Tax Services

Updates on the ‘fair tax’ debate

There have been a number of developments in the last week across the various strands of the ‘fair tax’ debate.

Evidence taken by UK and US Government committees

The evidence given by Google and Ernst & Young to the Public Accounts Committee on 16 May was accompanied by further evidence given by HMRC as to the way it approached the tax affairs of multinationals, in light of the questions put to Google. In addition, on 21 May, the US Senate Permanent Subcommittee on Investigations has taken evidence from Apple as part of its examination of the structures and methods adopted by multinationals to shift profits offshore and how such activities are affected by the US tax code. Finally, on the same day, as part of its enquiry as to whether a new approach is needed to taxing multinational groups, the House of Lords Economic Affairs Committee heard from representatives of accountancy firms as well as charities and non-governmental organisations (NGOs) who campaign on issues around corporation tax.

OECD Base Erosion and Profit Shifting (BEPS) project

Ahead of the scheduled publication by the OECD of the BEPS action plan in July 2013, HM Treasury and HMRC held an interactive half day event on 17 May 2013. The meeting was attended by business representatives, advisers and NGOs.

As a next step, the OECD annual forum will be held in Paris starting on 27 May, coinciding with the OECD Ministerial Council meeting. This year BEPS is on the agenda with the programme item Too Big to Pay Tax? on 29 May.

EU Finance Ministers (ECOFIN) meeting

The meeting of ECOFIN on 14 May reached an agreement on Council Conclusions on tax fraud, tax evasion, and aggressive tax planning. These Conclusions will be discussed by Heads of State at the meeting of the European Council on 22 May 2013.

In the Conclusions, the Council reaffirms that “all Member States recognize the importance of taking effective steps to fight tax evasion and tax fraud”, and recognises the need to tackle aggressive tax planning. More detail as to the Conclusions is available in our Global Tax Alert.

Tax Forum

The Forum on Tax Administration, comprising tax commissioners from 45 countries, met in Moscow on 16 and 17 May. It issued an agreed communiqué expressing commitment to co-ordinated action and determination to improve the effectiveness of the tax administrations and tackle trans-national tax fraud, tax evasion and aggressive tax planning. The Forum called for increased transparency and comprehensive exchange of information and welcomed the OECD BEPS project.

It stressed that the members of the Forum had developed a framework of co-operative compliance for the large business segment and would ensure that the way tax treaties are administered is effective in eliminating double taxation. To that end it was noted that a new Forum sub-group of competent authorities had been established, tasked with developing and implementing necessary improvements.

Labour party publication Corporate tax: transparency and reform

On 19 May, the Labour Party published a policy document which summarises the actions that Labour believes should be taken in relation to tax avoidance and transparency. In relation to tax transparency, the document states that Labour will push for the G8 to deliver “internationally agreed action on tax transparency” to pursue a new system of disclosure for multinational companies, extend tax disclosure rules to global transactions and require tax havens to pass on information about individuals operating through companies or trusts. If multilateral action cannot be agreed upon, Labour will consider unilateral action by the UK.

On tax avoidance, Labour will examine the effectiveness of the general anti-abuse rule, whether the transfer pricing rules can be improved (particularly in relation to intangibles) and consider what powers HMRC might be given to strengthen the corporate tax regime in the UK.

The ‘fair tax’ debate looks set to continue for some time and we will continue to update you on the various developments.

Meaning of interest: Upper Tribunal decision in Pike

The Upper Tribunal has rejected the taxpayer's appeal in Pike holding that a sum described as a premium payable on redemption amounted to interest. As a result, the security on which the taxpayer was claiming a loss was not a ‘relevant discounted security’ and, as such, the loss claimed was not allowable.

In reaching this decision, the Upper Tribunal repeated the reasoning of the First-tier tribunal that interest is a time-based return. The fact that, in this case, the entitlement to 7.25% return per annum clearly accrued on a daily basis, meant that it was, in reality, interest. The Upper Tribunal held that the description of the amount as a premium was not itself determinative. Also, the fact that the timing of the payment was such that the return would not be received until the loan itself was repaid was neutral and did not indicate whether that amount was a premium or a payment of deferred interest.

This case is a reminder that, as with all legal documentation, simply calling an instrument by one name does not make it so. The form of the instrument will be especially important when drafting a discounted instrument.

