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Wednesday 5 October 2016
In this Issue
News and Views from the Pinsent Masons Tax teamPM-Tax
© Pinsent Masons LLP 2016
@PM_Tax
Comment• Slicing the Apple pie by Heather Self• Aggregates levy and the infrastructure sector by Ian Hyde• How many will be caught by diverted profits tax? by Andrew Scott
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Articles• HMRC’s approach to countering ‘boundary pushing’ by Andrew Scott• Will Apple get a second bite? by Heather Self and Caroline Ramsay• Transactions in land by John Christian
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Our perspective on recent casesDollar Financial UK Ltd v HMRC [2016] UKFTT 598 (TC)The Durham Company Limited (t/a Max Recycle) v HMRC [2016] UKUT 417 (TCC)The Union Castle Mail Steamship Company Ltd v HMRC [2016] UKFTT 526 (TC)
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Events 17
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PM-Tax | Comment
Heather Self discusses the European Commission’s decision in its State aid case against favourable tax rulings given by Ireland to Apple.
Slicing the Apple pieby Heather Self
This comment previously appeared in Accountancy
The EU Commission’s decision on Apple, announced on 30 August, caused a seismic shock in the business and tax worlds. From a business perspective, the sheer size of the proposed €13bn bill – the largest ever tax settlement, and more than twice Ireland’s annual corporation tax revenues – was the main issue. But for tax specialists, the deeper question is what is the EU trying to do?
It started with a press release from the EU Commission in June 2014, announcing investigations into transfer pricing arrangements of Apple, Starbucks and Fiat. Since then, McDonalds and Amazon have been drawn into the net, and the Commission has hinted that it is looking at many other potential cases – having requested copies of tax rulings from all EU Member States. The key question is whether the tax rulings could constitute State aid: the giving of a selective advantage to companies, in a way which could distort the functioning of the Single Market.
The Starbucks and Fiat decisions were announced in October 2015, although the detailed reasoning was not published for several months after. The amounts involved were relatively small – $20m to $30m – and the basis for the decisions was a highly technical analysis of the basis on which transfer prices had been set. It seemed that the EU Competition Directorate wanted to second-guess the detailed tax processes of Member States, and potentially apply a different test from the well-known OECD principles. This looked to be mainly a technical battle, with strong grounds for appeal by both Member States and Companies. The decisions caused concern about whether rulings could be relied on, and uncertainty about where there might be State aid risk, but did not appear to be of significant impact.
The Apple decision is in a different league. Fundamentally, the Commission considers that large amounts of profits have not been taxed anywhere, and that the allocation of profits to Ireland, accepted by the Irish Revenue, does not reflect economic reality. Apple, the Irish Government and the US Government have expressed outrage, but for different reasons – and that is where it gets interesting. It is clear that profits have not been taxed, but does that give the EU any power to intervene? And if someone should be able to tax the profits, is it Ireland (where the sales were booked), other EU countries (where the customers are) or the US (where the R&D was done)?
Now take another look at the preliminary decisions in McDonalds and Amazon. McDonalds has a company in Luxembourg, with a US branch which is not taxed in either country. Amazon pays royalties from a Luxembourg trading company to a Luxembourg partnership, which does not pay tax in either Luxembourg or the US. The similarities with Apple start to look striking.
A big part of the underlying problem is that the US tax system has not been reformed since 1986, and is increasingly out of step with the rest of the world. Theoretically, it is a global system, but in practice non-US profits are usually only subject to US tax once they are remitted back to the US – and hence many US companies have built up substantial cash piles outside the US (Apple has some $180bn). Various quirks of the US system, particularly their “check the box” rules which allow flexibility in choosing whether entities are taxed as companies or partnerships, and relatively weak anti-avoidance rules, mean that international tax planning by US multinationals has been prevalent for many years. Indeed, as far back as 1961, President Kennedy referred to US companies who use “artificial arrangements between parent and subsidiary... in order to reduce sharply or eliminate completely their tax liabilities”!
The EU appears to be using State aid as a lever to incentivise a real shift in behaviour: the key message to the US Government appears to be that if the US does not tax its multinationals, the EU will find a way to do so. Add that to the OECD BEPS project and the need by many countries to raise more tax revenues, and the climate begins to look fiercely hostile.
