Tax Newsletter

Welcome to the latest issue of our tax newsletter in which we consider recent tax developments.

This includes a review of three cases concerning VAT. The first, Larentia + Minerva, is a CJEU decision which will require HMRC to allow more generous recovery of VAT by certain holding companies, and Intelligent Managed Services may similarly require HMRC to reconsider its practice, this time in the context of transfers of going concerns. Massey applied the VAT abuse principle to redefine arrangements in a situation where, although the tax planning was technically deficient, HMRC would otherwise have been unable to recover the VAT due to the liquidation of those companies primarily liable.

We also look at changes to legislation, both that contained in the Finance Act 2015 on the taxation of carried interest and the new withholding tax exemption for "qualifying private placements" on which further details have emerged, and also proposed additional requirements for large businesses in relation to compliance.

Changes to fund returns

Recent tax changes announced by the UK Government have largely reversed the favourable tax treatment previously enjoyed by UK fund executives on their returns from funds which are structured as limited partnerships. The changes affect:

• carried interest (i.e. executives' performance profit shares);
• executive co-investment (i.e. executives' returns on investment interests held in their own funds); and
• general partners' profit share (i.e. executives' direct interests in fixed management profit shares).

These changes are effective now and apply to fund returns arising today.

Our briefing "Recent UK tax changes to fund returns" gives more detail on the effects of the changes, compares the position under the new and historic rules, and suggests actions to be considered.

Larentia + Minerva: recovery of VAT by holding companies

The CJEU has ruled that a holding company that actively managed all of its subsidiaries did not need to apportion expenditure incurred on raising capital for the purpose of acquiring the subsidiaries between economic and non-economic activities.

This is a particularly helpful judgment for those looking to recover VAT costs on M&A transactions, and contrasts with HMRC's current approach to this issue.

Background facts
Larentia + Minerva is a shipping company that incurred input tax in raising capital from a third party which it used "to fund the acquisition of shareholdings in subsidiaries and [the provision of] services, in particular administrative and consultancy services, provided to those subsidiaries for remuneration". The subsidiaries took the form of limited partnerships.

The German supreme court considered that the input tax was used both for the services provided to the subsidiaries (referred to by HMRC as "business activities") and the acquisition of the shareholdings ("non-business activities") but could not decide how it should be apportioned.

Recovery of VAT by a holding company
The CJEU held that the holding companies' involvement in the management of the subsidiaries for consideration consisting of a management charge should lead to the conclusion that such holding companies carry out economic activities only, i.e. to the exclusion of any non-economic activity comprised of the investment in the subsidiaries.

This means that input tax incurred on the acquisition of subsidiaries would be recoverable in its entirety on the grounds that the only supplies made by such holding companies (i.e. ones who are involved in the management of its subsidiaries) were taxable supplies.

This contrasts with HMRC guidance, which stated that a holding company with some business activities, such as the provision of management services to its subsidiaries, and some non-business activities, would be able to recover input tax but only to the extent that the costs have a direct and immediate link to a taxable supply, i.e. the costs must be used for the purposes of the holding company's taxable supplies.

This decision overrides HMRC's guidance for holding companies with some business activities, e.g. those which provided management services, and enables holding companies to recover all input tax on acquisition costs (except, of course, where the services consist of VAT-exempt business activities, e.g. providing loans to the subsidiaries). This is clearly financially advantageous for such holding companies, and also avoids difficult determinations of how direct and immediate the link to the taxable supply needs to be.

Apportionment of the input tax would still be necessary where the input tax relates to the acquisition of multiple subsidiaries, only some of which are actively managed.

HMRC has yet to give its reaction to this part of the decision, which it references in VAT Input Tax Manual: VIT40100.

Restriction of VAT groups to corporate bodies
The CJEU also affirmed the Advocate General's opinion in this case that an EU Member State may not restrict membership of a VAT group to those having legal personality, unless that condition is appropriate and proportionate to prevent abusive practices or of tax evasion or avoidance.

