In the children’s nursery rhyme, all the king’s horses and all the king’s men couldn’t put Humpty Dumpty back together again following his fall. Unlike the royal entourage however, HMRC are much more determined to stop fragmentation [of profits] and have recently launched a consultation document, ‘Tackling Avoidance involving Profit Fragmentation’ inviting comments and feedback on its proposals to tackle arrangements that businesses employ with a view to place profits outside the reach of UK taxation.
A general principle of UK taxation is that a UK resident person, be they an individual or company, is taxable in the UK on the full amount of profits from any trade or profession that they carry on in this country or overseas.
Whilst it is normally apparent where profit generating activities take place and hence where that income should be taxed, HMRC are aware of arrangements which often involve offshore trusts and companies in low or nil tax territories that are designed to ensure that profits earned by a UK resident accrue for tax purposes in that other territory. Although the Revenue have successfully challenged some of these arrangements, enquiry time and resources are considerable and investigations often take several years to resolve.
Mr X, a UK resident, has skills that would enable him to earn significant profits and he operates a business either as a sole trader, partnership, or as a director of a company.
Some or all of the profits earned are moved to an offshore vehicle, Y Ltd, where little or no tax is paid. Usually, this is an offshore company owned by an offshore trust. Typically, Mr X is neither the settlor or trustee of the trust. In some cases, Mr X is said to be excluded from benefitting from the trust assets, but there will often be some means by which those amounts will/may accrue to persons who have links to him, including non-lineal relatives of Mr X.
The offshore entity will claim it is entitled to payment in respect of Mr X’s services to clients for a variety of reasons. For example:
Y Ltd will then claim, that as it does not carry on a trade or profession in the UK and is not resident in this country, then it should not be taxed on its profits in the UK.
Bianca is a UK resident management consultant, who provides her services to both domestic and overseas customers. A proportion of these services is attributed to the UK business and the income taxed accordingly here.
The remaining income receipts however are paid by customers directly to an offshore company in a tax haven, owned by a trust also located in the tax haven. These are paid on return for consultancy services allegedly provided by the offshore company, which has no assets other than access to the skills and services of Bianca herself, neither of which is exercised to any material extent in the tax haven.
Whilst Bianca is expressly excluded from benefitting from the trust, her relatives can benefit.
The underlying reality is that all income comes from a single underlying activity (namely the skills of the consultant, who is a UK resident), that no or negligible services are performed by Bianca in the low tax jurisdiction itself, and consequently the full profits should be taxed in the UK as profits of the consultant.
Harry is a UK resident and provides engineering services for clients in the UK. Customers pay Harry, but little profit is taxed in the UK, as Harry pays fees to an offshore company for “consultancy” which are deducted from profits and almost entirely cover the profits. The company receiving the fees is owned by an offshore trust which was settled many years ago by a distant relation of Harry. The company has no substance or assets.
The funds held in the company are then returned to Harry in various forms which are alleged to be non-taxable, for example, loans or payment of supposed business expenses. Harry has a lifestyle which could not be supported on the small amount of net profit received and taxed in the UK.
The reality again is that there is a single underlying source of income, namely the skills of Harry, who is a UK resident, that no or negligible services are performed by him in the low tax jurisdiction itself, and so the full profits should be taxed on Harry in the UK.
Whilst these two examples differ in some of their details, they share in common the shifting of UK profits to offshore vehicles in low tax jurisdictions, to bodies which are supposedly performing or providing services, but in reality have little or no substance. The truth is that the business is carried on by a UK resident individual, with core services such as office space, IT and support staff also located in the UK, and that the profit allocated offshore is excessive in relation to the services carried out overseas.
The aim of any new legislation will be to ensure that the correct amount of profit appropriate to the business activity in the UK is taxed in this country. In order to tackle arrangements of the type described above, the government is proposing a two-pronged attack.
New legislation would target arrangements where:
A final condition will give businesses immediate certainty as to whether the legislation applies to them. This will be that it must be reasonable to conclude that some or all of the offshore entity’s profit is excessive in relation to the profit-making functions it performs and that the excess is borne out of its connection to the UK individual.
There is no intention of catching activities where businesses are genuinely carried on, wholly or partly, in low tax territories for commercial reasons and with genuine commercial substance. All of the facts would be taken into account, for example, whether the profit assigned to those businesses was artificially distorted to take UK profits out of the UK tax charge.
There will be provisions to prevent profits being taxed twice (double taxation), i.e. in the UK and the foreign jurisdiction.
Those who get involved with these types of scheme will be required to notify HMRC on or before the time that the individual would submit their tax return. This would allow the Revenue to begin their enquiries earlier and establish the correct tax liability sooner.
A user or promoter of these arrangements might also have a duty to notify under the Disclosure of Tax Avoidance Schemes (DOTAS).
If HMRC has reason to believe that an amount is chargeable under the new rules, the department will be able to issue a charging notice to the taxpayers stating that payment of the amount shown in that notice will be required within a fixed period, for example, 30 days. The taxpayer would however have 30 days from the issue of a preliminary notice to make submissions in order to persuade HMRC that its view is wrong.
Closing date for comments is 8th June 2018.