possibility that the losses sustained may yet be offset by future profits made in the Member State in which it is resident”. In the Marks and Spencer (M&S) case in 2005, the CJEU found that certain aspects of the UK rules on group loss relief were incompatible with the EU principle of freedom of establishment. It ruled that if a member state allows a resident parent company to transfer losses suffered to a member of the group established within that member state in order to reduce its tax liability, it must offer the same possibility with respect to losses incurred by a subsidiary established in another member state where all other possibilities for relief have been exhausted. The UK updated its corporate tax rules to reflect the decision in 2006. It pointed out that the UK had confirmed that losses sustained by a non-resident subsidiary could be characterised as definitive where, immediately after the end of the accounting period in which the losses had been sustained, that subsidiary ceased trading and sold or disposed of all its income producing assets. A second challenge that cross border group relief was not permitted before the UK changed its group relief rules in 2006 was dismissed on the basis that the Commission had not shown any situations in which cross-border group relief on M&S principles for losses sustained before 1 April 2006 had not been granted. The Commission claimed that the UK’s amendments relied on a particularly restrictive interpretation of the 2005 decision. It said that the UK’s definition of ‘exhausted’ is particularly restrictive because the determination that it is impossible for losses to be used in future must be made immediately after the end of the accounting period in which the losses are sustained. It argued that this should instead be considered at the time when the claim for group relief is made in the UK, otherwise cross border group relief would only be available if the overseas company had been liquidated before the end of the accounting period. The Commission’s challenges were therefore dismissed. Comment It is relatively unusual to see a tax decision of the CJEU which backs the UK, rather than the Commission, but this decision does follow the Advocate General’s opinion. However, the Court does not go as far as the Advocate General who suggested that a review of the “appropriateness” of the M&S decision was “both possible and necessary” because the regime had resulted in “a virtually inexhaustible source of legal disputes between taxpayers and the member states’ tax administrations.” The UK argued that the provisions do not make cross-border relief conditional upon the non-resident subsidiary having been put into liquidation before the end of the accounting period. It said that evidence of an intention to wind up a loss-making subsidiary and initiation of the liquidation process soon after the end of the accounting period would be taken into account. As a result of the decision, the UK’s cross border group relief rules are likely to continue in their present very restrictive form. Groups seeking to claim the relief therefore need to take quick action to close down loss making overseas subsidiaries. The UK told the CJEU that an intention to liquidate the subsidiary “soon after” the end of the accounting period would be taken into account. It remains to be seen how this will be interpreted in practice. The CJEU said that the Commission had not shown that cross border group relief would only be available if the subsidiary was liquidated before the end of the accounting period in which the losses arose. It said that under Section 119(4) CTA 2010 the assessment as to whether the losses could be used by the subsidiary must be made by reference to the situation ‘immediately after the end’ of the accounting period. It said “It is thus clear from the wording of that provision that it does not, on any view, impose any requirement for the subsidiary concerned to be wound up before the end of the accounting period in which the losses are sustained”. Read the decision CONTENTS BACK NEXT 7694 PM-Tax | Wednesday 11 February 2015 11 >continued from previous page PM-Tax | Cases Cases (continued) HMRC v National Exhibition Centre Limited [2015] UKUT 0023 (TCC) FTT finding on the facts in card processing fee case upheld but UT agrees referral to CJEU on scope of the financial services VAT exemption. Before the FTT, the National Exhibition Centre (NEC) had been successful in reclaiming the VAT it paid on the booking fees it charged where customers purchased concert tickets by means of debit or credit cards. NEC had paid VAT initially believing that the card payment services constituted part of the single supply for events, but succeeded in its reclaim on the basis that it was a separate and distinct supply of card services which should be exempt. As for the challenge on Edwards v Bairstow grounds, the UT made it clear that it was not possible for the UT to exercise a fresh fact finding enquiry. Instead, the UT had to focus on whether the conclusion of the FTT was one that was not reasonably open for it to make, which would only then amount to an error of law. In determining whether the FTT was able to