This is important to the UK which also requires members of a VAT group to be corporates and subject to a relationship based on control. The UK could therefore be required to amend its VAT grouping rules to remove these restrictions and align the membership criteria more closely to those in the VAT Directive, i.e. close financial, economic and organisational links. A wider membership of VAT groups could then be possible.

Beteiligungsgesellschaft Larentia + Minerva mbH & Co. KG -v- Finanzamt Nordenham and Finanzamt Hamburg-Mitte -v- Marenave Schiffahrts AG

Intelligent Managed Services: TOGCs and intra-group supplies

The Upper Tribunal (UT) has decided that the transfer of a business to a company which makes supplies only within a VAT group is capable of being a transfer of a going concern (TOGC) and therefore outside the scope of the VAT charge.

This overturns the First Tier Tribunal's finding that there was no TOGC because the transferee's supplies to its fellow group members had to be disregarded.

Carrying on the same business as the transferor
Intelligent Managed Services Ltd (IMSL) transferred its banking support services business to Virgin Money Management Services Ltd (VMMSL), a member – but not the representative member – of the Virgin Money VAT group.

VMMSL also intended to carry on the business of supplying banking support services. However, unlike IMSL, it only made supplies to members of the Virgin Money VAT group. The group then made supplies of retail banking services to third party customers, which incorporated the banking support services supplied by VMMSL.

The FTT considered that VMMSL could not carry on the same kind of business as IMSL, as supplies made to fellow VAT group members must be disregarded. This view was supported by authority that only the representative member of a VAT group is treated as carrying on business on its own account. On this basis, VMMSL should be treated as not making any supplies at all which precluded the availability of TOGC treatment on the transfer.

Supplies to a VAT group member treated as made to the group
The UT, however, had the benefit of the recent Skandia decision on group supplies for VAT purposes. This confirmed that supplies made to a VAT group member are treated, for VAT purposes, as made to the group itself.

The UT also accepted IMSL's submission that where section 43(1) VATA 1994 provides that "any business carried on by a member of [a VAT] group shall be treated as carried on by the representative member", that is to be the case irrespective of whether the individual business makes supplies outside the group or not, and notwithstanding that supplies between members of a group are disregarded for VAT purposes under section 43(1)(a).

Furthermore, both parties accepted that, commercially, VMMSL intended to carry on the same kind of business as IMSL and that those services formed an integral part of the retail banking services provided by the group.

Against that background, the UT concluded that the transfer to VMMSL had to be capable of being a TOGC – the transfer should be regarded as being to the representative member under Skandia, and the representative member should be regarded as carrying on the same kind of business as IMSL by virtue of being deemed to carry on the business of VMMSL under section 43.

Less restrictive approach to TOGCs
This decision is significant, running contrary to what one might call long-established practice. We understand that HMRC has confirmed that it will not appeal, in which case the scope for claiming TOGC treatment on the transfer of business divisions in and out of a VAT group has been considerably increased.

This may result not only in cashflow benefits but also in real savings, particularly where the business transferred includes real estate or is itself a property letting business, because the consideration attributable to the real estate assets will not include VAT and the SDLT cost on the transfer will be reduced accordingly. HMRC's published policy on property letting businesses has always been that a TOGC is not possible where either: (i) the purchaser of a property rental business is a member of the same VAT group as the existing tenant; or (ii) a VAT group member sold a property currently being rented to another group member to a third party.

This decision may also mean that it is possible for purchasers to reclaim the SDLT paid on business transfers which have been charged to VAT on the basis that TOGC treatment, contrary to the decision above, is not available.

Please do not hesitate to contact us should you wish to discuss any of these issues further.

Intelligent Managed Services -v- HMRC

Improving large business tax compliance – a consultation document

HMRC is consulting until 14 October 2015 on a package of measures intended to encourage best practice tax compliance and address aggressive tax planning and failure to engage with HMRC among large businesses.

