Ernst & Young UK weekly tax news
Week ending 20 November 2009 In this issue
UK tax news
HMRC
HMRC Brief 69/09: Intrastat changes from 1 January 2010 (click here)
HMRC Brief 70/09: HMRC policy on 'electronic lottery terminals' and liability to VAT and Amusement Machine Licence Duty (click here)
New system for PAYE being introduced in three phases (click here)
Tax Law Rewrite – Corporation Tax and International and Other Provisions (click here)
Statutory Instruments
The Value Added Tax (Amendment) (No. 4) Regulations 2009 SI2009/2978 (click here) and explanatory memorandum (click here)
The Offshore Funds (Tax) Regulations 2009 SI2009/3001 (click here) and explanatory memorandum (click here)
The Enactment of Extra-Statutory Concessions (No. 2) Order 2009 Draft SI (click here) and explanatory memorandum (click here)
International tax news
Germany, India
Totalization agreement: Employee Provident Fund Organization releases Frequently Asked Questions and application form for Certificate of Coverage
Hungary
New Hungarian tax law change affects group financing companies
Russia
New draft transfer pricing law released
Spain
Spanish real estate investment (listed) companies regime
Taiwan
Ministry of Finance rules that foreign source income will be subject to the Alternative Minimum Tax from 1 January 2010
Tax cases
Grace v HMRC (Court of appeal)
Mr Grace was an airline pilot working for BA. He had previously lived in the UK but subsequently bought a house in South Africa. The Special Commissioner held that the rules applicable to temporary residents (now s832 ITA 2007) applied and on that basis Mr Grace was non-resident. The High Court rejected this argument and concluded that, on the facts. Mr Grace was clearly UK resident.
Lord Justice Lloyd approached the case from the perspective of the general rules on residence. Having confirmed that there was no statutory definition of residence for tax purposes, the judge reviewed the a list of case law authorities as providing the best guidance on the context and meaning of residence.
The judge agreed with the High Court that s336 TA 1988 (now s832 ITA 2007) was not applicable. although this was not directly in point. Whilst the judge accepted that Mr Grace was not in the UK with the intention of establishing residence, this was only part of the test. The presence in the UK as the base from which he operated as a pilot did not fit within the test "for some temporary purpose only".
LJ Lloyd then agreed with the High Court that even if the rules in s336 were not satisfied that it did not follow that Mr Grace was UK resident. The fact that Mr Grace was not in the UK for temporary purposes only did mean that UK residence had been proved according to the common law test.
Where LJ Lloyd differed from the High Court was in determining whether Mr Grace was UK resident. The judge cited Lysaght as saying that regular periods of physical presence may amount to residence but did not think that Lysaght went so far as to say that such regular presence did amount to residence. Accordingly he remitted the issue back to the First Tier Tribunal.
The other Lords in the Court agreed with Lloyd's judgment.
Full transcription
HBOS Treasury Services (First Tier Tribunal)
The case covered effectively three issues:
- The terms on which novations of derivative contracts may be tax neutral
- Whether the fee paid in respect of the novation was deductible
- How the value shifting rules applied if at all.
HBOS Treasury Services (‘Treasury Services’) held various swaps with AIG that had a positive value of approximately £180m. The HBOS plc group also had substantial other credit exposure to AIG which it wished to reduce. In order to do this, Treasury Services formed a new subsidiary (‘Dorus’) and subscribed for shares in return for £180mn cash. Treasury Services subsequently novated the valuable swaps into Dorus in return for £180m cash. Treasury Services treated the receipt as tax free as the group transaction provisions of paragraph 28 Schedule 26 FA 2002 were assumed to apply such that the intra group transfer should be disregarded for tax purposes. Treasury Services then sold the shares in Dorus to a third party, Swiss Re, for approximately £150m. The expectation was that within the Swiss Re group it would be possible to monetise the swaps without the then holder being taxed on the receipt of the £180m (otherwise Dorus would only have been worth £126m being the £180m net of the tax liability).