The answer, for those who have benefitted from low taxes as a result of sophisticated tax planning and past rulings, is to wake up and smell the coffee, as David Cameron once famously said. It’s time to recognise the risk of existing structures, and move towards something more robust – perhaps with a higher tax cost, but much less risk of challenge and uncertainty.
Heather Self is a Partner with almost 30 years of experience in tax. She has been Group Tax Director at Scottish Power, where she advised on numerous corporate transactions, including the $5 billion disposal of the regulated US energy business. She also worked at HMRC on complex disputes with FTSE 100 companies, and was a specialist adviser to the utilities sector, where she was involved in policy issues on energy generation and renewables.
E: [email protected]: +44 (0)161 662 8066
For further detail on the Apple State aid decision see also the article by Heather Self and Caroline Ramsay.
PM-Tax | Our Comment
PM-Tax | Wednesday 5 October 2016
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PM-Tax | CommentPM-Tax | Our Comment
Tax disputes partner Ian Hyde, who has practical experience of disputes with HMRC on aggregates levy issues, considers the application of the levy to the infrastructure sector.
A tax on infrastructure
Aggregates levy taxes extracting aggregates from the ground and will frequently apply to infrastructure projects. There is no general exemption for infrastructure and patchy exemptions mean it is hard to predict how it will apply.
Employers and contractors therefore face difficulties identifying if the levy applies and who should pay it. Increasingly, HMRC is taking an aggressive line as to when the tax applies and a narrow approach to exemptions and credits.
Why is aggregates levy a problem?
Aggregates levy is charged at £2 for every tonne of aggregate extracted from the ground and the business that “operates” the site has to register and pay the levy.
To be caught by the levy, the aggregate must be “commercially exploited” but this term is misleading as it doesn’t require the aggregate to be used “commercially” or even “exploited”. Instead it applies of the aggregate is:• removed from its originating site;• subject to an agreement to supply;• used for construction purposes; or• mixed with another substance other than water.
So, aggregates levy will normally apply to infrastructure projects involving either the removal of aggregate from a project site, or its use in construction on the site.
There is no general exemption from the levy when aggregate is extracted in the course of an infrastructure project; although a number of exemptions may apply to infrastructure projects in limited circumstances.
For example, the levy is not due where the aggregate arises wholly from the construction of a highway, or in connection with a railway, monorail or tramway construction. There is also an exemption for aggregate that is removed when a building (including its pipes and cables) is erected.
Where exemptions are not available, a credit may be obtainable depending on the destination of the aggregate, most obviously where it is disposed of as waste to landfill.
However, the exemptions are sparse and may not cover all aggregate extracted in the course of an infrastructure project, resulting in too many infrastructure projects being caught by the levy. Attempts to reform (see for example the recent consultation document on utility pipes) risk the quarry industry arguing state aid and in any event, are not the sort of measures guaranteed to grab Parliamentary time. The fact that this uncertainty adds to the difficulties in implementing national infrastructure projects is an irony perhaps lost on HMRC.
The issues for contractors and employers
Employers and contractors encounter a number of difficulties when faced with the risk of the levy applying.
Firstly, it can be difficult to establish whether there is a liability to aggregates levy. The exemptions and reliefs are difficult to navigate and have been badly drafted. Additionally, HMRC is taking an increasingly aggressive line on tax compliance issues beyond avoidance in an attempt to maximise tax revenues, even where the public policy for doing so is not obvious. This is reflected in a very broad approach to the circumstances where the tax applies and a narrow approach to exemptions and credits. As some of the reported Tax Tribunal decisions on aggregates levy demonstrate, HMRC often oversteps the mark in its views as to what the legislation means.
Secondly, the question often arises as to who is primarily liable to HMRC and so needs to be registered for the levy. This can affect some of the exemptions but also, more obviously, can determine where the risk for the tax applying lies. As contracts often do not provide for contractors to be able to reclaim the cost of aggregates liability from employers, it makes a difference whether the contractor or the employer is primarily liable to HMRC. For example, in the absence of an exemption, a project involving removing 1m tonnes of aggregate will add a £2m aggregate levy charge to the project cost, which may wipe out a contractor’s margins.
