Transfer of assets abroad and attribution of gains rules: changes in Finance Bill 2013 as published

Practical Law UK Legal Update 1-527-2486 (Approx. 8 pages)

Transfer of assets abroad and attribution of gains rules: changes in Finance Bill 2013 as published

by PLC Private Client

Background

Current rules

Separate rules prevent UK resident taxpayers from avoiding tax on:

Income by transferring assets to non-UK entities (Chapter 2, Part 13, Income Tax Act 2007 (ITA 2007) (TAA rules)).
Capital gains by sheltering them in certain non-UK resident companies (section 13, Taxation of Chargeable Gains Act 1992 (section 13)).

For information about the TAA rules and section 13 in their current form, see Legal update, Transfer of assets and attribution of gains rules: draft Finance Bill 2013 legislation revised: Transfer of assets abroad rules and Attribution of gains made by non-resident close companies.

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 the TAA rules and section 13. 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 that 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).

For more information about the infringement proceedings, see Legal update, Transfer of assets and attribution of gains rules: draft Finance Bill 2013 legislation revised: European Commission infringement proceedings.

Freedoms protected by 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 for the Finance Bill 2013

On 30 July 2012, the government published a consultation on draft legislation for the Finance Bill 2013 (FB 2013) to amend the TAA rules and section 13. This included, with retrospective effect from 6 April 2012:

For the TAA rules, a new exemption from charge for income attributable to a qualifying arm's length transaction (QALT).
For section 13, a new exemption from charge for assets 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.

On 11 December 2012, following the European Commission's announcement about referring the UK to the ECJ (see European Commission infringement proceedings), the UK government published revised draft legislation. The changes to the draft legislation:

On the TAA rules included:
- a new exemption for genuine transactions, replacing the QALT exemption; and
- new rules for matching income arising to a person abroad with benefits received by persons other than the person who transferred assets abroad (non-transferors).
On section 13 included an amended definition of "economically significant activities".

References in the rest of this legal update to the "draft legislation" are to the version published on 11 December 2012.

As part of the 2013 Budget, the government announced (but did not publish) the following changes to the draft legislation:

For the TAA rules:
- a change to the exemption for genuine transactions to allow part of a transaction to qualify; and
- the removal of the new matching rules for benefits received by non-transferors. There will be a further consultation on these provisions, which will now be postponed until the Finance Bill 2014.
For section 13, the removal from the new exemption for economically significant activities of the requirement that activity be carried on wholly outside the UK through a non-UK business establishment.

For more information about the history of the draft legislation, see Private client tax legislation tracker 2012-13: Transfer of assets abroad and attribution of gains rules.

FB 2013 published

The government published FB 2013 on 28 March 2013. It includes the changes to the TAA rules and section 13 announced as part of the 2013 Budget.

For information about other measures of interest to private client practitioners in FB 2013, see Legal update, Finance Bill 2013 published: private client tax measures.

Changes to legislation on TAA rules

The legislation on the TAA rules has been included in FB 2013 as clause 26 and Schedule 10 (Schedule 10).

The two changes announced as part of the Budget are implemented by:

A new provision allowing the genuine transactions exemption to apply to part of a transaction (see Genuine transactions exemption: part of transaction can qualify).
The deletion of the new rules for matching the income arising to the person abroad with benefits received by non-transferors that were set out in Part 4 of the Schedule in the draft legislation (and would have been substituted for sections 732 to 735A of ITA 2007).

In addition, the following changes have been made to the draft legislation:

For the purposes of the genuine transactions exemption, correction of the reference to EU treaty provisions and addition of European Economic Area (EEA) Agreement provisions (see Genuine transactions exemption: relevant treaty provisions).
(Note: the mistake identified in this bullet has been corrected in the Finance Bill as reintroduced on 9 May 2013. It now inserts new section 721(3A) and (3B) of ITA 2007 before section 721(4).) An odd change to the order of subsections to be inserted in section 721 of ITA 2007 (individuals with power to enjoy income as a result of a relevant transaction) (paragraph 10(3), Schedule 10). The draft legislation inserted new section 721(3A) and (3B) after existing section 721(3). It has been amended in Schedule 10 to insert new section 721(3B) and (3C) before section 721(3). New section 721(3A) is now inserted, after section 721(3), as a consequential change of the abolition of ordinary residence (paragraph 61(3), Schedule 44, FB 2013; see Private client tax legislation tracker 2012-13: Abolition of ordinary residence). We assume that the reference to "before" is a mistake. The explanatory notes still reflect the draft legislation. The substance of the provisions inserted is unchanged, taking into account the clarification in the next bullet. (For details of the substance, see Legal update, Transfer of assets and attribution of gains rules: draft Finance Bill 2013 legislation revised: TAA rules: income charged is deemed amount and TAA rules: prevention of double charging.)
Clarification that relief from double charging applies where the individual charged is liable for income tax on the same income under other provisions and all that income tax has been paid (paragraphs 10(3) and 14(4), Schedule 10, inserting new sections 721(3C)(b) and 728(2A)(b) of ITA 2007). The draft legislation referred to "all income tax" for which the individual was liable, but HMRC had confirmed to us that this was not intended to refer to income tax payable on other income (see Legal update, Transfer of assets and attribution of gains rules: draft Finance Bill 2013 legislation revised: TAA rules: prevention of double charging).
A non-substantive amendment to the wording of a consequential change to section 746(2) of ITA 2007 (paragraph 19, Schedule 10). The consequential change is required to clarify that, for the purposes of deductions and reliefs, the individual charged is treated as receiving a deemed amount of income rather than the income arising to the person abroad.

