Issue 96 – 17 November 2009


This month’s newsletter contains a technical examination by Lara of how the UK is introducing legislation or practices which override existing double tax treaty arrangements, and has prompted me to comment on the uncertainty this creates for the taxpayer, and how this trend is manifesting itself in other countries. Indeed, we have been involved with negotiations with tax authorities not only in the UK, but also Denmark, France, Italy, Spain and Switzerland, and the examples we have seen show a disturbing trend. Our advice has generally been to withstand sometimes intimidatory allegations and threatened assessments which are based neither on law nor indeed the relevant facts. In some cases, neither the source of income nor the residence of the taxpayer had any connection with the country claiming their desired share of the global tax bite.

I believe tax payable on earnings is an essential ingredient to a successful and caring society, but I do believe in the basic freedoms to have certainty when planning one’s affairs. Double tax treaties are supposed to provide this certainty, yet they seem to be capable of being unilaterally overwritten by subsequent domestic legislation bought in by a particular country. The first example I can remember is as far back as 1981 when the US introduced its Foreign Investment in Real Property Taxes Act (FIRPTA), and included a provision that shares in companies owning US real estate would also be considered as real estate for the purposes of FIRPTA. Thus even though double tax treaties may have stated that the sale of shares in companies (representing movable property) would only be taxable where the alienator is resident (which may have been outside of the US for non US investors), FIRPTA had the effect of overriding such a provision.  Since then, there have been innumerable instances of similar treaty overrides, and one is left to wonder how sacrosanct the terms of a freely negotiated double tax treaty are for the unsuspecting taxpayer.  And indeed, what are the remedies if the tax administration of a particular country refuses to accept the taxpayer’s reasonable interpretation of any of its provisions.

And then there is the Freedom of Establishment clause in the Treaty of Rome, with which all EU countries should comply. This means that a structure can be created with the certain knowledge that, for example, the profits of an entity created in one jurisdiction will only be taxed in that jurisdiction, and not in the country of residence of the parent, whether this be a corporation or an individual. Yet the number of cases that are brought before the European Court of Justice shows how little attention tax authorities are paying to EU legislation. Clearly, tax payers are frightened at the cost of challenging tax authorities by bringing actions before the ECJ, since in many cases the prospective costs far outweigh the tax liabilities with which they are being penalised. 

I thought you may be interested to read the “Your Charter” section of HMRC’s own website.  The rights of the taxpayer are very nobly stated, but some of our experiences do not seem to correspond with the following:

Your rights

What you can expect from us

  • Respect you
  • Help and support you to get things right
  • Treat you as honest
  • Treat you even-handedly
  • Be professional and act with integrity
  • Tackle people who deliberately break the rules and challenge those who bend the rules
  • Protect your information and respect your privacy
  • Accept that someone else can represent you
  • Do all we can to keep the cost of dealing with us as low as possible

What is not covered is:

  • Ensure our legislation and practices provide you with certainty to enable you to compute your tax liabilities

Surely this is not too much to ask in a world where complex international transactions require definitive knowledge of the costs of effecting these transactions.

Tax – a reality or merely a figment of HMRC’s imagination?

The interaction of the UK’s domestic anti-avoidance provisions with its double tax treaties has been the subject of cases such as Bricom, Strathalmond and Willoughby, all discussed below.  Until recently, the question of whether the terms of a treaty will override such provisions has rested on complex legal deliberations on the interpretation of the legislative drafting in question.  However, the UK has, since these cases, made some moves to clarify matters in relation to both income tax and capital gains tax, with the effect of imposing the dominance of domestic law over international law.

The case of Bricom Holdings Ltd v IRC 1997 STC 1179 concerned whether the provisions of the UK/Dutch double tax treaty could override UK domestic controlled foreign company legislation.  In short, the question was, could the interest article in this treaty, which exempted from UK tax interest payments made by a UK company to its Dutch subsidiary, so exempt the income received by the Dutch company (a CFC of the UK company) as a result of these interest payments from being taken into account in assessing chargeable profits for the purposes of the CFC rules?  It was decided in this case that the interest in question was merely an element in a calculation and that what was apportioned to the UK company under the CFC rules was not the actual profits of the Dutch company but notional profits of an equal amount.  The argument, therefore, was that as it was not the actual income which was apportioned but only notional income, the provisions of the treaty (which applied to actual income in the form of the interest payments) could not apply.
In this case, Millett LJ disagreed with the argument that the interest lost its character as interest by being deemed to be another person’s income on the basis that this was not an accurate description of the statutory process.  He cited the case of Lord Strathalmond v IRC [1972] 1 WLR 1511.  In this case, Lord Strathalmond was assessed to income tax on his wife’s income under a particular UK anti-avoidance provision which no longer exists.  It was held in this case that Lord Strathalmond was entitled to treaty relief just as his wife was (she was tax resident in the United States and under the UK/US treaty the income in question was exempt from tax in the UK), because it was the same income that was deemed to be his and not just an amount equal to this income.