Aggregates Levy and the Infrastructure Sectorby Ian Hyde
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>continued from previous page PM-Tax | Our Comment
Aggregates Levy and the Infrastructure Sector (continued)
The future
Aggregates levy is a difficult tax and is caught by conflicting government objectives. Consequently, for political reasons, the aggregates levy position is unlikely to improve for businesses involved in infrastructure projects.
The tax is clearly intended to apply to the quarrying industry, distorting the market in favour of recycled aggregate. However, one of the recurring problems with aggregates levy is that quarrying companies are not the only businesses that extract aggregate from the ground. It is for this reason that the tax is not framed by reference to the purpose of the extraction but the fact that aggregate is extracted. Infrastructure projects are therefore brought within the scope of the tax.
Indeed, since it was first introduced, the legality of the aggregates levy exemptions has been challenged by the British Aggregates Association (BAA) on the basis that they constitute State aid, contrary to EU law. State aid refers to advantages or incentives granted to certain commercial companies by national or local governments to the disadvantage of others. This challenge is still on-going but the point is that any move by the UK government to change the legislation would be fraught with difficulties.
To thwart any arguments of illegal state aid and ensure tax revenues are maximised, HMRC is expected to continue to seek to apply the levy to projects, irrespective of whether on reflection anyone would have thought the tax should apply in the first place.
Ian Hyde is a Partner with over 25 years’ experience in advising on tax strategy with a particular interest in tax risk. Ian specialises in tax disputes, representing clients in all aspects of tax risk and tax litigation, including alternative dispute resolution, appealing to the Tax Tribunal and the higher courts up to the Supreme Court, references to the European Court, judicial review, tax investigations and in tax related commercial disputes and professional indemnity matters. He acts for a wide range of clients and on a range of direct and indirect taxes including tax avoidance structures, taxation of film scheme structures, pensions tax, VAT, customs duties, aggregates levy and landfill tax.
E: [email protected] T: +44 (0)121 625 3267
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Andrew Scott considers how many companies will be caught by diverted profits tax in the light of recent comments from HMRC.
The UK’s new diverted profits tax (DPT) has applied since April 2015, but we are now beginning to see how many multinationals it will catch, as the first deadlines for notifying HMRC of potential chargeability have passed and there are reports of the first charging notice being issued.
Multinational companies approached by HMRC as being potentially liable for the new tax should be prepared to present their case fully, given the considerable resources that the tax authority has at its disposal.
When does it apply?
Broadly, DPT applies in two circumstances. The first is where there is a corporate group with a UK subsidiary or permanent establishment (PE); and where there are arrangements between connected parties which “lack economic substance” in order to exploit tax mismatches. One example of this would be if profits were taken out of the UK subsidiary by way of a large tax deductible payment to an associated entity in a low-tax jurisdiction.
The second situation in which DPT can apply is where a non-UK resident trading company carries on activity in the UK in connection with supplies of goods, services or other property; and that activity is designed to ensure that the non-UK company does not create a PE in the UK. Where this is the case, DPT will apply where either the main purpose of the arrangements put in place is to avoid UK tax, or a tax mismatch results in the total tax take from UK activities being significantly reduced.
The charging mechanism
DPT applies from 1 April 2015 and is charged on diverted profits at a rate of 25%; 5% higher than the corporation tax rate. However it is a new tax, separate from the corporation tax regime, and has its own specific rules for assessment and payment.
Companies do not self-assess their liability for DPT and instead must notify HMRC if they are potentially within the scope of the tax and are not subject to any of the exemptions. Usually, this notification must be given within three months after the end of the company’s accounting period, but this was extended to six months
for accounting periods ending on or before 31 March 2016. This means that companies with a 31 March year end had until 30 September to make their first notification.
If, following notification, HMRC considers that a company may be liable it will issue a ‘preliminary notice’ setting out the grounds on which it considers that DPT is payable and calculating the tax based on certain simplified assumptions.
On receipt of a preliminary notice, the company will be given the opportunity to correct any obvious errors. HMRC can then issue a ‘charging notice’ if it still believes DPT is due, which the company will then have 30 days to pay. HMRC then has 12 months to review the charge to DPT and reduce or increase it if necessary; however, the company will only be able to appeal the DPT charge once this 12 month review period has passed.
The fact that there is no right of appeal until 12 months after payment of any DPT will mean that companies that are ultimately successful on appeal will suffer a significant cash flow disadvantage.
So who will be caught?