reach the conclusion that it did, the UT considered all the evidence that was open to the FTT. The UT said that the finding of the FTT was one which was possible to be made. It also said that the FTT was correct to adopt an approach which considered the true commercial reality of the situation. Doing so followed the Court of Session’s decision of Scottish Exhibition Centre and, whilst not binding, “it has long been the position that the interpretation of tax legislation ought, so far as possible, to follow the decisions of the cross-border court.” HMRC did not challenge the FTT’s finding that the booking service supplied by the NEC was for its own account and not as agent for the event promoter. Instead HMRC claimed that the FTT asked itself the wrong question in finding that the booking fees charged by the NEC amounted to a “payment card processing service”, and secondly that the FTT made an error of law under Edwards v Bairstow principles because the conclusion was not one reasonably and properly open to it. HMRC’s appeal relating to the supply was dismissed. The FTT agreed to refer to the CJEU the question of whether card processing services fell within the financial services exemption. The parties asked that if the UT dismissed HMRC’s appeal, the case should be referred to the CJEU on the question of whether card processing services were exempt from VAT pursuant to the exemption for financial services. Comment The issue of whether the card processing services are within the VAT exemption for financial services has also been referred to the CJEU by the FTT in the recent case of Bookit. It is to be hoped that the CJEU will provide some clarity on the issue. The UT considered its jurisdiction, and confirmed that it could only hear appeals relating to matters of law. The UT therefore dismissed HMRC’s first ground of appeal, saying that it was clear from its judgment that the FTT had considered the issue from the point of view of the consumer, and that in asking itself the correct question the UT had not made an error of law. Read the decision CONTENTS BACK NEXT 7694 PM-Tax | Wednesday 11 February 2015 12 >continued from previous page PM-Tax | Cases Cases (continued) PricewaterhouseCoopers LLP & Another v HMRC [2015] UKFTT 0007 (TC) The UK’s block on the recovery of input VAT on business expenses is lawful in spite of the way it was re-enacted in 1988 and a CJEU referral was refused. PWC appealed against HMRC’s refusal to allow the repayment of input tax incurred in relation to non-employee business entertainment. PWC said the block on recovering input tax on business entertainment in the UK has been unlawful since 1988. PWC claimed that the effect of the unlawful extension to the input tax block in 1988 was that the entire block became unlawful under EU law in relation to all business expenses, i.e. not just those relating to overseas customers. PWC claimed that it should be able to reclaim input VAT on all business expenses and argued that a reference to the CJEU was required to determine the issue. When the Sixth VAT Directive (6VD) was introduced, it envisaged that the EU Council would publish rules regarding the deductibility of business expenses. Those rules were never introduced, but Article 17(6), 6VD included a transitional provision allowing member states to continue to use the rules relating to business expenses that were in effect prior to the introduction of the 6VD. Judge Barbara Mosedale dismissed PWC’s reliance on the Advocate General’s opinion in Van Laarhoven. She said that any ambiguity in the Advocate General’s opinion would not amount to a sufficient reason for a referral to the CJEU. Before 1988 the UK had rules blocking the reclaiming of VAT on business expenses which included an exemption allowing input tax recovery on business expenses relating to overseas customers. In 1988 (after the introduction of the 6VD, which was directly effective) the existing rule was repealed and Article 2 of the Value Added Tax (Special Provisions) (Amendment) Order 1988 contained an input tax block on the recovery of business entertainment expenses which did not contain an exception for entertaining overseas customers. Judge Mosedale also found that there was no further case law which could support PWC’s case. In fact, she agreed with HMRC that another decision, Ampafrance, defeated PWC’s argument directly. In that case a narrow block existing prior to the 6VD had been repealed, and then a wider block enacted post-6VD. The FTT said that Ampafrance is authority for a block introduced after the 6VD to be valid to the extent that it corresponds with a pre-6VD block, even if the rest of the new law has no legal effect. Given these findings, the FTT did not make a reference to the CJEU and dismissed PWC’s appeal. Judge Mosedale was also not swayed by PWC making clear their intention to appeal should their case fail, stating that the test for being allowed to appeal is lower than that for a reference. The UK government accepted in Danfoss that the extension to the block by removing the overseas customer exemption was unlawful, and ultimately reversed the legislation. The government also made refunds where input VAT had been incurred