Why a company may not be tax resident where you think
What are the implications of the Development Securities case for tax residence procedures?
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Introduction
Questions frequently arise as to what steps must be taken to ensure a company is tax resident in a particular jurisdiction. This is important as tax residence determines the tax regime principally applicable to the company and whether it is entitled to claim the benefit of double tax treaty relief as a resident for treaty claims for withholding tax exemptions, etc.
The First Tier Tribunal decision Development Securities (No.9) Limited and others –v- HMRC [2017] UKFTT 0565 (TC) held that a company was treated as resident in the UK because its "central management and control" was exercised by its UK parent company, and not by its board of directors which met in Jersey.
In the light of this decision, this briefing note recaps and sets out:
- when companies are treated as non-resident;
- how board control can be usurped; and
- the implications of this decision for best practice in setting governance procedures for offshore tax residence to mitigate the risk of HM Revenue & Customs challenge.
UK Tax Residence
Companies incorporated in the UK (or SEs or SCEs which have or have previously had a UK registered office) are only treated as non-resident for tax purposes if they are treated as non-resident by a double taxation treaty.
This generally means that they must be resident in a territory party to such a double taxation treaty and their place of effective management for the purposes of the treaty is the other treaty state.
Companies incorporated elsewhere are treated as UK-resident if they are centrally managed and controlled in the UK and are not treated as non-resident by a double taxation treaty.
The main principles of this test are set out in "Central Management and Control" below.
There are certain specific provisions applicable to UCITs or AIFs which deem them to be non-resident if certain conditions are satisfied.
Central Management and Control
The current residence test emerged from the De Beers case, which was decided in accordance with the principle that the court must look to where the central management and control of the company abides. This is a question of fact in each case, but usually the articles of association of a company will vest control in the board of directors. If the board habitually meets in a particular country to discuss the high-level strategic decisions of the company (as opposed to day-to-day management) and applies its mind to such decisions, the company will normally be treated as residing in that country; however, the test looks at where decisions are actually made, and the location of meetings may not be determinative if the evidence suggests that decisions are taken elsewhere.
If it can be demonstrated that the directors merely "rubber-stamp" the decisions of another individual or body, the court will be willing to find that central management and control is exercised by that other individual or body. Mere influence over the board by another party will not necessarily amount to central management and control, but directing the decision-making of the board or outright usurpation of control of the company most likely will.
Shareholder control, such as control by a parent company, is not sufficient per se to constitute central management and control. However, if the board of directors merely implements decisions already taken by the parent company and does not exercise any strategic autonomy then there is a risk that central management and control will be found to belong to the parent.
So what happened in Development Securities?
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Three companies were incorporated in Jersey ("JerseyCo"), as subsidiaries of Development Securities Plc ("DS Plc"). It was proposed that the UK members of the Development Securities group ("DSG") would grant the three JerseyCos call options, which, if certain conditions were satisfied, would enable the JerseyCos to acquire shares in property owning companies and certain properties. The sole reason for incorporating the JerseyCos was to enable DSG to implement a plan to crystallise latent capital losses. First, the price payable by the JerseyCos on exercise of the call options was an amount equal to the historic base cost of the asset (rather than its current market value) plus indexation accrued to that time. This meant that the price paid was significantly in excess of the then market value (as the assets were standing at a loss for capital gains purposes). Second, shortly after the acquisition, the JerseyCos would become UK tax resident and when such assets were eventually sold to a third party, the resulting increased capital loss could be set off against DSG's capital gains, reducing the group's tax liability. The facts of this case were unusual for the following reasons:
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Where were the JerseyCos tax resident?
The court decision contained a detailed assessment of all the factual background to the decision-making by the JerseyCos, which amounted to 82 pages in total. This investigated what role individuals at these companies had in making decisions and investigated the functions of the board of directors examining board minutes, written documentation, contemporaneous meeting notes and the witness evidence of the directors.
Given that (i) the key decisions to enter into and exercise the options were taken at board meetings in Jersey, (ii) the majority of directors were Jersey residents and were professionals with an real estate background and (iii) the directors applied their minds properly to the decisions that required resolution (they reviewed paperwork provided to them prior to board meetings, asked questions and requested counsel's opinion on the legality of entering into the transaction), it might have been suspected that it was the directors who exercised the central management and control of the JerseyCos from Jersey.
The court rejected HMRC's submission that the question to be considered was whether there was a "scheme of management" in the UK and preferred an analysis as to where the central management and control was exercised.