Almost 100 multinationals have been identified as potentially within the scope of the new tax, and HMRC is expecting many of them to dispute the charge, HMRC’s director-general of business tax, Jim Harra, told the Financial Times recently. He said that many of those companies had been “taken by surprise” by the scope of the tax.
There have also been press reports of HMRC issuing its first DPT charging notice to a multinational company. In that case the charge has apparently been raised in respect of a royalty payment for offshore intellectual property.
What should companies do?
It is very interesting to see the view from the top at HMRC on the application of the diverted profits tax. It is clear that the scope of the tax is wide and it is also clear that the resources given to HMRC to assess DPT issues are being effectively deployed.
PM-Tax | Our Comment
How many will be caught by diverted profits tax?by Andrew Scott
PM-Tax | Wednesday 5 October 2016
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>continued from previous page
How many will be caught by diverted profits tax? (continued)
This is bound to result in HMRC seeking to explore in depth with taxpayers whether a DPT charging notice should be issued. As the tests rely so heavily on questions of fact, it is vital that taxpayers engage in full fact-finding and present the evidence to HMRC in as cogent a way as possible to support their arguments.
Any company which has notified potential liability for DPT will need to consider very carefully how to engage with HMRC whilst HMRC considers whether to issue a notice. A taxpayer will have only a relatively limited amount of time to put its case, and, if HMRC issue a notice, the company will have to pay the tax up-front. It will then have to wait a year before it can appeal and get back any tax that is ultimately found not to be due.
Andrew Scott is a Legal Director who advises on both direct and indirect tax so far as affecting businesses (corporation tax, CFCs, diverted profits tax, bank levy, VAT and stamp duties). Andrew has a sophisticated understanding of UK tax law as a result of his time at HMRC Solicitor’s Office and as a drafter of UK tax law. While at HMRC, Andrew worked on the policy behind diverted profits tax.
E: [email protected] T: +44 (0)20 7490 6191
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PM-Tax | Articles
As revealed in a recent judicial review challenge in relation to landfill tax repayments, HMRC has developed a new concept – ‘boundary pushing’ – for identifying conduct of which it does not approve but which falls short of avoidance. However, in a context where already established concepts such as avoidance and evasion are so slippery, it is time to abandon old favourites altogether and use words that more accurately distinguish between ‘acceptable’ and ‘unacceptable’ conduct. Anything short of this risks the continued haziness affecting – for the worse – the development of tax law and its practical implementation in the way intended by Parliament.
The distinctions between tax avoidance, evasion, mitigation or planning and – a new entrant in the field – boundary pushing are murky and are becoming murkier still. There is much uncertainty about the meanings of these terms, which risks confusing HMRC’s operational attitude to particular transactions and the development of tax policy. Both taxpayers and HMRC need to develop a different linguistic register to distinguish between what is acceptable and what is not.
It is commonly said that tax evasion is illegal and tax avoidance isn’t: for example, Stroud’s Judicial Dictionary of Words and Phrases (8th edn) claims that Lord Tomlin’s judgement in IRC v Duke of Westminster [1936] 19 TC 490 is the authority for this proposition. But is it? Lord Tomlin said many things in that famous judgment, but said nothing about what constitutes ‘evasion’ or ‘avoidance’, preferring to focus instead on the legal effect of the arrangements made between the Duke of Westminster and his employees.
As an explanation of what tax avoidance is, the formulation is, in any event, less than helpful: an explanation that ‘x’ isn’t something says little about the intrinsic nature of ‘x’ itself. Furthermore, the explanation is likely to confuse; and the reason is simple enough: the word ‘evade’ is ambiguous. In the Privy Council case of Simms v Registrar of Probates [1900] AC 323, Lord Hobhouse held that ‘everybody agrees that [‘evade’] is capable of being used in two senses: one which suggests underhand dealing, and another which means nothing more than the intentional avoidance of something disagreeable’. Interestingly, he went on to observe that ‘probably everyone thinks [a desire to avoid a tax is] desirable per se’, while failing to say what he meant by ‘avoid’.
In addition, whether or not high judicial authority can be found for the distinction, defining expressions by reference to the concept of legality is also unhelpful. Many tax avoidance schemes fail in their desired outcome; and, where that happens, the result is that a taxpayer is legally obliged to pay more tax than he hoped for. The so-called legal avoidance leads to the result that the taxpayer, wrongly as a matter of law, paid too little tax.
