Transfer of assets and attribution of gains rules: draft Finance Bill 2013 legislation revised | Practical Law

Transfer of assets and attribution of gains rules: draft Finance Bill 2013 legislation revised | Practical Law

The government has substantially revised draft Finance Bill 2013 legislation amending anti-avoidance rules dealing with the transfer of assets abroad (Chapter 2, part 13, Income Tax Act 2007) and the attribution of gains made by non-UK tax resident companies that are closely controlled by UK participators (section 13, Taxation of Chargeable Gains Act 1992). This is a detailed legal update on the revised version published on 11 December 2012.

Transfer of assets and attribution of gains rules: draft Finance Bill 2013 legislation revised

by PLC Private Client
Published on 29 Jan 2013 • United Kingdom
The government has substantially revised draft Finance Bill 2013 legislation amending anti-avoidance rules dealing with the transfer of assets abroad (Chapter 2, part 13, Income Tax Act 2007) and the attribution of gains made by non-UK tax resident companies that are closely controlled by UK participators (section 13, Taxation of Chargeable Gains Act 1992). This is a detailed legal update on the revised version published on 11 December 2012.
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On 11 December 2012, HMRC published revised draft legislation for inclusion in the Finance Bill 2013 to amend anti-avoidance rules dealing with the transfer of assets abroad (Chapter 2, Part 13, Income Tax Act 2007) and the attribution of chargeable gains realised by non-UK tax resident companies that are closely controlled by UK participators (section 13, Taxation of Chargeable Gains Act 1992). The government has made significant changes to meet criticism that the original draft legislation did not make the rules compliant with EU law, but it is still unclear whether compliance will be achieved.

Background

Separate rules prevent UK resident taxpayers from avoiding tax on:
  • Capital gains by sheltering them in certain non-UK resident companies.
  • Income by transferring assets to non-UK entities.

Attribution of gains made by non-resident close companies

As a general rule:
  • Non-UK tax resident companies that do not carry on a trade in the UK through a permanent establishment are not subject to UK tax on their chargeable gains (section 10B, Taxation of Chargeable Gains Act 1992 (TCGA 1992)).
  • Chargeable gains realised by a company are not taxable in the hands of its shareholders.
However, non-UK resident companies that would be close companies if UK resident are subject to anti-avoidance rules contained in section 13 of the TCGA 1992 (section 13). Section 13 permits any chargeable gains that such companies realise to be brought within the UK tax net by attributing those gains to UK resident shareholders and certain other persons in proportion to their interest in the company. However, there is no attribution to a shareholder if the amount apportioned to him is 10% or less of the chargeable gain (attribution threshold).
The persons to whom gains can be attributed include the trustees of non-UK resident trusts. Although non-UK resident trustees would not themselves be subject to tax on the attributed gains, those gains may be further attributed to a UK resident settlor or beneficiary of the trust under rules in sections 86 and 87 of TCGA 1992.
Gains on assets used only for the purposes of a trade carried out outside the UK are excluded from the charge under section 13, but there is currently no motive test excluding arrangements whose purpose does not include tax avoidance.
For more information about the operation of section 13, see:
For information about the operation of sections 86 and 87 of TCGA 1992, see:

Transfer of assets abroad rules

Chapter 2 of Part 13 of the Income Tax Act 2007 (ITA 2007) contains wide and complex anti-avoidance provisions known as the transfer of assets abroad rules (TAA rules). Broadly, the rules apply where an individual ordinarily resident in the UK has made a transfer of assets (relevant transfer) to an overseas company, trust or other entity (person abroad) with an aim of reducing the transferor's UK tax liability. Where they have effect, the rules may attribute income arising to the person abroad to:
  • The transferor, if he or his spouse or civil partner:
    • has the power to enjoy income as a result of the relevant transfer or associated operations (relevant transactions) (section 720, ITA 2007); or
    • receives a capital sum as a result of relevant transactions (section 727, ITA 2007).
  • Other individuals ordinarily resident in the UK who receive a benefit as a result of relevant transactions (non-transferors) (section 731, ITA 2007).
No charge arises under these rules if the taxpayer satisfies an officer of HMRC that either of the following exemptions applies:
  • There was no tax avoidance purpose behind any of the relevant transactions.
  • All of the relevant transactions were genuine commercial transactions on arm's length terms and any tax avoidance purpose was incidental.
(Sections 737 and 738, ITA 2007.)
For more information about the rules, see:

