August 2011 (113) – Treaty Shopping

Yes, I know that I promised to leave you alone during the summer and not produce an August Newsletter, but three important events have happened which you need to know about.

Firstly, IFS is moving to 44 Southampton Buildings, London, WC2A 1AP, with new telephone number +44 (0)203 368 6968 as from 30 August.

I decided that the time was right to sell my beautiful office in St John’s Wood and move closer to the heart of London, and I look forward to welcoming you to our new office in the near future.

Secondly, HMRC issued a technical note on 1 August 2011 entitled ‘Tax Treaties Anti-Avoidance’. It is without doubt one of the most wide ranging Consultative Documents I have read, designed to stop ‘treaty shopping’ not as we generally understand the term, but in the widest possible understanding of the term. This Newsletter briefly summarises some of the aspects of the Consultative Document and our concerns should it become adopted in its current form.

Thirdly, Barclays Wealth have agreed to sponsor this year’s ITSAPT conference on 3 November at The Landmark Hotel, London. Please view our conference programme and booking form on our website – click here – and note that there is an early bird discount from 31 July to 31 August, albeit a slightly reduced discount, for those who have not yet booked a place.

Finally, the stock markets may be showing an even more than usual August volatility, but the state of the Euro is of far more long lasting concern. Previous newsletters have expressed my doubts of the sustainability of the Euro without political union, and I believe it has only lasted in its current form for a decade because the first seven years or so were boom years. During this period of good economic growth, there may have been no need for the fiscal tools of adjustment to monetary crises, ie interest rates, taxes and devaluations. When the growth spurt stopped, countries (and individuals) continued to borrow beyond their means until the chickens came home to roost! Tax increases and public spending cuts are extremely difficult to achieve during periods of stagnation, which leaves no fiscal mechanisms available with just a single currency i.e. EU countries in need of these mechanisms cannot adjust their interest rates or currency value. The Euro demise (in its current form) is almost as certain as the ERM (exchange rate mechanism) demise, yet there is too much political pride resting on its maintenance that some form of compromise will undoubtedly be reached. So far the solution seems to be commonly guaranteed Eurobonds, but even German growth has stagnated, so is this just another short term palliative measure?

I wish you bon continuation of your summer break. With kind regards.

Roy Saunders


I have been advising clients, students and colleagues for several years that one needs to go beyond the specific provisions of any double tax treaty and look at its purpose, often contained in the title of the convention, which is ‘the avoidance of double taxation and the prevention of fiscal evasion’. The artificial use of treaties to actually create fiscal evasion, or avoid just a single level of taxation, was never the intention of the authorities who have entered into relevant treaties and multilateral conventions. Indeed, there have been some Court cases where tax authorities have argued that the relevant convention should be entirely ignored because it has simply created the fiscal evasion which it was intended to prevent.

It is therefore understandable that the UK wishes to introduce specific legislation to prevent what it considers to be an abusive use of conventions, as indeed the Commentary to Article 1 of the OECD Model Taxation on Income and Capital accepts in paragraph 9.4. However, the Consultative Document suggests provisions relating to UK residents and non -UK residents which seem to go far beyond the concept of abuse. For UK residents, the proposed legislation states that double tax treaties will not prevent income, profits or gains being charged to UK tax, or at a rate higher than that proposed in double tax treaties, if a ‘scheme’ has been put in place whose purpose is to prevent or reduce the extent of UK taxation chargeable. Thus an individual may remain UK resident for the purposes of these proposals even if he has become resident in another country under the tie breaker provisions of the relevant treaty.

So taken together with the new Statutory Residence Test (SRT – see our July newsletter), an individual, say a writer who has just written a book to rival Harry Potter, could have decided to move to say Switzerland, relying on advice to sell his permanent home in the UK and acquire a new permanent home in Switzerland. In this way he could presumably rely on the provisions of the treaty to ensure that any future royalty income would be subject to tax only in Switzerland, and not the UK.

However, he still has family connections in the UK and may fall foul of the number of days he is allowed to spend in the UK taking into account ‘connecting factors’ involved. Until the announcement of this Consultative Document, the effect of the SRT would have been overridden by the relevant double tax treaty provisions, which should have preference. However, if HMRC consider the individual’s move to Switzerland to be a ‘scheme’ to obtain the benefit of the double tax treaty provisions, then the individual will remain subject to UK tax on all future royalty income if he breaches the conditions of Part C of the SRT.

For non-residents, a similar concept applies if a treaty has been used to reduce or exempt UK tax. Thus, the traditional use of Luxembourg or Dutch finance companies to lend money to businesses in the UK without a UK tax charge may no longer be viable if the financier is offshore based without an appropriate direct tax treaty with the UK (private equity funds beware!).

There are so many ramifications of the legislation that it may take some time for the extent of concerns to be realised. For example, a UK company with a foreign treaty based subsidiary could acquire an asset through that subsidiary in the belief that the absence of capital gains tax in the subsidiary would be preserved. This would be in accordance with the relevant Article 13 of the double tax treaty between the UK and the country of residence of that subsidiary. This proposed legislation removes the protection of the treaty and exposes the UK company to a Section 13 capital gains tax assessment.

There has been considerable speculation that the double tax treaties between the UK, Jersey, Guernsey and the Isle of Man may be terminated in view of the fact that these countries no longer create the problem of double taxation in the light of their own unilateral absence of taxation for the majority of corporate income earned. The consultative document may avoid the necessity for terminating treaties, merely rendering them impotent to prevent UK taxation being levied. It should be noted that the proposed legislation only applies to dividends, interest or income from debt claims, royalties or income falling within the ‘other income’ article of the double tax treaty. 

So treaties will still take precedence as regards the taxation of business profits and the clarification of what comprises a permanent establishment or otherwise, as well as for dependent and independent personal service income and other income under Article 14 et seq of the OECD Model Treaty.

The legislation is applicable once enacted and overrides the provisions of a double tax treaty even if the activity, eg becoming non-resident, occurred prior to the date of enactment. It is hoped that representations will be made to HMRC that remove the scope for uncertainty that the Consultative Document raises. On the one hand, HMRC are introducing the SRT to remove the uncertainty regarding the previous absence of a statutory definition of residence, yet they are now introducing what could result in far greater uncertainties regarding how properly negotiated double tax treaties are applied through unilateral measures. At the very least, the definition of the term ‘scheme’ must be clarified so that genuine commercial activities carried out for bona fide reasons can fall outside of the scope of the proposed legislation, even if tax mitigation may result therefrom.