The criteria for determining which businesses will be within the scope of the proposals has not yet been determined. However, HMRC intends to identify an objective threshold which will, broadly, include those businesses administered by HMRC's Large Business Directorate. One possibility is to use the same threshold as set for the Senior Accounting Officer requirement, i.e. those businesses with a turnover of more than £200m and/or a balance sheet total of more than £2bn for the preceding financial year.

The proposals are:

1. A legislative requirement to publish the business's board-approved UK tax strategy
   This would enable public scrutiny of the business's approach towards UK tax planning and compliance, and should set out the business's attitude to tax risk, its appetite for tax planning and its approach to its relationship with HMRC. It may also cover the governance framework describing the way a business takes decisions on taxation. Other elements to be covered in the strategy might include the target UK effective tax rate and the measures taken to achieve that target, but would not include the amount of tax actually paid.

   The focus on the UK strategy is slightly surprising, given that many of the affected businesses will be multinationals, and may even involve additional compliance burdens if businesses need to split out a UK strategy from their overall plan.

   HMRC also suggests that there should be a named individual at Executive Board level with accountability for a business's published tax strategy. As with other legislation imposing potential personal liability, this is unlikely to be popular but HMRC will be keen to ensure that businesses are not merely paying lip service to this requirement, and personal accountability is clearly a powerful way of securing focus.

2. A voluntary "Code of Practice on Taxation for Large Business"
   Businesses would be asked to commit to this Code on a voluntary basis. The Code would provide a common set of principles to encourage adoption of the most positive tax compliance behaviours, and which businesses themselves can use to promote exemplary behaviours across their organisation. The draft Code largely focuses on being open, transparent and not structuring transactions in a way which will have tax results that are inconsistent with the underlying economic consequences unless there exists specific legislation designed to give that result.

   Unlike the Banking Code, HMRC does not intend to name (or otherwise publish any information on) signatories to, or compliance with, the Code, or otherwise publicly identify which businesses are or are not signatories. However, it is likely that those who do sign up will include this fact in their published strategy, and therefore remaining silent on this issue might well be viewed as an indicator of a failure to commit to the Code. Another reason to sign up would be the effect on HMRC's risk profiling of the business; the increased attention associated with a higher risk profile could also be a significant incentive.

   HMRC would expect Code compliance to form part of a business's existing risk management approach, and does not envisage offering routine opinions on the extent to which specific transactions are or are not "Code compliant". This is clearly unhelpful where businesses are endeavouring to comply with new obligations and we do not understand why a different approach is being taken here from that in respect of the Banking Code. Some sort of materiality threshold could prevent HMRC being inundated with minor queries on Code compliance, and offering guidance of this sort would, again, encourage businesses to commit to the Code.

3. A narrowly targeted "Special Measures" regime
   This regime would be to tackle the small number of large businesses that persistently undertake aggressive tax planning, or refuse to engage with HMRC in an open and collaborative manner. Unlike the other two measures, this would not automatically apply to businesses passing any turnover/balance sheet-size test, but would apply after a period "on warning" and if the high-risk corporates programme had not been effective.

   The sanctions imposed on businesses within the Special Measures regime might include:

   • Increased reporting and disclosure requirements between HMRC and the business.
   • Withdrawing or limiting the extent to which HMRC provides certainty to businesses – for example, the availability of non-statutory clearances or informal opinions on the level of risk attached to proposed transactions.
   • Naming and shaming.
   • Withdrawal of the defence of reasonable care against any penalties charged. This would result in any penalties being charged on the basis that the behaviour was at least careless, if not deliberate.

Expected impacts
One can predict that those tending away from co-operation with HMRC and towards more aggressive planning will be able to devise a tax strategy that does not markedly influence their behaviour in practice and are unlikely to sign up to a voluntary code, the non-signatories of which are neither publicised nor sanctioned. The Special Measures regime does involve more concrete consequences for poor compliance but this does seem to add rather unnecessarily to the raft of powers already available to HMRC.