Abolition of ordinary residence

The government has published draft legislation for inclusion in the Finance Bill 2013 (FB 2013) to abolish the concept of ordinary residence for tax purposes from 6 April 2013. From that date, the TAA rules will apply to individuals who are resident in the UK under the proposed statutory residence test. For information about the proposed changes to residence and ordinary residence, see Private client tax legislation tracker 2012-13: Statutory residence test and Abolition of ordinary residence. For information about the current definitions, see Practice note, Residence and ordinary residence: definitions for UK tax purposes.

European Commission infringement proceedings

On 24 October 2012, the European Commission announced that it had decided to refer the UK government to the EU Court of Justice (ECJ) over section 13 and the TAA rules. This followed a formal request to the UK to amend both sets of rules on 16 February 2011. The Commission considers that the two regimes are incompatible with the fundamental EU rights to freedom of establishment and free movement of capital under the Treaty on the Functioning of the European Union (TFEU), because the restrictions they impose are disproportionate (that is, they go beyond what is reasonably necessary to prevent abuse or tax avoidance and any other requirements of public interest).
EU law allows member states to restrict treaty freedoms to counteract tax abuse if the restrictions target "wholly artificial arrangements" that do not reflect economic reality, for example, because they are designed to escape the tax normally due on profits generated by activities carried out in that state (Cadbury Schweppes plc v Commissioners of the Inland Revenue (and related appeal) (Case C-196/04); see PLC Tax, Practice note, ECJ direct tax cases: where are they now?: Cadbury Schweppes).
The referral to the ECJ came after the UK government had published the first version of draft legislation to amend the rules (see Draft legislation published on 30 July 2012). It is not clear whether the Commission referred the UK to the ECJ because it did not believe that the legislation would make the rules compliant with EU law or because it wished to continue the infringement process until the legislation had been amended to its satisfaction.
For more information about the infringement proceedings, see Legal update, Transfer of assets abroad and attribution of gains rules referred to EU Court of Justice.

Freedoms protected by the TFEU

The TFEU protects a range of freedoms, including:
  • The free movement of goods, under Title II of Part Three.
  • The free movement of persons, services and capital, under Title IV of Part Three. Title IV includes:
    • free movement of workers (Article 45);
    • freedom of establishment (Article 49);
    • free movement of services (Article 56); and
    • free movement of capital (Article 63).

Draft legislation published on 30 July 2012

On 30 July 2012, HMRC published a consultation on draft legislation to amend section 13 and the TAA rules. The consultation closed on 24 October 2012.
The Chartered Institute of Taxation (CIOT) and the Institute of Chartered Accountants in England and Wales (ICAEW) both expressed the view that the draft legislation did not fully address the EU law issues raised in the infringement proceedings.
For information about the draft legislation and links to the comments by CIOT and the ICAEW, see Private client tax legislation tracker 2012-13: Transfer of assets abroad and attribution of gains rules.

Original draft amendments to section 13

The original draft legislation on section 13 proposed that, with retrospective effect from 6 April 2012:
  • The categories of assets excluded from charge would be expanded to include those:
    • used only for the purposes of economically significant activities carried on outside the UK by the disposing company through a business establishment in a territory outside the UK; or
    • effectively connected with any part of a business establishment in a territory outside the UK through which the disposing company carried on a trade wholly or partly outside the UK, or economically significant activities outside the UK.
    (Business establishment test.) For the meaning of "economically significant activities", see Original definition of economically significant activities.
  • A motive test would be introduced as an alternative to the other exclusions from charge. Section 13 would not apply where neither the disposal, nor the acquisition or holding, of an asset formed part of a scheme or arrangements of which the main purpose, or one of the main purposes, was the avoidance of liability to capital gains tax (CGT) or corporation tax.
  • Furnished holiday lettings (FHL) outside the UK would fall within the existing exclusion of trading assets in certain circumstances.
In addition, the consultation invited views on the following points, with a view to making any amendments from 6 April 2013:
  • The size and nature of the attribution threshold for minority shareholders.
  • How a de minimis approach to small liabilities might be designed.
  • The extent of problems caused by section 13 for non-UK resident companies operating as public investment funds.
  • The interaction of section 13 with double taxation agreements (DTAs).
For further details, see Legal update, Transfer of assets abroad and attribution of gains rules: consultation published: Amendments to section 13 from 6 April 2012 and Amendments to section 13 from 6 April 2013.

