Central management and control and SPVs

The Court of Appeal has reinstated the decision of the FTT in finding that the board of directors of Jersey subsidiaries acting on instructions from its UK parent company in entering into transactions which formed part of a group tax planning scheme did not exercise central management and control: HMRC v Development Securities Ltd [2020] EWCA Civ 1705. Whilst the directors did not act mindlessly, merely checking the legality of the transactions which were uncommercial from the Jersey companies' perspective before entering into them did not detract from the fact that they had in effect simply acted on the instructions from the parent company.

The Court considered that the Upper Tribunal (in overturning the decision of the FTT) had misunderstood the reasoning of the FTT, which the majority considered could not be criticised. However, Nugee LJ expressed reservations concerning that original decision and the extent to which it should have stood. However, since the taxpayer had not sought to uphold the decision of the Upper Tribunal on alternative grounds, those reservations were not directly relevant to the decision.

Nevertheless, the decision (and the reservations expressed by Nugee LJ) leave the question of how far a non-UK subsidiary may simply follow the instructions of its UK parent whilst remaining non-resident somewhat uncertain. It seems perhaps that a more active engagement in the understanding and approval of the transactions may be needed and that merely focussing on the legality of the transactions requested by the parent will not be enough.

Background

The case involved the implementation of a tax planning scheme put together for Development Securities by PwC designed to obtain the benefit of indexation relief on capital assets that were now standing at a loss. It was essential to the success of the scheme that the transfer of those assets was made to Jersey SPV companies which were not UK tax resident. The three Jersey companies were incorporated in Jersey and had three "professional" Jersey based directors and one director from Development Securities.

HMRC contended that the Jersey SPVs were, in fact, resident in the UK. The central management and control of those SPVs was not in fact carried out by the directors in Jersey. In particular, those SPVs had been set up for a very particular purpose by the parent company and once that purpose had been carried out the Jersey directors would be replaced by UK directors (allowing the benefits of the indexation allowance to be obtained). In particular, the arrangements involved the purchase of the relevant assets at a price in excess of their market value and HMRC contended that this was evidence of the fact the directors were not exercising central management and control but had abdicated that control to the parent company. The FTT agreed with HMRC at first instance finding that, although the directors had not acted "mindlessly", their deliberations had been directed towards the legality of their actions in approving transactions that were on their face uncommercial. They had given no real consideration to the transactions themselves and had simply acted on the instructions of the parent company. On appeal, the Upper Tribunal considered that the FTT had erred in law in concluding that the directors of the Jersey companies had abdicated their responsibilities such that central management and control (CMC) was in reality in the UK.

Decision of the Court of Appeal

The Court set out the principles to follow in cases of corporate residency as follows:

• The overarching principle is that a company resides for tax purposes where its real business is carried on, and that is where CMC actually abides;
• The principle applies in relation to subsidiaries, including special purpose vehicles;
• It is the actual place of management, not that in which it ought to be managed, which fixes the residence of a company;
• A company may be resident in a jurisdiction other than that of its incorporation not only where a constitutional organ exercises management and control elsewhere, but if the functions of the company's constitutional organs are usurped, in the sense that management and control is exercised independently of, or without regard to, its constitutional organs, or if an outsider dictates decisions (as opposed to merely proposing, advising and influencing decisions);
• On the other hand, CMC of a subsidiary will not be taken to be in a jurisdiction other than that of its incorporation just because it is following a tax planning scheme propounded by its parent. Nor need it matter that a company's board takes decisions without full information or even in breach of the directors' duties;
• Events before or after the particular date in question may be relevant as casting light on the position on that date; and
• Where a company is resident is essentially a question of fact.

The Upper Tribunal had criticised the decision of the FTT on a number of grounds, but essentially considered that the FTT had been misled by the uncommerciality of the arrangements from the perspective of the Jersey companies and that the basis for their conclusion that the Jersey directors had abdicated responsibility was that the FTT had concluded that the directors had failed to decline to do something that was improper or inadvisable, in that they had entered into so-called uncommercial transactions.

The careful analysis of the FTT's decision by the Court of Appeal showed that this was simply not true. The FTT had taken the view that the directors had not "actively engaged" with the decision to enter into the transactions requested of them by the parent company. All the directors had done was to consider whether they were legally entitled to carry out those uncommercial transactions.