Evasion
Of course, the accepted modern position is that tax ‘evasion’, despite the expression’s ambiguity, is being used in the sense of ‘underhand’ dealing. Deciding whether or not conduct is underhand is, arguably, to move into the world of morality rather than law. It would seem better to use a more established legal concept, such as whether the conduct involves fraud or dishonesty or whether it constitutes the commission of a criminal offence. As things currently stand, there is a very close correlation between criminal conduct and dishonest conduct in the tax context. That will, however, change as a result of the introduction of the ‘strict liability’ offence in Finance Act 2016: an honest error in a return relating to offshore income or assets could result in imprisonment unless the taxpayer can show reasonable care. Instead, it would seem much simpler to refer to fraudulent tax evasion. It is surely worthy of note that the concept of tax evasion is not one known to UK statute law, but that the concept of fraudulent tax evasion is.
Avoidance
So, what does tax avoidance mean?
In HMRC’s Measuring tax gaps (2015), avoidance is defined as ‘bending the rules of the tax system to gain a tax advantage that Parliament never intended. It often involves contrived, artificial transactions that serve little or no purpose other than to produce a tax advantage. It involves operating within the letter – but not the spirit – of the law.’ This definition owes a debt to what Lord Goff of Chieveley in Ensign Tankers Ltd v Stokes [1992] STC 226 referred to as ‘unacceptable’ tax avoidance, which ‘typically involves the creation of complex artificial structures by which, as though by the wave of a magic wand, the taxpayer conjures out of the air a loss, or a gain, or expenditure, or whatever it may be, which otherwise would never have existed’.
PM-Tax | Articles
HMRC’s approach to countering ‘boundary pushing’by Andrew Scott
This article was published in the Tax Journal on 9 September 2016
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PM-Tax | Articles>continued from previous page
HMRC’s approach to countering ‘boundary pushing’ (continued)
Clearly, HMRC sees the GAAR as operating at the extreme end of avoidance. Consequently, it would be unlikely to accept a working definition of ‘unacceptable’ tax planning solely by reference to it. That is no reason not to seek to build on what is already there, however. Perhaps this could take the form of moving from a ‘double’ reasonableness test to a ‘single’ one; and seeking to tease out the it’s-too-good-to-be- true sniff test so that it operates beyond a search for the principles or policy objectives of the relevant provisions.
All of this matters because it is quite clear that HMRC attaches weight to whether or not conduct constitutes what it regards as ‘avoidance’. A taxpayer will be put to significant proof to demonstrate that a scheme ‘works’ and, as a general matter, HMRC’s operational response is one of zero tolerance if it starts off on the footing that conduct does constitute ‘avoidance’.
Boundary pushing
It is into this already crowded field that a new concept has arrived: ‘boundary pushing’. In the recent judicial review case of R (on the application of Veolia ES Landfill Ltd/Viridor Waste Management) v HMRC [2016] All ER (D) 132, the claimants sought a judicial review of HMRC’s decision to refuse to repay landfill tax which the claimants had paid but which HMRC subsequently regarded as wrongly paid (because of the Court of Appeal decision in Waste Recycling Group Ltd v HMRC [2009] STC 200 (WRG)), before then deciding that the tax was in fact lawfully due.
In assessing the fairness or otherwise of HMRC’s decision to refuse repayment (in circumstances where others had had their claim met before the shutters came down), one issue was whether the campaign by tax advisers to encourage repayment claims constituted unacceptable boundary pushing. Insofar as HMRC regarded the conduct as unacceptable ‘boundary pushing’, had it acted unlawfully in taking this into account as a factor in deciding to refuse the repayment claims?
The court thought not, but one matter of interest is the observation of Mr Justice Nugee that: ‘Both counsel ... appear to have taken the term “boundary pushing” as an allegation of impropriety – Mr Grodzinski [for the taxpayer] glossing it as inappropriate behaviour and Mrs Hall [for HMRC] treating it as akin to tax avoidance, although somewhat reserving her position on the second occasion. But although it appears to have become something of a vogue phrase within HMRC, it is not a term of art, and no attempt was made in argument to explore precisely what is meant by it.’