Original draft amendments to TAA rules

The original draft legislation on the TAA rules proposed that, with retrospective effect from 6 April 2012:
  • Non-UK incorporated but UK resident companies would be excluded from the rules.
  • A further exemption from charge would be added to the extent that income was attributable to a "qualifying arm's length transaction" (QALT). A QALT would be a relevant transaction that:
    • was effected on or after 6 April 2012;
    • was an arm's length transaction within the meaning of 738(3) of ITA 2007 (for the purposes of the existing exemption for genuine commercial transactions); and
    • was effected for the purposes of economically significant activities carried on (or to be carried on) outside the UK (see Original definition of economically significant activities).
    This exemption would apply even where the transaction was influenced by tax considerations.
The consultation document also asked for views on the following points, with any amendments to take effect from 6 April 2013:
  • The need for rules matching income arising to a person abroad with benefits received by a non-transferor.
  • Double charges. (HMRC currently exercises discretionary powers to prevent double charges not provided for in the legislation.)
  • The application of double taxation treaties. (There is currently disagreement about whether double non-taxation can occur where a DTA exempts the income arising to the person abroad from UK tax.)
For further details, see Legal update, Transfer of assets abroad and attribution of gains rules: consultation published: Amendments to transfer of assets abroad rules from 6 April 2012 and Amendments to transfer of assets abroad rules from 6 April 2013.

Original definition of economically significant activities

In the original draft legislation, for the purposes of section 13, "economically significant activities" meant activities that both:
  • Consisted of the provision by the disposing company of goods or services to others on a commercial basis and with a view to the realisation of profits on a scale commensurate with the size and nature of the establishment.
  • Involved the use of employees, agents or contractors in numbers, and with the competence, commensurate with the realisation of profits on that scale.
The definition for the purposes of the TAA rules was the same in substance, although the wording of first limb differed slightly as it did not refer to a company and the profits had to be commensurate with the size and nature of the activities rather than of an establishment.
Investment business was excluded from the definition in both cases.

UK government publishes revised draft legislation

On 11 December 2012, the UK government published revised draft legislation for inclusion in the Finance Bill 2013, accompanied by Tax Information and Impact Notes (TIINs) and a summary of responses to the consultation (response document) (see Sources).

Changes to draft legislation on section 13

The key changes to the draft legislation on section 13 are that:
  • The attribution threshold for shareholders is increased from 10% to 25%.
  • The definition of "economically significant activities" is recast, with the aim of reflecting EU law more closely. Investment business is no longer automatically excluded.
  • The business establishment test is simplified. The government has decided that it is unnecessary to have a separate exemption for gains on the disposals of assets that are "effectively connected" with a business establishment outside the UK.
The amended legislation will apply to disposals made on or after 6 April 2012.
The proposed new motive test and provisions on furnished holiday lettings are unchanged, as are the provisions allowing taxpayers to elect not to apply the new rules to disposals made in the tax year 2012-13.
The government will give further consideration to:
  • Connected persons issues, including the rules connecting partners in a partnership.
  • Influence issues, for example, where the holder of a shareholding exceeding 25% could demonstrate inability to exercise significant influence.
  • Small liabilities.
Because of the changes now proposed, the government considers that it is unnecessary to make special provision for public investment funds (and there was a limited response to this question on consultation).

Revised definition of economically significant activities

For the purposes of section 13, "economically significant activities" means activities that both:
  • Consist of the provision by the disposing company of goods or services to others on a commercial basis.
  • Involve:
    • the use of staff (employees, agents or contractors) in numbers, and with the competence and authority;
    • the use of premises and equipment; and
    • the addition of economic value, by the company, to those to whom the goods and services are provided;
    commensurate with the size and nature of those activities.
The new elements are the references to the authority of staff, the use of premises and equipment and the addition of economic value. The previous reference to the scale of profits has been removed.