on supplies to overseas customers. Comment As PWC made it clear that they would be appeal the decision if they were unsuccessful, we have probably not heard the last of this case. Read the decision CONTENTS BACK NEXT 7694 PM-Tax | Wednesday 11 February 2015 13 >continued from previous page PM-Tax | Cases Cases (continued) HMRC v Astral Construction Limited [2015] UKUT 0021 (TCC) Development of nursing home incorporating redundant church building was a zero-rated supply. Astral supplied construction services relating to the development of a nursing home on the site of and incorporating a redundant church. The church building formed the main entrance and reception area of the nursing home post-development, with new 2-storey ‘wings’ being added either side of the church, which were collectively around six times the size of the church building. The UT upheld the FTT’s decision, agreeing that the question of whether the works were a conversion or enlargement/extension of the church was a “question of fact, degree and impression”. The UT therefore upheld the FTT’s decision that the “sheer scale” of the development works meant that “as a matter of impression, size, shape, function and character” the nursing home was “so vastly different” from the existing church so as to preclude a finding that it constituted a conversion or enlargement of the church. Astral treated the supplies as zero-rated on the basis that they were made in the course of the construction of a building designed for use for a relevant residential purpose (i.e. as a nursing home). HMRC disagreed; it decided that the works were not the construction of a building but the extension or conversion of an existing building which qualified as a special residential conversion (under Item 1, Group 6, Schedule 7A VATA), such that the supplies were eligible for the reduced VAT rate of 5%, but were not zero-rated. The UT also rejected HMRC’s contention that there must be a construction of a completely new building (i.e. without incorporating an existing building such as the church) in order to qualify as a zero-rated “construction of a building” under Item 2 of Group 5 of Schedule 5 to the VAT Act. Comment This case demonstrates that there is no exact measure of what will constitute a ‘construction’ of a building for the purposes of the relevant VAT legislation and what will be an ‘extension’ or ‘conversion’. It will be a matter of fact and degree and involve a comparison of factors such as the size, function, character and impression of the premises pre and post-development. The fact that an original building has been retained and incorporated into the structure of the post-development premises will not in itself mean that the works are an extension or conversion as opposed to a construction. Astral’s appeal to the FTT was upheld, the FTT finding that the nature and extent of the development works meant that the nursing home was neither a conversion nor an extension of the existing church. HMRC appealed to the UT. Read the decision CONTENTS BACK NEXT 7694 PM-Tax | Wednesday 11 February 2015 14 >continued from previous page PM-Tax | Cases Cases (continued) Biffa (Jersey) Ltd & Another v HMRC [2015] UKFTT 0010 (TC) Costs awards follow the successful party in each appeal, even if two related appeals resulted in one win for the taxpayer and one for HMRC. Biffa (Jersey) Ltd (Jersey) took part in a scheme which failed before the FTT. The scheme involved Jersey buying its own shares from another group company, BHL for £200 million and then cancelling those shares. A year later BHL bought 200 further shares in Jersey for £214 million from another Biffa group company and again sold the shares back to Jersey, but for £200 million. Jersey claimed that HMRC should pay its costs on the basis that Jersey had appealed against an assessment amounting to over £14 million and only paid £500,000, effectively succeeding in respect of 95% of the tax at stake. BHL said HMRC should pay its costs as its appeal had been succeeded in full. HMRC claimed Jersey should pay 65% of its costs. It said that the Biffa companies took part in the same scheme and therefore should not be assessed on costs separately. HMRC also argued that the arguments against each company were in the alternative, and therefore, success in one meant that HMRC had defeated the scheme. HMRC did reduce its costs claim however, to 65% on account of dropping its claim against BHL only a few months before the hearing. BHL claimed that the £14 million difference between what it paid and sold the shares for should be treated as interest under a deemed loan and therefore an allowable deduction. HMRC denied the deduction for BHL and assessed Jersey on the basis that the £14 million deemed loan was income. Jersey and BHL appealed to the FTT. In an earlier decision the FTT found that Jersey was liable to corporation tax on the loan. However, the parties had agreed that the assessment could only be raised in relation to a small period of time due to time limits. The taxable interest was therefore only £500,000. HMRC did not succeed on an alternative argument which would have meant the full amount was taxable. Shortly before the original