Tax Avoidance Including Fragmentation

The Government has released a consultation document putting forward proposals to introduce legislation to counter arrangements designed to move profits of smaller businesses and trades to offshore, low tax jurisdictions. The consultation, “Tax avoidance involving profit fragmentation”, details the Government’s proposal to introduce legislation targeted at such arrangements, to require early notification of such arrangements and to allow HMRC to require early payment of disputed tax.

However, as the consultation recognises, there is a large overlap between the proposals and HMRC’s existing anti-avoidance measures and administrative powers. As such, the introduction of a raft of new rules and powers (as opposed to extending existing rules and powers appropriately) would appear to both unnecessary and contrary to any efforts to simplify the tax system.

Background

In the Autumn Budget 2017, the Government announced that it would consult on proposals to prevent UK traders and professionals from avoiding tax by arranging for their UK business profits to accrue to entities resident in territories where no tax, or only a low rate of tax, is paid.

The Government is concerned that arrangements undertaken generally by individuals, partnerships or smaller companies or groups and designed to reduce UK tax by allocating profits to an offshore entity are difficult for HMRC to counter effectively. The examples given in the consultation document by HMRC involve smaller businesses setting up offshore structures to receive part of the profits from their activities, such as a UK management consultant diverting payments for its services to an offshore company or a UK architect paying fees to reduce profits to an offshore company.

Whilst the consultation document accepts that a number of existing anti-avoidance measures can be used to counter-act such arrangements (such as the transfer of assets abroad rules, transfer pricing, disguised remuneration etc), the Government is concerned that the offshore nature of the arrangements (often involving offshore trusts) make it difficult for HMRC to gather the necessary information to levy UK tax effectively. There are also concerns that some individuals using such arrangements leave the UK before the end of the period of enquiry, making collection of tax difficult.

As a result, the Government is putting forward proposals which have three elements:

• a new targeted anti-avoidance rule

• a requirement to notify affected arrangements

• power for HMRC to require payment of the disputed tax in advance.

TAAR

The consultation document proposes that new legislation would target arrangements where:     

• there are profits attributable to the professional or trading skills of an individual (A) resident in the UK, whether A is trading as an individual or a partner, or conducting business through a company

• some or all of those profits (alienated profits) end up in an entity Z which results in “significantly less tax” being paid on them than would have been paid had they arisen to A. An “entity” for these purposes would be interpreted widely, and would include a company, partnership or trust, whether or not having legal personality

• a, or a connected person, or someone acting together with A or the connected person, is able to enjoy economic benefits from the alienated profits, and 

•  it must be reasonable to conclude that some or all of Z’s profit is excessive having regard to the profit-making functions it performs (with the excess being attributable to the connection between it and A).

It is proposed that the “significantly less tax” test will be based on effective tax rates (rather than headline rates) and will trigger if the tax rate is 80% or less of the UK tax on the same profits.

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. However, all of the facts would be taken into account, for example, whether the profit assigned to those businesses was artificially skewed to take UK profits out of the UK tax charge.

As regards the need for a connection between A and the offshore entity, the Government proposes a very wide approach. It is proposed that the “excessive profits” test will involve examining all of the facts around the arrangements. If the facts show that the sums paid to the connected entity are in reality in return for services actually carried on in the UK, and that sums paid to the offshore entity ultimately benefit members of A’s family, then the condition will be met. Indeed, the Government intends to apply a wider connection test that used in existing legislation. An important element of this would involve a “power to enjoy” test. The concept of a person having “power to enjoy” assets or sums of money involves situations where the person may not directly receive an amount but where they benefit from it in another, indirect way. This encompasses aspects such as paying off loans for family members, placing money in a trust that will make payments to the trader’s children or grandchildren, or in other ways directing how funds should be applied. So if A is arranging for trading receipts to be paid to an entity in a low tax jurisdiction, and has power to enjoy diverted sums, then unless they are caught by existing anti-avoidance legislation, those trading receipts will be caught by the proposed new legislation and added to trading profits for UK taxation purposes. If A cannot enjoy the profits personally, but persons connected with A can do so, again these will be caught.

The rules will also cover situations in which A and Z are not formally connected but are “acting together”. This will involve looking at all the circumstances, and in particular whether the alienation of profits that occurs would happen in a genuine commercial arrangement. These connection rules are likely to involve the following ideas. An individual is connected with another entity:

• if the UK individual can influence where funds go, and how they are allocated, or

• if the individual has power to influence how the entity to which sums are diverted conducts its affairs. The key point is that this is what happens in practice, whatever the formal arrangements might be

• persons will also be connected if they are able to act together in ensuring that funds are allocated in a particular way.

The connection rules will also apply to someone with a UK trade or profession, who has arranged or directed that payments should be made to the offshore entity involved in the arrangements. In these circumstances, the UK person will be deemed to be connected with the entity receiving the payments.

Notification and payment of tax

The Government believes that the special features of these schemes, which often rely on concealment of facts behind complex structures and exploit the fact that HMRC may not have the right to force the production of information held offshore, make it appropriate to introduce legislation to provide for notification of use of this type of arrangement and for earlier payment of tax.

It is proposed that the notification requirement will deliberately be set wider than the conditions required to bring sums into charge, to allow HMRC to examine cases where there is room for doubt over whether the new provisions apply or not. The proposal is that notification will be required where the first three features set out in the bullets in the section headed TAAR are present (ie all of the features except the final one, ie that it must be reasonable to conclude that some or all of Z’s profit is excessive).

Generally, notification will be required when arrangements are entered into which fall within the legislation, or if changes are made which bring arrangements within the legislation. Notification will not be needed if the arrangements have already been notified under the Disclosure of Tax Avoidance Schemes (DOTAS) rules, or if the person accepts that other legislation applies in priority to counteract the arrangements in question.

If HMRC has reason to believe that an amount is chargeable under the new rules, HMRC 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 then have a period of 30 days to make submissions that may result in HMRC changing its view. If HMRC considers that a charge is still due (which may differ from that set out in the preliminary notice) it may issue a charging notice, which will require payment of tax and be followed by a review period during which the charge may be adjusted. The review period is intended in most cases to allow HMRC to determine whether the initial charging notice was insufficient, in which case a supplementary charge would be imposed during that period; excessive, in which case it should be reduced as soon as this becomes apparent; or should be fully withdrawn. Only after the end of the review period would it be possible for the case to be taken to appeal.

Commencement

The Government intends that the new rules should apply from 01 April 2019 onwards for corporation tax and 06 April 2019 for income tax and Class 4 NIC, and will apply to all profits diverted on or after that date. It will apply to all arrangements in existence at that date, whenever the arrangements were entered into.

Comments

The consultation document is open for responses until by 08 June 2018, which should be sent by e-mail to profitfragmentation.mailbox@hmrc.gsi.gov.uk

Clearly there is a significant overlap between the proposed new rules and existing (or contemplated) rules. There are many existing anti-avoidance measures that might be brought against such arrangements where they have little or no substance. Equally, the DOTAS rules (as well as the proposed EU DOTAS rules) would already catch many such arrangements. HMRC also has power to issue accelerated payment notices (APNs) in cases that fall within the DOTAS rules or the GAAR. This proliferation of anti-avoidance rules and administrative measures against arrangements which (as described by HMRC) would fall squarely within existing HMRC’s existing powers of counter-action seems unnecessary and unfortunate. An approach that extends HMRC’s existing powers in relation to advance notification and payment to the most blatant of the arrangements targeted by the consultation would appear to be a simpler and more satisfactory approach.