It is hard, therefore, to see what of any significance this will add to HMRC's existing powers. The consultation document itself lists at length the other measures pushing for higher standards of tax compliance and greater transparency, such as the Disclosure of Tax Avoidance Schemes regime, the Senior Accounting Officer regime, the General Anti-Abuse Rule, anti-avoidance legislation more generally, as well as wider disclosure initiatives, in particular sectors such as the Extractive Industries Transparency Initiative and the Capital Requirements Directive.

On the other hand, this may well impact on already compliant businesses, but in terms of adding yet more burdens rather than changing behaviour.

Any business likely to be affected by these proposals will need to begin considering strategy issues immediately. Please do not hesitate to call any of the tax partners listed at the back of this newsletter to discuss what may be required in more detail.

"Improving Large Business Tax Compliance" (HMRC consultation document)

Massey: VAT planning and abuse

The Upper Tribunal (UT) has applied the Halifax abuse principle to recharacterise arrangements involving the supply of sporting services at a golf course.

This allowed VAT to be recovered from a person other than the suppliers of the services (which had gone into liquidation) even though the arrangements were later agreed to be ineffective to remove liability for VAT under the relevant legislation.

Restructuring of a golfing business
A partnership (Hilden), which ran a golf course as a business making VATable supplies, transferred its golfing business to two companies in order to take advantage of the business of sports exemption contained in Group 10 Schedule 9 VATA 1994 for supplies of certain services closely linked to sport or physical education supplied by non-profit-making organisations.

The two companies in question were limited by guarantee and were prohibited from distributing profits by their constitutional documents. It was initially considered that this brought them within the definition of "non-profit-making bodies" for the purposes of the exemption.

Hilden retained the golf course and let it to the two companies, which paid rent. The rent was the higher of £364,000 per annum or 50 per cent of the companies' annual turnover; considerably higher than a commercial rent. In practice, the companies were invoiced what they could afford to pay and so, in effect, the rent operated as a profit-stripping mechanism.

Hilden's contention was that, as a result of this restructuring, it was now making exempt supplies of land, while the two purportedly non-profit-making companies made exempt supplies of sport services. HMRC attacked these arrangements on the grounds that they were abusive.

Effectiveness of scheme is not a prerequisite for abuse
The companies were, it was subsequently agreed, profit-making after all. The consequence of this was that VAT should have been charged on their supplies of sporting services and was thus owed to HMRC. However, relying on a straight application of the legislation to show that the scheme failed to work as intended on a technical analysis would leave HMRC unable to recover the unpaid VAT from the liquidated companies.

As it was, the judge considered that it is not necessary for the scheme as a whole to work for there to be abuse.

Specifically, a tax advantage contrary to the VAT Directives had still been obtained, i.e. that VAT was not paid on eligible sporting supplies, and the benefit of these supplies had accrued to Hilden in the form of higher rents than would otherwise have been achievable. These VAT-free rents were an inherent part of the scheme as they effectively stripped the profit out of the companies, as well as depriving them of the means to pay any liability to VAT that could arise.

This is a potentially wide extension of the abuse principle which could be significant in allowing HMRC to recover unpaid VAT from other parties to transactions, even where the VAT position would not normally be in dispute.

However, it may be that the decision is not as far-reaching as first appears. The focus of this decision was on the shifting of profits from taxable sporting supplies into a genuinely exempt supply of land via the mechanism of the uncommercial rents. Where none of the elements of a scheme meet the legislative requirements to obtain the desired tax consequences, it would be harder to show that a tax advantage had been obtained and therefore the scheme should be less susceptible to redefinition on the grounds of abuse.

Applying the abuse principle
The test for abuse, as set out in Halifax, is that: (i) there must be a tax advantage contrary to the VAT Directives (as discussed above); and (ii) the essential aim of the transactions is to obtain a tax advantage.