hearing HMRC said it would not contest BHL’s appeal and the FTT therefore found for BHL in its appeal. The FTT decided that Jersey was not entitled to costs for its appeal and that costs should be awarded to HMRC as the FTT had ruled in favour of HMRC and the only reason for the reduction in the tax due was as a result of HMRC overlooking a time limit. The FTT said that HMRC’s case against BHL was distinct from that against Jersey. The FTT relied on the earlier FTT decision of Versteegh Ltd to find that because the arguments against Jersey and BHL were not made in the alternative, BHL was successful in its appeal and should be awarded costs despite the scheme’s failure overall. The FTT now had to deal with three applications. First, Jersey asked the FTT to amend its decision to make clear that it was successful in part, with the decision adjourned for the parties to agree figures. The FTT refused, stating that this was not the case and that it had not allowed an appeal in part, but instead gave a decision in principle in HMRC’s favour. It made clear that the parties had agreed between themselves that only £500,000 could be properly assessed because the remaining interest had occurred in an earlier, now protected, period. The FTT then considered whether it should make a general costs order “to reflect the overall justice of the case” in light of BHL and HMRC being successful in related appeals. The FTT rejected HMRC’s reduction of its costs to 65% as having no justification. The FTT considered other ways to apportion responsibility for costs, including by reference to the number of issues won or the number of appeals won, but rejected them all. It decided to not make a costs order that “depart[ed] from the straightforward approach of ordering the unsuccessful party in each appeal to pay the costs of the successful party, even where the two appeals are connected.” The FTT said that the possibility of BHL’s costs being more than HMRC’s was a litigation risk and one that HMRC could have avoided by reviewing its case against BHL earlier than a few months prior to the hearing date. Comment This interesting decision shows that the tribunal will not easily depart from the principle that costs are awarded to the successful party – even if multiple appeals relate to essentially the same scheme. There is a risk that HMRC will lose out in this case as its costs could well be much lower than BHL’s. Read the decision CONTENTS BACK NEXT 7694 PM-Tax | Wednesday 11 February 2015 15 PM-Tax | People People Tori Magill joins our Contentious Tax Team We are very pleased to announce that Tori Magill has joined our Contentious Tax Team. Tori is a Director specialising in fraud and avoidance investigations, with experience gained in HMRC’s highest profile investigation roles. Tori is a former Group Leader in HMRC’s Specialist Investigations (SI) directorate, responsible for HMRC’s most complex fraud and avoidance investigations and litigation. Previously Tori was a Criminal Investigations Team Leader specialising in Organised Crime and Technical Taxes, and was HMRC’s policy expert for HMRC’s Criminal Investigations and Civil Fraud Investigations for direct tax, indirect tax and Excise duties. She was also responsible for the design and implementation of the Contractual Disclosure Facility for civil fraud investigations, and was the policy owner of HMRC’s Offshore Disclosure facilities. Prior to joining HMRC, Tori worked in a top 10 accounting firm where she lead their Tax Litigation and Dispute Resolution Team, and headed up the firm’s Tax Transparency policy. Tori said; “I am delighted to be joining what is currently the only Tax Team in the UK market that can offer clients the full spectrum of Contentious Tax services. The renowned expertise of the individuals and the market-leading collective creates a formidable client service offering. The team aims to be the firm of choice for all contentious tax issues, and I am very much looking forward to the challenge of being a part of achieving that.” Tori is the LexisNexis Litigation and Disputes Expert and her latest article will be published in Tax Journal this month (and will appear in the next edition of PM-Tax). She tweets as @tori_magill. Tori Magill Tax Director T: +44 (0)20 7490 6419 M: +44 (0)7825 692250 E: [email protected] Tell us what you think We welcome comments on the newsletter, and suggestions for future content. Please send any comments, queries or suggestions to: [email protected] We tweet regularly on tax developments. Follow us at: @PM_Tax PM-Tax | Wednesday 11 February 2015 CONTENTS BACK This note does not constitute legal advice. Specific legal advice should be taken before acting on any of the topics covered. Pinsent Masons LLP is a limited liability partnership registered in England & Wales (registered number: OC333653) authorised and regulated by the Solicitors Regulation Authority and the appropriate regulatory body in the other jurisdictions in which it operates. The word ‘partner’, used in relation to the LLP, refers to a member of the LLP or an employee or consultant of the LLP or any affiliated firm of equivalent standing. 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