Changes to draft legislation on TAA rules

The government acknowledged that the draft legislation on the TAA rules published in July 2012 was at an early stage of development. The single clause originally published has now been replaced by a clause and schedule (Schedule) running to more than ten pages.
The key changes are that:
There is no change to the proposal to exclude non-UK incorporated but UK resident companies from the rules with effect from 6 April 2012 (paragraphs 2 and 9(1), Part 2, Schedule).

TAA rules: exemption for genuine transactions

The exemption for genuine transactions is introduced by inserting a new section 742A in ITA 2007 (paragraphs 3 to 8 and 9(2), Part 2, Schedule).
Income is to be left out of account so far as an individual satisfies an HMRC officer that it is attributable to a transaction made on or after 6 April 2012 that meets two conditions:
  • Condition A is that:
    • if, viewed objectively, the transaction were to be considered to be a genuine transaction having regard to any arrangements under which it is effected and any other relevant circumstances, and
    • if the individual were to be liable to tax under Chapter 2 of Part 13 to ITA 2007,
    the individual's liability to tax would, in contravention of Title II or Title IV of the TFEU, constitute an unjustified and disproportionate restriction on a freedom protected under that Title.
  • Condition B is that the individual satisfies an HMRC officer that, viewed objectively, the transaction must be considered to be a genuine transaction having regard to any arrangements under which it is effected and any other relevant circumstances.
(The reference to the TFEU in Condition A should presumably be to Titles II and IV of Part Three; see Freedoms protected by the TFEU.)

Meaning of "genuine transaction"

There is no definition of "genuine transaction" as such. However, it is provided that:
  • To be considered a genuine transaction, a transaction must not, having regard to any arrangements under which the transaction is effected and any relevant circumstances:
    • be on terms other than those that would have been made between persons not connected with each other dealing at arm's length; or
    • be a transaction that would not have been entered into between such persons so dealing.
    (Arm's length requirement.) This wording is taken from section 738(3) of ITA 2007, which was previously incorporated by reference.
  • The arm's length requirement does not apply if:
    • the relevant transfer is made by an individual who makes it wholly for personal reasons (and not commercial reasons) and for the personal benefit (and not the commercial benefit) of other individuals, and
    • no consideration is given (directly or indirectly) for the relevant transfer or otherwise for any benefit received by any individual who benefits,
    and all the assets transferred, income arising from them and assets representing the assets transferred or accumulations of income (specified assets and income) are dealt with accordingly.
  • Where any specified asset or income is used for the purposes of, or received in the course of, activities carried on in a territory outside the UK by a person (relevant person) through a business establishment which the relevant person has in that territory, in order for the transaction to be considered a genuine transaction, those activities must:
    • consist of the provision by the relevant person of goods or services to others on a commercial basis; and
    • involve:
      • the use of staff (employees, agents or contractors) in numbers, and with competence and authority,
      • the use of premises and equipment, and
      • the addition of economic value, by the relevant person, to those to whom the goods are provided,
      commensurate with the size and nature of those activities.
    Apart from referring to a relevant person rather than to a company, this requirement is identical to the definition of economically significant activities for the purposes of section 13 (see Revised definition of economically significant activities). A "business establishment" is the same as a "permanent establishment" as defined in the Corporation Tax Act 2010, reading references to a company as references to a person.

TAA rules: matching rules for benefits

The rules for matching the income arising to the person abroad with benefits received by non-transferors, which are currently contained in sections 732 of 735A of ITA 2007, are substituted by new sections 732 to 735 (paragraph 22, Part 4, Schedule).
There are no changes of substance to the rules for calculating:
  • The benefits that can be matched (now defined as "relevant benefits").
  • The income that can be matched (now defined as the "relevant income amount" for a particular tax year), except that there is a new provision requiring income arising on or after 6 April 2013 to be left out of account if the non-transferor is liable for income tax on it under provisions other than the TAA rules and all income tax for which he is liable has been paid (see TAA rules: prevention of double charging).
(New section 732, ITA 2007 and paragraph 29, Schedule.)