The judge referred to Lord Sumption's comments in Pendragon that, when deciding whether the essential aim of the transaction has been to obtain a tax advantage, "it may be necessary both to analyse each transaction in a scheme individually and also to consider the effect of the scheme as a whole when identifying the essential aim of the transactions".

The UT concluded that the First Tier Tribunal had been right to find that the essential aim of the arrangements had been to obtain a tax advantage, as they were artificial and inconsistent with normal commercial practice. In particular, that the rent payable was more than commercial rent and more than the companies could afford to pay, and that Hilden accepted whatever amount the companies could afford.

Redefining the arrangements so that the supplies were treated as made directly by Hilden is self-evidently the pragmatic answer to ensuring that HMRC could recover the VAT on the sporting supplies in this particular situation.

It would be concerning if this were to be a move towards secondary liability by the back door. However, it is more likely that schemes which do not involve an effective element of exemption or relief (such as the exempt supply of land here) will continue to be attacked under the letter of the law, rather than by recharacterisation.

Massey/Hilden Park -v- HMRC

Qualifying private placement withholding tax exemption

HMRC has been consulting on the new UK interest withholding tax exemption for qualifying private placements and a further draft of the relevant regulations has just been circulated for comment. The basic conditions were set out in the Finance Act 2015 and merely required interest to be paid on a security representing a loan to which a company is a party as debtor and which is not listed on a recognised stock exchange.

The crucial details are, therefore, contained in this secondary legislation.

Impact of the exemption
We issued our briefing "Qualifying private placements – new UK withholding tax exemption" when the first draft of the regulations were published; this latest draft helpfully clarifies certain matters and removes yet more of the conditions.

However, our key point remains that this new exemption will not be as seminal a change as had originally been hoped. It seems increasingly clear that the benefit of the exemption is, in practice, likely to be limited to lenders resident in countries which have double tax treaties with the UK, particularly those for which the rate of withholding was merely reduced under the treaty to five or ten per cent rather than eliminated altogether.

This means that lenders in China, Japan, Korea, Italy and Indonesia will now be able to lend direct to the UK without suffering any withholding, which could open up some new sources of capital.

A second ongoing consultation could, however, lead to wider relaxations of the UK withholding regime in the Finance Act 2016.

Changes since the last draft
HMRC has responded very positively to the various concerns raised at the last consultation working group meeting. In particular:

• It has been clarified that loans as well as debt issued in the form of notes or bonds will be eligible for the exemption.
• Existing debt which meets the new conditions has been brought within the exemption. This is particularly helpful as it removes the need to renew treaty clearances, and will eliminate withholding altogether on eligible existing debt which currently benefits only from a reduced rate under a treaty.
• The minimum value of the security or placement remains at £10m, but it has been confirmed that this is the value as at the date the placement is entered into. Fluctuations in value will not therefore affect the exemption.
• The debtor must certify that it reasonably believes it is not connected to the creditor. It is expected that an issuer will require in loan documentation that a new certificate be provided if the security is transferred by the creditor.
• Convertible debt may now qualify for the new exemption.

Next steps
There are a couple of aspects to this that Ashurst is still discussing with HMRC, in particular whether UK lenders lending through partnerships and offshore incorporated borrowers will be able to benefit from the exemption.

The next working group meeting will take place at the beginning of October where we hope to obtain some more clarity on these remaining issues.

Wider consultation on withholding
HMRC is currently undertaking a full review of options in relation to withholding on interest, including considering its abolition, although change is not expected under this wider review until mid-2016.

That review was started as a result of the decision to abolish certain withholding on interest paid on bank accounts. While that limited change is only going to apply to bank accounts, it has triggered this wider review of withholding on interest more generally. See the HMRC consultation document "Deduction of income tax from savings income: implementation of the Personal Savings Allowance" for more details.

It is too soon to tell where that is going to end up but a number of groups are pushing for further relaxations of the regime, especially for partnerships which cause particular issues at the moment.