The Court noted that it was clear from their decision that the FTT found, having considered the written and oral evidence in great detail, that, aside from reviewing the corporate law advice, there was "no consideration or discussion on the merits (or otherwise) of the Jersey companies entering into the arrangements whether from their own perspective or taking into account the wider benefit to the group, that the Jersey board were simply administering a decision they were instructed to undertake by their parent, in checking the legality of the plan and then administering the other consequent actions prior to handing over completely to the UK group and that the Jersey board merely passed the formal relevant resolution for the Jersey companies to enter into the arrangements and subsequently to exercise them on the basis of the instruction received without any engagement with the substantive decision albeit having checked that there was no legal bar to them carrying out the instruction.

Equally, the FTT had recognised that the mere fact that a 100% owned subsidiary carries out the purpose for which it was set up, in accordance with the intentions, desires and even instructions of its parent does not mean that central management and control vests in the parent. It was not this per se that the FTT had focussed on, but the lack of any consideration of the transactions to be entered into, apart from their legality.

Since the Court held that the Upper Tribunal's criticisms of the FTT decision had not been well-founded, the Upper Tribunal had been wrong to set aside that decision and the FTT's decision should be reinstated.

Obiter opinion of Nugee LJ

However, Nugee LJ expressed reservations over that original decision nevertheless. (These were not actually directly relevant to the decision however since the taxpayer had not sought to uphold the decision of the Upper Tribunal on any alternative grounds.)

Nugee LJ noted that this was the first case where "the local board of directors of a company had actually met, had understood what they were being asked to do, had understood why they were being asked to do it, had decided it was lawful, had reviewed for itself the transactional documents, had been found not to have acted mindlessly, but had nevertheless been found not to have exercised CMC". Nugee LJ considered that was a "significant departure from the previous case law". Nugee LJ did not consider that the authorities establish that CMC can only be exercised by "actively engaging" with the decision "if that means (as it appears the FTT meant) considering for themselves the merits and demerits of a proposal. The question is not why the directors made the decision they did, or how much thought they gave to it, or what they did or did not take, or should or should not have taken, into account. The question is a much simpler one, namely: did they make the decision?" Nugee LJ would have considered, on the basis of the FTT's findings of fact, that the Jersey directors had exercised their decision making function such as to locate CMC in Jersey despite following the parent company's instruction:

"On the FTT's findings, the directors regarded themselves as in effect instructed to enter into, and then exercise, the options by DS plc on the basis that DS plc certified that it was for the Group's benefit, and without discussing or considering the benefit for themselves. That seems to me to be an explanation of why they decided to enter into, and then exercise, the options; it does not to my mind justify a conclusion that they did not decide to do those things at all."

These reservations of the FTT's decision were not, however, shared by the majority of the Court.

Comment

The original FTT decision caused some concerns as to the location of company residence in the case of SPVs set up to carry out a specific function. The decision of the Upper Tribunal appeared to restore the status quo by stressing the mere fact that an SPV carries out the functions for which it was specifically set up says nothing about where central management and control is located.

However, the decision of the Court of Appeal will again raise some concerns. At the very least, the Court has (by a majority) approved an approach which stresses that the local directors must consider the merits of the specific transactions to be entered into. It is not sufficient, as here, for the attention of the directors to be solely directed to the question whether they were legally entitled to enter into those transactions. Simply asking whether transactions could be entered into did not detract from HMRC's argument that the directors followed instructions from the parent to carry those transactions out (whilst not however "acting mindlessly"). A more active engagement in understanding and approving the transactions (perhaps both from the perspective of the individual companies and the group) would be expected to ensure that the directors were not merely following instructions.

Fortunately, this decision is not anticipated to affect the viability of the non-UKs SPVs widely used across a range of market sectors. In principle, local boards provided by third party corporate service providers are still capable of ensuring the SPV's central management and control is exercised in the intended non-UK jurisdiction. However the Court of Appeal's judgment increases the need for prudent residency compliance to achieve this i.e. it reinforces the importance of ensuring that non-UK SPVs boards consider in detail the commercial effect of any transactions they consider, and in particular distinguish between the commercial benefit for the SPV itself and its wider group or other transaction parties. Similarly, it reinforces the need to ensure that any transaction benefits and is in the interests of each of the SPVs or entities involved in the transaction on an individual level as well as the wider group or transaction parties overall. It also increases the importance of ensuring that both of these elements are clearly documented in the board minutes, so that suitable evidence is readily available in case the basis of the decisions and/or tax residence of the non-UK SPV is every queried in the future.