There were three points in dispute on which the Tribunal were required to decide. Firstly, whether the novation of the swap should be treated as an intra group transaction and ultimately that the novation would be disregarded for tax purposes (per para 28 Sch 26). Secondly, whether Treasury Services was entitled to a deduction for the fee that it paid. The third item involved determining whether, in the event the novation was tax neutral, the shares in Dorus (which were subsequently sold for £30m less than the subscription price) should realise a capital loss for Treasury Services or whether the transaction should be adjusted under the value shifting provisions. If it was found that the value shifting provisions were in point, there was then the additional question of by how much the consideration for the disposal of the Dorus shares should be adjusted.
In order to determine whether the novation of the derivatives to Dorus fell within paragraph 28, there was much discussion as to whether the words of paragraph 28(1) should be taken in a narrow fashion or interpreted more broadly to reflect the commercial context in which the provision was to operate. The Tribunal found in favour of HMRC (ie that Dorus had not replaced Treasury Services as a party to the original derivative contracts and, as such, the transaction should not be treated as tax free). This was on the basis that para 28(1) did not apply to the novation as that situation was instead governed by para 28(4). As the novation in question did not meet the equivalence test in para 28(4) the novation was not within the ambit of the paragraph and was not a tax neutral transation.
The Tribunal did accept that the fee paid by Treasury Services was deductible for tax purposes.
As the Tribunal found that cash received by Treasury Services was taxable there had been no ‘tax free benefit’ in respect of the disposal of the shares and thus the value shifting legislation was not in point. However, in case the Tribunal’s determination of the application of paragraph 28 was overturned on appeal the third question was also considered. Treasury Services chose between two similar schemes from different promoters. The primary difference between the arrangements put forward was the pricing of the shares. The scheme which was ultimately implemented prima facie enabled Treasury Service to realise a capital loss on the sale of the Dorus shares. As a result, the Tribunal concluded that the pricing of the share subscription and novation was selected deliberately in order to avoid a capital gain and to generate an ‘unrealistic’ loss.
Approach to construction
The Tribunal’s decision is limited to the specific issue of the construction of para 28 and its application to the novation in question. The approach of the Tribunal in determining how para 28 should be interpreted is interesting, however.
The key phrase in para 28(1) was ‘the transferee [to replace] the transferor as a party to the derivative contract’. HMRC’s contention was that a novation never satisfied this as the transferee never became a party to the original contract.
The taxpayer’s contention was that ‘replace’ was not a word with any particular legal meaning. In the context of derivatives, where it was contemplated that asset and liabilities would be transferred, it appeared therefore that a wide meaning should be given to the word replace. The position could be differentiated from that for loan relationships.
The Tribunal’s starting point was to give para 28(1) a wider commercial interpretation in the context of the overall derivatives code, than the strict wording of the paragraph in question. To do otherwise would be to make definitions elsewhere in the code potentially meaningless.
The Tribunal then considered the relevance of para 28(4) and whether that amended the need to give a broad interpretation of para 28(1). The Tribunal held that the existence of para 28(4) explained why para 28(1) was written narrowly – as it was expanded by para 28(4) to apply to novations. There was no longer anything obviously contradictory to the intentions of Parliament in reading para 28(1) narrowly.
The construction of a particular piece of legislation can therefore be influenced by
- The general context of the legislation and the commercial transactions to which it is intended to apply
- Any specific legislation which qualifies or narrows the initially wide scope of the legislation in question.
Full transcription
Cooksey v HMRC (First Tier Tribunal)
Issues associated with allegations of possible fraud
The case summarises how a number of issues are impacted by allegations of possible fraud, namely:
- how HMRC's Code of Practice 9 (suspected serious fraud) interacts with criminal proceedings
- what is the burden of proof in discharging an assessment (and whether this burden is affected by an allegation of fraud)
- whether the question of discovery is changed by an allegation of fraud.
The Tribunal cited Brady v Group Lotus Car Companies as support for the fact that it is for taxpayer to show that an assessment is wrong. HMRC may allege fraud but they do not take on the burden of proving it. As to discovery, the Tribunal cited Aramayo as support for the proposition that discover means only "comes to a conclusion from an examination".
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