Genuine transactions exemption: relevant treaty provisions

The genuine transactions exemption is set out in new section 742A of ITA 2007, which is introduced by paragraph 7 of Schedule 10.

The first condition for the exemption to apply (condition A) is that the individual's liability to tax under the TAA rules would (subject to certain assumptions) contravene a "relevant treaty provision". This is a new definition.

A relevant treaty provision is one of the following:

Title II or IV of Part Three of the TFEU (see Freedoms protected by TFEU).
Part II or III of the EEA Agreement. The EEA Agreement (which is not defined) allows the European Free Trade Association (EFTA) countries Iceland, Liechtenstein and Norway (but not Switzerland) to take part in the single market without EU membership. (For information about the EEA Agreement, see PLC EU, Legal update, EFTA: Council adopts conclusions on EU relations with EFTA countries.)
The provision of any subsequent treaty replacing one of the provisions above.

(New section 742A(4), ITA 2007.)

The draft legislation referred only to TFEU provisions and that reference was incorrect (see Legal update, Transfer of assets and attribution of gains rules: draft Finance Bill 2013 legislation revised: TAA rules: exemption for genuine transactions). The amended reference to the EU treaty provisions is merely tidying up. However, the inclusion of EEA Agreement provisions extends the scope of the exemption to transactions involving Iceland, Liechtenstein and Norway where a treaty freedom is engaged. While Iceland and Norway tend not to feature in tax planning, Liechtenstein is more important and its relevance has increased because of the Liechtenstein disclosure facility (LDF). (For information about the LDF, see Practice note, UK/Switzerland tax co-operation agreement and Liechtenstein Disclosure Facility: comparison tables.)

Genuine transactions exemption: part of transaction can qualify

The second condition for the genuine transactions exemption to apply (condition B) is that the individual satisfies an HMRC officer that the transaction is genuine.

If condition B is not met in relation to the whole transaction, the new provision allows the exemption to apply to income attributable to a part of the transaction that does meet condition B (new section 742A(14) and (15), ITA 2007).

If this provision applies, it will be necessary to attribute income to both:

The transaction.
The part of the transaction that qualifies for the exemption.

It seems likely that some form of apportionment will be required in many cases, and it would be helpful for HMRC to provide guidance and examples. Practitioners advising on this exemption may want to suggest that accounting and record keeping should be reviewed with a view to completing tax returns.

Changes to legislation on section 13

The legislation on section 13 is in clause 61 of FB 2013 (clause 61).

The change announced as part of the 2013 Budget has been implemented by an amendment to new section 13(5)(ca). This now excludes from charge an asset used only for the purposes of economically significant activities carried on wholly or mainly outside the UK by the disposing company (clause 61(3)). It is no longer necessary for those activities to be carried out in a business establishment in a territory outside the UK.

There is no change to the definition of "economically significant activities" in new section 13A(4) (clause 61(4)).

Comment

While the changes made to the draft legislation are to the taxpayer's advantage, they do not address all of the concerns raised during the consultation process about whether the legislation will achieve compliance with EU law. There is still a lack of proportionality in some respects. For example, a charge may arise under section 13 if the non-UK resident company fails to meet the economically significant activities test for a short period during its ownership of an asset, and a shareholder who has owned a share in a non-resident company for a short period can be charged under section 13 in respect of a gain relating to a much longer period (for which the non-resident company held the asset concerned). As we have commented before (in Legal update, Transfer of assets and attribution of gains rules: draft Finance Bill 2013 legislation revised: Comment), there is likely to be uncertainty (and so possibly litigation) about EU compliance for as long as the government remains 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.

The history of this legislation also illustrates a weakness in the government's much-vaunted consultation process. The consultation document published in July 2012 contained a detailed discussion of the EU law issues and set out the reasoning behind the government's chosen approach. It attracted detailed comments from professional bodies. However, the summary of responses to the consultation, tax information and impact notes (TIINs) and FB 2013 explanatory notes contain little in the way of reasoning. We do not know why the government has chosen to make the amendments that it has at each stage or why it believes that these will be sufficient to achieve compliance with EU law.

The July 2012 consultation document did promise a more general review of these rules, so we hope that this will happen at some point. The FB 2013 amendments make some improvements, but they add further layers of complexity to legislation that is (particularly in the case of the TAA rules) already notoriously difficult to apply.

To follow the progress of the FB 2013 measures, see Private client tax legislation tracker 2012-13: Transfer of assets abroad and attribution of gains rules.

Sources

Clause 26 and Schedule 10, FB 2013 (Transfer of assets abroad).
Clause 61, FB 2013 (Attribution of gains to members of non-resident companies).
FB 2013 explanatory notes.

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