Matching by tax years

In summary, relevant benefits and the relevant income amount are now matched as follows:
  • Relevant benefits received in a particular tax year are matched with the relevant income amount for that year.
  • If the relevant benefits exceed the relevant income amount, they are reduced proportionately. The unmatched part of the relevant benefits is carried back and matched with previously unmatched relevant income amounts, on a year-by-year basis, starting with the most recent.
  • If the relevant benefits exceed all the relevant income amounts remaining to be matched from previous years, they remain available for matching with unmatched relevant income amounts in future years.
  • Similarly, if the relevant income amount for a particular tax year exceeds the relevant benefits for that tax year, the unmatched part is carried back or, if still unmatched, remains available for matching in future years.
(New section 733, ITA 2007.)
This procedure is broadly the same as that used for matching capital payments to beneficiaries with gains made in non-UK resident settlements for the purposes of section 87 of TCGA 1992 (see Practice note, Taxation of offshore trusts: capital payments to beneficiaries: How to match capital payments and trustee gains). It remains the case that the TAA rules apply in priority to section 87 charges for a particular tax year, but relevant benefits that are unmatched in that year under the TAA rules can be charged under section 87, in which case they cannot be carried back or forward under the TAA rules (new section 734, ITA 2007).
The new matching procedure differs from the current rules, which require the sum of the benefits in a particular tax year and any unmatched benefits from previous tax years (total untaxed benefits) to be compared with the sum of income from the particular tax year and any unmatched income from previous tax years (available relevant income). Any benefits or income that remained unmatched are available to be matched in future years. There is no rule about matching benefits proportionately if they exceed the relevant income.
Transitional provisions provide that unmatched benefits or income from before 2013-14 are calculated under the existing rules but treated as having been received (if benefits) on 5 April 2013 or as arising (if income) in 2012-13 (paragraphs 26-28, Schedule).

Order in which different types of income are matched

Different types of income within a relevant income amount are matched in the following order:
  • Any benefits arising to an individual who is a non-UK domiciled remittance basis user (RBU) (section 735 benefits):
    • are matched first with UK income; and
    • if they exceed the UK income, they are reduced proportionately and the balance matched with non-UK income.
  • Any benefits arising to an individual who is not a non-UK domiciled RBU (non-section 735 benefits):
    • are matched first with non-UK income that has not been matched to section 735 benefits; and
    • if they exceed the non-UK income, they are reduced proportionately and the balance matched with UK income that has not been matched to section 735 benefits.
(New section 734A, ITA 2007.)
(Currently a RBU may be either not domiciled in the UK or not ordinarily resident in the UK, but from 6 April 2013 all RBUs will be non-UK domiciled; see Abolition of ordinary residence.)
The term "non-UK income" means income that would be relevant foreign income of the person abroad if that person were a UK resident individual. It remains the case that when the TAA rules operate to treat non-UK income as arising to a RBU, that income is charged to tax under the remittance basis rules only if the corresponding matched benefit or income is remitted to the UK (new section 735, ITA 2007).
The current matching rules for different types of income cover only section 735 benefits (although that definition is not used). Benefits arising to non-domiciled RBUs are matched in the order received, first against UK income in the order received and then against foreign income in the order received. There are no rules about the order of matching for individuals who are not non-UK domiciled RBUs. Therefore, it remains uncertain how unmatched non-section 735 benefits from before 2013-14 should be matched.

TAA rules: prevention of double charging

Charges under the TAA rules are prevented from applying where both:
  • The transferor (where the transferor is charged) or a non-transferor (where a non-transferor is charged) is liable for income tax on the same income under provisions other than the TAA rules.
  • All income tax for which that individual is liable has been paid. (There is no qualification of "income tax" for this purpose. However, since we first published this legal update, HMRC has confirmed to us that the reference to income tax for this purpose is only to the tax that arises on the same income under the provisions other than the non-TAA rules, not to all the income tax for which the taxpayer is liable.)
This is achieved by amending the separate provisions identifying:
  • Transferors who have the power to enjoy income as a result of a relevant transaction (section 721, ITA 2007).
  • Transferors who receive capital sums as a result of a relevant transaction (section 728, ITA 2007).
  • Non-transferors who receive a benefit as a result of a relevant transaction (new section 732, ITA 2007) (see TAA rules: matching rules for benefits).
(Paragraphs 10(3) and 14(4), Part 3 and paragraph 22, Part 4, Schedule.)
These amendments remove the current provisions stating that it does not matter, for the purposes of sections 721 and 728, whether the income would otherwise be chargeable to tax.

