Offshore property development and investment companies and UK corporation tax:the changing landscape
10 Feb 2017
Written by Paul Hotchkiss
It seems that the last few years have brought an onslaught of measures aimed at bringing non-UK residents within the UK tax net, something which is as true for non-resident companies as it is for individuals. In relation to offshore companies engaged in developing property in the UK, there have been two developments in the last 18 months which have changed the landscape for such companies significantly. We understand that HMRC are starting to follow up on these changes with a letter writing campaign. In this article we take a general look at the current environment for offshore property development companies in view of the recent changes, as well as considering issues that all offshore companies need to be aware of, such as the current view on corporate residence and the IOM/UK Double tax treaty (DTA). We also consider HMRC’s attitude to tax compliance and UK tax liabilities of non-UK resident companies, and what you should do if you receive a letter from HMRC querying your companies possible liability to corporation tax (CT) (both currently and historically): this is becoming increasingly commonplace. We expect HMRC to focus significant efforts in this area in the next year or so. Finally we will consider the UK Government’s proposal to bring non-resident property owning investment companies within the CT net.
We will first consider HMRC’s change in approach.
Change in interpretation of IOM/ UK DTA – November 2015
As you may be aware, HMRC changed its interpretation of the current DTA in November 2015. Ordinarily double tax treaties contain provisions to allocate taxing rights and to determine the tax residence of treaty parties, eg individuals and companies. The DTA of 1955 was commonly thought to contain no such provision. However, in late 2015 HMRC published their view that the DTA does have and always has had a corporate residence tie-breaker. The DTA tie-breaker is ‘old-fashioned’: it is not based on the OECD model treaty, nor on the well-known concept of central management and control (a subtlety which isn’t always identified). Under the DTA a company:
“shall be regarded as resident in the United Kingdom if its business is managed and controlled in the United Kingdom and as resident of the Island if its business is managed and controlled in the Island”.
The CSP industry on the Island, amongst other Manx professionals, are well-versed in the concept of central management and control (colloquially and often incorrectly referred to as ‘mind and management’) as a determinant of corporate residence. Most such Isle of Man professionals are used to trying to ensure that companies are solely tax resident on the IOM (assuming this is appropriate). As we know, central management and control is normally taken to mean “the highest level of control of a business”, or the place where strategic decisions are taken. However, the concept of ‘management and control’, often present in colonial-style treaties, looks at a lower level of control, similar to the concept of ‘place of effective management’ (POEM), which is commonly found in the tie-breaker clauses in DTAs based on the OECD model treaty. POEM is defined as the
“place where key management and commercial decisions that are necessary for the conduct of the business of an entity as a whole are in substance made”.
If we consider HMRC’s change in interpretation, if management and control of a business is in the UK, and not also in the IOM, a non-UK resident company by incorporation could be UK resident under the DTA by management and control, and therefore subject to CT on its worldwide profits. Furthermore, if the management and control of a company is in both the IOM and the UK, HMRC’s view is that this company is outside the DTA, ie both countries have taxing rights. In this case, reference needs to be made to domestic law, ie in the UK if the company’s central management and control is in the UK it would be UK resident under case law, but also Manx resident by virtue of incorporation. The effect is the company will have to file returns in both the UK and the IOM and therefore will be subject to CT in the UK.
Trading in the UK by a PE
Until July 2016, the second and only other way that an offshore company could be within the UK CT net was if it traded in the UK through a UK PE.
Again many of our professional CSP staff, will be familiar with the PE definitions for UK tax purposes. There are both the UK domestic definition and the DTA definitions to consider, noting the DTA takes precedent over UK domestic law. From a DTA perspective, a PE can either constitute a branch, management or other fixed place of business through which the business (business is a wider concept than trade) of the company is wholly or partly carried on (noting the concept of business is wider than trade) or where an agent exists in the UK who acts on behalf of the company and who has and habitually exercises the authority to do business on behalf of the company. Note: a ‘building site or construction or installation project’ is specifically listed as constituting a PE as a matter of UK domestic legislation but not in the DTA.
For many years non-UK resident property development companies have locked horns with HMRC over whether a building site in the UK is a PE within the DTA definition. The reason for this was that the DTA exempts the industrial or commercial profits of a Manx enterprise from UK tax unless the business is conducted in the UK through a PE. Various arguments why a building site does not constitute a PE or why no taxable profits arise from such a PE have been expounded over the years: eg there is no definition included in the DTA therefore there cannot be a PE, if a third party contractor is used it is not the company’s PE, it belongs to the contractor, no profits can be attributed to the PE because a third party contractor is charging arm’s length fees. I am not saying these approaches are correct: they are the arguments sometimes used or prepared to be used. However, many developers do not or have not claimed treaty relief: they have simply assumed the profits are exempt from tax. As a result HMRC have often been blind to the quantum and existence of any profit arising.