However, the case of IRC v Willoughby 1995 STC 143 again took the view approved in Bricom – that the income of one person which is deemed to be that of another under UK anti-avoidance rules cannot benefit from a treaty.  In this case, it was discussed whether UK/Isle of Man treaty prevented the profits of a Manx enterprise from being deemed to be income of the taxpayer under Section 739 TA 1988 (now Section 720 et seq. ITA 2007), which attributes income earned offshore as a result of a transfer of assets by a UK resident individual to that individual.  The Special Commissioner in this case said no, on the basis that there is a distinction between actual income of an individual and actual income of another person which is deemed to be income of the individual.

It seems, therefore, that there is some difference of opinion in the judiciary as regards whether a double tax treaty can protect against anti-avoidance provisions attributing offshore income to UK residents. But what about equivalent capital gains tax provisions? Section 13 TCGA 1992 attributes gains of a non-resident close company to its UK resident participators. The capital gains tax article in the OECD Model Treaty (Article 13) provides that gains are taxable only in the contracting state of which the alienator is resident (except in the case of gains from immovable property and permanent establishment assets in the other contracting state).  Following the argument of Millett LJ in Bricom, the gains should not lose treaty protection because they are deemed domestically to be the gains of another person.  Indeed, because Section 13 taxes actual gains rather than a notional amount, the argument run in Bricom and Willoughby that the treaty should not apply because the gains somehow lose their initial character, should not apply.  The UK tax authorities do seem to accept this in their Capital Gains Tax Manual, para 57380.  However, this view is not formalised in legislation, therefore leading to some scope for uncertainty.

For income tax purposes, Section 59 Finance Act 2008 goes some way to protecting the enforceability of UK domestic anti-avoidance provisions, irrespective of contradictory terms in a double tax treaty.  This section states that the permanent establishment article in a double tax treaty is not to be read as preventing the income of a UK resident from being chargeable to tax – precisely how we thought it should be read!  This is one of three sections on double tax relief in FA 2008 (sections 57 – 59) aimed at combating tax avoidance schemes, such as the use of trusts to exempt partners in a foreign partnership from UK income tax.  However, it is not clear whether Section 59 is aimed at a particular scheme or whether it was introduced to allow HMRC to impose the UK anti-avoidance rules in any and all cases, irrespective of the existence and wording of a double tax treaty.

For capital gains tax purposes, the UK has introduced in some of its recent treaties, a specific saving provision in Article 13 (or its equivalent) which has the effect of overriding this Article where UK domestic anti-avoidance provisions apply.  Treaties containing this override are the ones with Mauritius, Australia, Canada, the US and New Zealand.  On a reading of the drafting of these overrides (they are almost identical), they do not appear to apply to Section 13, but instead to the provision of UK law which counters avoidance of capital gains tax by temporary non-residents (Section 10A TCGA 1992).  Indeed, the 2003 Technical Explanation to the US/UK Treaty states that the intention of this override is to allow the UK to apply Section 10A (and does not mention Section 13).  However, the Exchange of Notes to the 2003 Protocol to the New Zealand/UK Treaty states that this provision also applies to Section 13.  As the wording of the override in the New Zealand Treaty is almost identical to that in the other treaties noted above, are we to assume that the overrides in these treaties also specifically apply to Section 13, and how does this fit with Bricom and the view expressed by HMRC itself in its Capital Gains Tax Manual?

We must also ask how these new moves to reinforce the dominance of UK domestic law fits with EU law.  After all, if we are to have freedom of movement and establishment within the EU, how can the UK justify charging to tax UK residents in respect of offshore income and gains where these arise within the EU?  Clearly, the capital gains tax override mentioned above has not been concluded in a treaty where the corresponding country is an EU Member State, but Section 59 FA 2008 does seem contrary to EU law, as well as international law.

Of course, the test for all of this is how this will be applied in practice but it does certainly seem to fit with the attitude of the UK in recent years to anti-avoidance and tax schemes in general.