TAA rules: income charged is deemed amount

The TAA rules are amended to state that the income that is charged on a transferor or non-transferor is not the income arising to the person abroad, but a deemed amount equal to that income. This is intended to make it clear that DTAs should not lead to double non-taxation (see Original draft amendments to TAA rules).
Amendments are made throughout the rules to achieve this, including statements inserted in the provisions identifying transferors and non-transferors (sections 721, 728 and new section 732, ITA 2007; see TAA rules: prevention of double charging) (Part 3, Schedule).

Next steps

The revised draft legislation, like all the Finance Bill 2013 legislation published on 11 December 2012, is open for technical consultation until 6 February 2013.
The government will also carry out a more detailed review of wider suggestions made in response to the consultation document and consider whether changes can be made that are fair, do not weaken the provisions and do not impose further cost to the Exchequer (page 3, response document). It acknowledges the time and effort that went into some very detailed consultation responses recommending a complete overhaul of the TAA rules, in particular.

Comment

The government has chosen to press ahead with the changes it judges necessary to make section 13 and the TAA rules compliant with EU law, while promising a further review of wider points. There is almost no comment on why the government believes that the revised legislation will meet EU requirements, which contrasts with the detailed discussion in the consultation document. However, it is clear that the government is determined to place the burden on taxpayers to show that activity is economically significant or that a transaction is genuine, rather than to accept the burden of showing that either is wholly artificial. As CIOT has pointed out, this is always likely to leave a gap that gives rise to uncertainty and the risk of applications to the ECJ. Some practitioners have already expressed the view that the revisions may not achieve compliance with EU law (for example, see Article, 2012 Autumn Statement and other festivities: European friends join the party). The government hasn't taken up suggestions to offer advance clearance procedures.
While any new exemption is welcome in principle, the new genuine transaction test under the TAA rules is convoluted. The taxpayer must not only work out whether, if genuine, the transaction would infringe any EU treaty freedoms, but also satisfy HMRC that it is in fact genuine. To be regarded as genuine, the transaction must either be on arm's length terms or be a gift with no strings attached. If it involves a business establishment outside the UK, that establishment must carry out economically significant activities.
It is obviously intended that a genuine transaction should reflect an underlying economic (but not necessarily commercial) reality. The revised legislation therefore seems to offer increased scope for gifts that escape the TAA rules, provided that the settlor cannot benefit (as the transfer must be for the benefit of "other individuals"). However, planning on this basis may be limited by the application of the settlements legislation and sections 86 and 87 of TCGA 1992. (The current overlap between these various rules has led CIOT to suggest that the TAA rules could be abolished altogether if the CGT provisions were extended to income tax for trusts not caught by the settlements legislation.) HMRC guidance will be required on the meaning of "personal" (as opposed to "commercial") reasons for, and benefits from, transfers.
As with the QALT exemption previously proposed, this exemption will require income to be apportioned to the extent that it is not attributable to a genuine transaction. There is no guidance on this as yet.
The lack of apportionment in other areas is one reason why the revised legislation may infringe EU law, because it continues to be disproportionate. For example, a non-UK close company may use an asset over a period of time and for some (short) time during that period fail to satisfy the business establishment test. It appears from the drafting that the benefit of the defence is then lost entirely, with no scope for adjusting the amount apportioned to participators.
It is helpful to have express statutory provisions on matching and double charges under the TAA rules, although the matching rules don't help with the treatment of unmatched benefits from before 2013-14 arising to individuals who are not non-UK domiciled RBUs. The provisions to avoid double non-taxation under treaties are billed as clarification, which assumes that the government's view is correct (the ICAEW, for example, believes that such provisions would change the law).

Sources

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