Proposed changes to the taxation of partnerships

The consultation published by HMRC on 20 May 2013 proposes making a number of changes to the way in which partnerships are taxed.

Limited liability partnerships (LLPs) and ‘salaried members’

At present, the law provides that members of an LLP are taxed as though they are partners in a partnership and deemed to be partners for all tax purposes, even though an LLP is a body corporate. The consultation document proposes removing this presumption and requires, instead, that the terms of each individual's membership are considered to determine whether they most closely resemble that of a partner in a partnership or that of an employee

Profit and loss allocations – partnerships with ‘mixed members’

There are a number of changes proposed to partnerships with ‘mixed members’. Partnerships with ‘mixed members’ are primarily those with a mixture of individual and corporate members, but also include partnerships with resident and non-resident members.

For partnerships with mixed members, the consultation proposes the introduction of motive tests with regard to the allocation of profits or losses. Where one of the main purposes of the allocation of profits is to secure a tax advantage, those profits can be reallocated in certain circumstances. Where one of the main purposes of the allocation of losses is to allow a partner to obtain a reduction in tax liability (ie to claim relief against income or capital gains tax) no relief will be given for that loss.

Transfer of profits in exchange for payment

There are also proposals to deal with circumstances where one person contributes capital to a partnership or makes a payment to another member in return for receiving a new or increased share of the profit. Again, in these circumstances there will be a motive test and where one of the purposes of the arrangement is to secure a tax advantage the payment which is made will be taxable on the person receiving it as though it were profits of the partnership.

The changes are intended to be included in Finance Bill 2014 and will be effective from 6 April 2014. This consultation, which asks for replies by 9 August, is independent of the Office of Tax Simplification's forthcoming review of the taxation of partnerships.

Impact of the statutory residence test (SRT)

With effect from 6 April 2013 the UK Government will introduce a statutory test of personal tax residence and reform the tax treatment of employees who are not ordinarily resident in the UK. Both reforms replace a diverse and confusing body of existing law and practice. One of the main objectives of these reforms is to give taxpayers certainty as to their residence position whilst ensuring that most people would be unaffected by the new rules.

The SRT, and associated reforms being developed in support of it, will be a key benefit to UK employers by reducing the costs of relocating employees in the UK. To this end, it is a helpful alignment of personal tax policy with wider trends in UK corporate tax policy, both of which can be said to support the UK's commitment to lead the G20 in competitiveness.

However, an unwelcome side effect will be an increase in the cost of moving employees into the developing markets where UK business needs to excel to succeed.

The key issue will be how quickly organisations react to the risks and opportunities that the new rules set out. For more insight as to the medium term impact on UK businesses and their mobile employees, please see our Human Capital Services alert.

First-tier Tribunal considers operation of the construction industry scheme (CIS)

The First-tier Tribunal decision in the case of Island Contract Management (UK) Ltd (ICM(UK)) has recently been published. ICM(UK) lost its appeal against HMRC determinations for failure to operate the CIS correctly and has been found liable to pay in excess of £42 million to HMRC.

ICM(UK) was a wholly owned subsidiary of Island Contract Management (ICM). ICM was based in the Isle of Man. ICM(UK) was set up for the purposes of receiving payments from contractors and agencies. Amounts received gross by ICM(UK) were transferred to ICM who then, after deducting a commission, made payments to individual construction workers who undertook the work. Payments were made gross to the individuals on the basis that ICM, based in the Isle of Man, was outside the jurisdiction of UK tax.

HMRC successfully challenged the arrangements both on the construction of the CIS rules (such that payments made by ICM(UK) to ICM should have been subject to withholding) and that the arrangement served no legitimate commercial purpose but was designed specifically to circumvent the CIS.

The CIS is something that businesses may need to pay specific attention to, particularly where there is an overseas connection. As shown in this case, HMRC is looking beyond the UK and is increasingly focusing on off shore arrangements.

For more detail please see our Employment Tax Alert.

First-tier Tribunal considers VAT exemption for payment processing services

In the case of National Exhibition Centre Ltd, the First-tier Tribunal has considered whether booking fees levied by the taxpayer in respect of credit card and debit card payments made by customers for concert ticket purchases were properly exempt from VAT, being the consideration for a supply of payment processing financial services.