While considering that "the lines of distinction as regards who is controlling a subsidiary for a limited and/or specific purpose may be rather fine ones", the decision draws a distinction between a subsidiary established to perform a finance function for a group which responds to proposals put by the parent in the expectation that they will be approved (because they make commercial sense) and a subsidiary which is asked to perform a single transaction which is wholly uncommercial.
It found that the directors appointed to the board were in reality, in accepting their appointment, agreeing to implement the parent's decisions barring any legal impediment. While the board of directors took every effort to ensure its action was legal there was no evidence that it took the commercial decision to implement the transaction or that it considered its merits. Rather DS Plc had taken this decision and the board of directors was merely verifying that it could be implemented legally. Therefore, the JerseyCos were centrally managed and controlled and resident in the UK and not in Jersey where the board meetings were held.
How does this compare with previous residence cases?
The facts of this case were similar to Wood –v- Holden where the Court of Appeal held that the Dutch company was managed and controlled by the board of directors in the Netherlands even though (i) the directors acted under guidance and influence from its UK parent company and (ii) the Dutch company had a limited remit. It was solely incorporated into the structure to save tax.
However, in Wood –v- Holden there were strong commercial reasons for the Dutch company to resolve to enter into the transaction, the Dutch company made a substantial profit on sale of the assets so even though the directors were adopting their UK parent's recommendation, it made commercial sense for the Dutch company in its own right. In contrast, there was no commercial rationale nor corporate benefit to the JerseyCos to approve entering into the transactions.
Two other points to note are: (i) in Wood –v- Holden the directors took advice from PwC who made a positive recommendation to sell the assets, whereas in this case the only advice taken by the directors was to the legality of entering into the transaction, rather than whether the transaction should be entered into at all; and (ii) in Wood –v- Holden the burden of proof was on HMRC to prove the Dutch company was tax resident in the UK, as it had an established history of non-UK residence, whereas in this case the burden of proof was on the Appellant to establish the newly incorporated JerseyCos were tax resident in Jersey.
Appointment of Offshore Directors to UK Boards
Although the Tribunal found that it was the parent company, DS Plc, that was exercising central management and control of the JerseyCos, rather than the UK resident director, it would be prudent to ensure that any UK resident director is not conducting any negotiations as regards strategic and management matters by himself without consultation with the offshore directors. That person should also avoid being the only contact with UK advisers of strategic plans. The Court expressly confirmed that in other circumstances a UK- based director could exercise central management and control through actions taken outside of board meetings.
Going forward it should be noted that all correspondence that relates to a disputed transaction can constitute evidence which the courts consider. It is important to consider whether the tone of email exchanges reflects the timing of the decision-making process. For example, individuals should be careful about loose terminology (for example, stating that events "will" occur, rather than "may" occur before they have been considered by the offshore board).
Lessons to be learnt about offshore residence
- If a non-UK company is entering into a transaction which, absent tax advantages lacks commercial rationale, this will be scrutinised by the courts and they will make every effort to uncover why such decision was taken and by whom it was taken. Directors who sit on multiple boards should keep detailed notes of each meeting, ask relevant questions and seek advice where necessary. They must ensure they have given real consideration to any proposal and are actively engaged in any strategic or management decision.
- Conversely where the non-UK company is taking the strategic decision to implement commercial transactions proposed to it by its UK parent, provided it can be established that these commercial decisions were made outside the UK, by its board, the fact that the transaction was proposed by its UK parent will not of itself cast doubt on its offshore residence.
- Courts will not take board meeting minutes at face value, and will look to uncover the substance of the meeting and the board's discussions, including handwritten notes and emails. Loose terminology will be scrutinised and errors will indicate a lack of attention by directors.
- When appointing directors for a non-UK resident company, it is important to not only check that they have the relevant background and expertise, but that they are fully aware of the role they are undertaking and have sufficient expertise to be involved in taking commercial decisions for the company.
- The offshore company should have access to all relevant information that is required to allow them to make informed strategic decisions, for example, legal and tax structure papers, step plans and projected cash flows.
- The entire relevant period of the business will be scrutinised, not only what happens at board meetings.
What next?
It remains to be seen whether this decision will be subject to appeal but in the meantime this decision should serve as a useful reminder that following tax residence procedures and guidelines is extremely important. Ultimately these decisions are highly fact-dependent and careful attention to this issue will be the best course of action to minimise the risk of residence challenge.
Co-author: Preena Gandhi
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