UK and International Tax news
Targeted Anti Avoidance Legislation And Treaty Shopping
Monday 8th August 2011
HMRC has recently published a technical note together with draft legislation to apply to avoidance schemes that seek to exploit the provisions of double tax agreements [DTAs].
The Government announced in the March 2011 Budget that it intended to introduce legislation in the 2012 Finance Bill to counter avoidance schemes that exploited the provisions of DTAs. The draft legislation forms the basis of consultation on this proposal which is being conducted in line with the Tax Consultation Framework.
The UK has around 120 bilateral DTAs with other countries and territories. The purpose of these DTAs is the avoidance of double tax and the prevention of fiscal evasion. Their intention is to secure that, as far as possible, the taxpayers of each country may trade or invest in the other country without the deterrent of unrelieved double taxation. At the same time, it is important to ensure that taxpayers do not exploit the terms of the agreements and differing tax systems in each country for tax avoidance purposes.
HMRC however considers that both UK resident and non-UK resident persons continue to exploit the provisions of DTAs through the use of tax avoidance arrangements. These arrangements attempt to access the benefits of treaties when they are not properly due to secure the result that items of income, profit or gain are not subject to tax in the UK.
In the past, response to these schemes has been to legislate to close them down as they have arisen or to rely on anti-avoidance measures in DTAs themselves. However, HMRC has observed that avoidance activity exploiting the provisions of DTAs has continued and the Government now considers that a broader anti-avoidance measure is required to prevent further loss of tax in this area.
For UK residents, the proposed legislation is intended to reinforce the principle that, except in narrow and explicit circumstances (for example, articles dealing with students or government service), DTAs do not restrict the right of the UK to tax its residents.
The proposed legislation will apply where a DTA makes provision that income, profits or gains of a UK resident are either not subject to UK tax, not to be subject to UK tax at a rate exceeding the rate specified in the DTA or not to be treated as income, profit or gains of a UK resident and chargeable to UK tax.
Where certain avoidance conditions are met, the proposed legislation will apply such that the provision in the DTA will not prevent the income, profits or gains either being charged to UK tax, being charged to UK tax at a rate exceeding that specified in a DTA or being treated as the income, profits or gains of the UK resident and chargeable to UK tax.
The avoidance conditions are that:
(a) a scheme is put in place by one or more persons;
(b) the provision would not apply to the income, profits or gains in the absence of the scheme; and
(c) the main purpose, or one of the main purposes, of a person in putting the scheme in place is to ensure that the provision does apply to the income, profits or gains.
The above reference to residents means residents for DTA purposes. However, for the purposes of the draft legislation, the meaning of UK resident is based on UK law. As a result a person resident in both the UK and another state for the purposes of their domestic tax laws, but resident in the other state for the purposes of the DTA will still be a UK resident for the purposes of the proposed legislation. This is to prevent UK residents manipulating the residence tie-breaker provisions in the UK’s DTAs – for example by moving their permanent home overseas for a short period in order to avoid UK tax on income or chargeable gains but without ever losing their UK residence.
HMRC recognises that the definition of UK resident may need to be revisited in the light of the outcome of the consultation on the introduction of a statutory residence test.
The proposed legislation will apply to all income arising on or after the date of enactment, and to chargeable gains accruing from disposals made on or after the date of enactment.
With regard to non-UK residents, the purpose of the proposed legislation is to ensure that non-UK residents cannot use a DTA to reduce their liability to income tax on UK source income unless that reduction is properly due under the DTA. In practice, this means that it will counter “treaty shopping” arrangements, which arrangements employed by persons resident in a foreign country to reduce their liability to UK income tax by accessing the benefits of a treaty between the UK and a third country.
The proposed legislation will apply where a DTA makes provision that specified categories of income will not be subject to income tax in the UK, or will not be subject to tax at a rate exceeding the rate specified in the DTA, and certain avoidance conditions are met. These include where:
(a) a scheme is put in place;
(b) the provision would not apply to the amount of the income in the absence of the scheme; and
(c ) the main purpose, or one of the main purposes, of a person in putting the scheme in place is to ensure that the provision does apply to the amount of the income.
Where it applies, the draft legislation provides that the DTA will not limit the income tax that can be otherwise be charged on the relevant income under the Taxes Acts.
The proposed legislation will only apply to UK source income that is described in a DTA as dividends, interest or income from debt-claims, royalties or income falling within the Other Income article of a DTA (i.e. income about which no specific provision is made in a DTA). The question whether income has a UK source is decided on the basis of the terms of the relevant DTA.
The proposed legislation will apply to all income arising on or after the date of enactment regardless of when the DTA was made or the scheme was put in place.
HMRC has asked for comments on their technical note by 22 September 2011. Feedback received will be used to form the final version of the draft legislation that will be published in the Autumn and there will be a further opportunity to comment thereon.
If you would like further details on the draft legislation, please contact Keith Rushen on +44 (0)20 7486 2378.Contact Us