The Tribunal allowed the taxpayer's appeal, holding that the booking fees were consideration for a card handling service, they satisfied the requirements of the relevant VAT exemption under EU law, and they were not consideration for a debt collection service (which is explicitly excluded from the VAT exemption). The Tribunal specifically distinguished the taxpayer's factual situation from that of the supplier in the AXA (Denplan) case. In the latter case, the CJEU held that Denplan, which acted for the creditor, provided a taxable debt collection service when collecting and remitting payments from third parties. However, in the present case, the Tribunal observed that the taxpayer acted for the debtor (not the creditor). The Tribunal further held that debt collection is a service that can only be performed for a creditor. It, therefore, followed that the taxpayer's booking fees were properly exempt supplies.

This decision is in line with the earlier Court of Appeal and Court of Session judgments in the cases of Bookit Ltd and Scottish Exhibition Centre Ltd respectively. Any taxpayers who make charges for handling or processing payments may wish to consider the implications of these decisions for their businesses.

Other UK developments

Government amendments proposed to Finance Bill 2013

Government amendments have been tabled to the Finance (No 2) Bill. The amendments relate to the following:

Schedule 10 – Transfer of assets abroad (definitional clarification)

Schedule 14 – Research and development expenditure credits (amendments to ensure the credit works as intended)

Schedule 16 – Tax relief for video games development (commencement provisions)

Schedule 17 – Television and video games tax relief (commencement provisions)

High Court finds settlement in Goldman Sachs case to be lawful

In dismissing UK Uncut's application for judicial review, Mr Justice Nicol said that the deal was “not a glorious episode in the history of the Revenue”, but found that it was not unlawful.

In his ruling of 16 May, the Judge noted that HMRC did not appear to have taken a contemporaneous note of its oral agreement with Goldman Sachs and had taken into account irrelevant considerations that should not have featured in the decision making. However, the judge found that, on the evidence given, HMRC's decision on the settlement would inevitably have been the same even without the irrelevant considerations.

Supreme Court considers when transactions can be set aside

In two joined cases, Futter and Pitt, the Supreme Court has considered the position where the trustees of a settlement exercise a discretionary power intending to change the beneficial ownership of trust property, but the effect of what they do turns out to be different from that which they intended. The question for the court was whether their act can be set aside by the court and if so, what is the correct legal test to determine in what circumstances and on what basis the court can intervene.

The Supreme Court judgment gives a detailed review of the case law in this area and largely, but not entirely, endorsed the Court of Appeal's conclusions. The purported exercise of a discretionary power on the part of trustees will be void if what is done is not within the scope of the power. If an exercise by trustees of a discretionary power is within the terms of the power, but the trustees have in some way breached their duties in respect of that exercise, then (unless it is a case of a fraud on the power) the trustees' act is not void but it may be voidable at the instance of a beneficiary who is adversely affected.

It is generally only a breach of duty on the part of the trustees that entitles the court to intervene. It is not enough to show that the trustees' deliberations have fallen short of the highest possible standards, or that the court would, on a surrender of discretion by the trustees, have acted in a different way. Where the trustees have obtained and followed professional advice, and that advice turns out to be wrong, they cannot be said to be in breach of their fiduciary duties, and the court cannot intervene to void their actions.

However, the Supreme Court did overturn the decision in Pitt and ruled that, on the facts of the case, the transaction could be set aside on grounds of mistake.

First-tier Tribunal considers the historical VAT treatment of medical prosthesis and drugs

In the ‘lead case’ of Nuffield Health, the First-tier Tribunal has considered the VAT treatment of medical prostheses (eg artificial hip joints or pacemakers) and drugs supplied to hospital in-patients in the period prior to 1 January 1998. Specifically, the disputed issues were whether such supplies were at the relevant times separate zero-rated supplies (in line with a Court of Appeal ruling in 1997) or part of a single exempt supply of medical care (as HMRC now contends based on subsequent case law) and, accordingly, whether the input tax incurred on related expenditure was recoverable.

The Tribunal dismissed the taxpayer's appeal, holding that the prosthesis and drugs formed part of a single supply of exempt health care. A number of retrospective (Fleming) VAT claims were understood to be resting upon the outcome of this lead case.