The UK Government has tried to put the treaty point beyond doubt on several occasions. They did this firstly by amending the DTA, and then, in July 2016, they amended the territorial scope of CT so that a non-UK resident company is now within scope of CT if it carries on a trade of dealing in or developing UK land (for the purposes of disposing of it). The new legislation is complicated, broad in its scope and sometimes unhelpfully vague. The guidance, issued in December 2016, has added some clarity, and reassurance that genuine investment transactions will not be caught:
“These rules do not alter the treatment of or recharacterise investment activities, except where they are part of such a wider trading activity. In particular, they do not apply to transactions such as buying or preparing a property for the purpose of earning rental income, or as an investment to generate rental income and enjoy capital appreciation.”
The legislation is however intentionally drafted to catch most if not all offshore companies developing and trading property in the UK (or assets deriving their value from UK property) with a view to selling it, rather than retaining it for investment purposes. An example of the type of transactions which can be caught include selling shares in a company which derives its value from UK property. In summary, with regard to non-UK resident companies dealing or developing UK land the treaty is no longer in point: what matters now is the distinction between trading and investment. This in itself can give rise to many oddities and uncertainties: in reality most, if not all, UK property related transactions ought to be considered to make sure these rules do not apply.
However, the historic position is still very much of interest to HMRC.
HMRC letter writing campaign being launched
We understand that HMRC are in the process of sending out letters to offshore companies who they believe may have developed or traded property in the UK. From what we understand, these letters are focussed on whether the companies are or were within scope of CT in respect of their UK activities. We understand that to date a few hundred letters have been sent out, with thousands more potentially on the way.
The prize for HMRC is of course large and they don’t necessarily have to consider whether there is a PE or not if they can successfully challenge corporate residence, or more correctly ,whether the DTA actually applies because of the ‘looser’ meaning of management and control as opposed to central management and control. If management and control of these companies is in the UK, then they are resident in the UK for corporate tax and therefore subject to CT on any profits and chargeable gains. Failing that HMRC has the PE argument to pursue, with the result that any profits attributable to it are brought within the CT net.
Our understanding is that this initiative initially relates to property development companies; however, in our view any offshore company with a UK presence should be mindful of the issues and ensure that they are operating in such a way that they do not leave a footprint for UK tax purposes. All is not lost though: HMRC will have to prove where the place of management and control is and assuming this is in the Isle of Man they will then need to prove a PE exists in the UK and, if it does, assess the level of profits (if any) which might be attributed to it. We are dealing with complex concepts here and any enquiry may result in HMRC demanding sight of all minutes, e-mails and contracts and similar.
What about the possible change relating to investing companies?
For many years, offshore companies investing in land and property would register under the non-resident land lord scheme, receive rents gross and then submit UK income tax returns. Occasionally HMRC would raise enquiries, but in our experience this rarely happened; the enquiries we have seen often related to the deductibility of loan interest and similar. However, the UK Government have long held the view that they ‘lose’ a significant amount of tax in this area. Their answer seems to be to bring such companies within the scope of CT, and they are to consult on this. Frankly, if loss of tax is happening it makes sense. Bringing a company within the scope of CT means a whole host of changes: CT self-assessment returns and tagging of accounts, the general CT rules including transfer pricing, loan relationship rules and deductibility of loan interest will all be in point - to name but a few. This is likely to result in three things: (1) make tax return completion a lot more complex;(2) provide HMRC with much more information and (3) increase the risk of enquiries into the historic position of companies.
It is commonplace to come across property investment companies that ‘push the envelope’ in areas such as loan interest deductibility. It may be time to look at policies in this area to make sure any such policies adopted are defensible.
How can we help?
At Hotchkiss Associates we are very familiar with the concepts involved having some 20 years experience in both advising on the current and historic application of the DTA, investing v trading in general terms, corporate residence plus the New Land trading rules. Furthermore we advise extensively on property investment companies. Please contact us on 00 44 1624 872140 or firstname.lastname@example.org for an initial chat if you would like more information or have companies which might be affected: these matters cannot be ignored, especially when the letters arrive.