Other international developments

Australia: Budget 2013/14 includes measures to limit interest deductions

On 14 May 2013, the Australian Government issued its 2013/14 Federal Budget. The Budget contains major proposals to restrict the ability of multinational groups to deduct interest expenses where debt levels exceed a maximum allowable level. The changes have effect for years commencing on or after 1 July 2014 and will be subject to further consultation with industry.

As anticipated, the safe harbour debt ratio will reduce from 75% (3:1 debt to equity) to 60% (1.5:1) for general investors, while the ratio for finance entities will reduce to 15:1 from 20:1. The Government has also announced the full repeal of the provisions allowing tax deductions for interest expenses that have a nexus with the production of certain non-assessable foreign dividends. These provisions will be replaced with the general requirement that interest is deductible only where it supports assessable income. Other announced changes to the thin capitalisation rules include amendments to the worldwide gearing test ratios and an increase in the de minimis test.

More detail on these and other corporate tax changes is available in our Global Tax Alert.

Canada: Measures to counter international tax evasion and aggressive tax avoidance

On 8 May 2013, the Canadian Government announced a number of measures aimed at addressing international tax evasion and avoidance. Although most of these measures were included in Canada's 21 March 2013 Federal Budget, a new measure is the creation of a Canada Revenue Agency unit to target international tax evasion and avoidance.

In related developments, on 1 May 2013, the Standing Committee on Finance submitted a report to the Canadian House of Commons entitled Tax Evasion and the Use of Tax Havens, and on 9 May 2013 the tax administrations of the US, the UK and Australia announced a plan to share tax information involving trusts and companies holding assets on behalf of taxpayers in various low-tax jurisdictions throughout the world.

Our Global Tax Alert summarises these developments and their implications.

India: Courts consider issues of permanent establishment

A recent ruling of the Delhi Income Tax Appellate Tribunal in the case of Convergys Customer Management Group Inc has considered (i) whether a permanent establishment existed in India under the India/US income tax treaty, (ii) the appropriate methodology for attributing profits to such a permanent establishment, (iii) the taxability of software payments and ‘link charges’ as ‘royalties’ under the treaty, and (iv) the obligation to pay advance tax under such circumstances.

The Tribunal found that the US company's employees frequently visited the premises of its Indian subsidiary and some of its seconded employees worked in key positions. The Tribunal held that, as these employees have a ‘fixed place’ at their disposal and since the Indian subsidiary was, practically, the projection of the taxpayer's business in India, the taxpayer had a fixed place permanent establishment in India. Payments to reimburse the taxpayer for software and link charges were also held not to meet the definition of royalties under the treaty.

More detail on the decision is available in our Global Tax Alert.

In the separate case of Clifford Chance a recent ruling of the Special Bench of the Mumbai Income Tax Appellate Tribunal has considered whether professional services rendered from outside India in connection with Indian projects or clients were taxable in India under Indian tax law and the India/UK tax treaty.

In a previous case, the Bombay High Court had held that the rendition of services in India was an essential condition for their taxability in India. There was subsequently a retroactive amendment to Indian tax law allowing income by way of fees for technical services relating to Indian projects to be taxed in India even if the services were rendered from outside India.

The Special Bench held that the retroactive amendment is restricted in its application to specific income streams such as technical services fees and it did not impact the taxpayer in this case as its income was assessed on the basis that it was income from a business connection rather than from technical services. The Special Bench confirmed that the text of the India/UK treaty itself explains the scope and ambit of profits indirectly attributable to the permanent establishment. It does not result in the grant of extensive taxation rights to the India to tax services rendered from outside India.

For more detail please see our Global Tax Alert.

China: Clarifying guidance on permanent establishments

On 19 April, the Chinese State Administration of Taxation released SAT Announcement 19, which clarifies certain issues related to corporate income tax collection on services provided by non-resident companies to Chinese companies under labour dispatch arrangements.

Pursuant to Announcement 19, if a non-resident company dispatches personnel to work for a Chinese company and two conditions are met, those personnel would generally be seen as giving the dispatching company an establishment/location to provide services in China. The two conditions are:

• The dispatching company assumes the responsibilities and risks of the work performed by the dispatched personnel, wholly or partly

• In general, the dispatching company examines and evaluates the work performance of the dispatched personnel

More detail on the announcement is available in our Global Tax Alert, which also considers some of the factors that would suggest no permanent establishment exists.