Mr Justice Nugee did not attempt his own definition but held that: ‘In the context of landfill tax, it seems to me that what was characterised as boundary pushing was the repeated attempt to extend the principle in WRG ... by putting forward new and increasingly imaginative examples of the use of waste.’
In IRC v Willoughby [1997] STC 995, Lord Nolan considered this to be a generally helpful approach to the ‘elusive’ concept of tax avoidance before commenting: ‘In a broad colloquial sense tax avoidance might be said to have been one of the main purposes of those who took out such policies, because plainly freedom from tax was one of the main attractions. But it would be absurd in the context of section 741 to describe as tax avoidance the acceptance of an offer of freedom from tax which Parliament has deliberately made. Tax avoidance within the meaning of section 741 is a course of action designed to conflict with or defeat the evident intention of Parliament.’ (my emphasis)
So far as there is anything like a consensus view on what ‘avoidance’ might mean, the above observations by Lord Nolan is probably it. Among other things, it decisively rejects the notion that, at least in a statutory context, avoidance can sensibly mean taking advantage of reliefs in a ‘plain vanilla’ way, such as putting money in an ISA.
There are, however, a number of significant difficulties with everything discussed so far:• The ‘broad colloquial’ sense of ‘avoidance’ is actually its ordinary
meaning. In the Shorter OED (6th edn), avoidance is the action of keeping away or prevention.
• HMRC’s view seems to assume that the avoidance works; otherwise, the taxpayer cannot fairly be said to be operating within the letter of the law.
• The Lord Nolan formulation begs the questions as to whom the intention of parliament must be ‘evident’; what constitutes an intention of parliament that is ‘evident’ or a case where law is ‘deliberately’ made; and by what means one is to ‘discover’ this.
Indeed, seeking to find the Parliamentary intent leads to the conundrum that successful tax avoidance is inherently impossible. That conundrum is most lucidly expounded by Lord Hoffmann in his much quoted comments in his 2005 article in the British Tax Review ([2005] BTR 197) that: ‘Tax avoidance in the sense of transactions successfully structured to avoid a tax which Parliament intended to impose should be a contradiction in terms. The only way in which Parliament can express an intention to impose a tax is by a statute that means that such a tax is imposed. If that is what Parliament means, the courts should be trusted to give effect to its intention. Any other approach will lead us into dangerous and unpredictable territory.’
The Hoffmann view underpinned the approach taken by the Aaronson report on the GAAR and the subsequent legislation (which, as a parliamentary counsel, I drafted). One of the GAAR’s innovations was to seek to define a particular course of conduct as so unacceptable (‘abusive’) that an adverse tax effect should attach to it. The conceptual framework adopted by the GAAR offers the most promising approach to identifying conduct that, although honest, is otherwise to be regarded as unacceptable.
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HMRC’s approach to countering ‘boundary pushing’ (continued)
As I took part in the decision making process in the case in question (both as a member of the Business Tax Contentious Issues Panel and of the Tax Disputes Resolution Board), it would not be appropriate for me to say much about the particular case. However, it does seem to me that there is a need to do what was, apparently, not done in the case and seek to define ‘boundary pushing’ or abandon the concept altogether. As with HMRC’s operational approach to avoidance, this matters because it is likely to inform HMRC’s generic approach to particular issues, as well as informing its particular approach to acts done by particular taxpayers.
Concluding remarks
‘“When I use a word,” Humpty Dumpty said, in rather a scornful tone, “it means just what I choose to mean – neither more nor less.”’ (Lewis Carroll, Through the Looking Glass)
The efficient and effective running of the UK tax system in accordance with the law would, in my view, be increased if intellectually more robust concepts were used to describe differing taxpayer behaviours and their legal consequences. The current confused landscape is capable of materially affecting HMRC’s response to taxpayer conduct. To continue to use words such as ‘avoidance’ that are inherently ambiguous has confused us all: the confusion has increased, is increasing and ought to be diminished.
The way forward is to distinguish between conduct that constitutes fraudulent evasion and conduct that does not; and then seek to build on the concepts used in the GAAR to define conduct that (although honest) constitutes conduct that, by reference to factors with some objective reality, can reasonably be regarded as ‘unacceptable’. Nothing more will do.
Andrew Scott is a Legal Director who advises on both direct and indirect tax so far as affecting businesses (corporation tax, CFCs, diverted profits tax, bank levy, VAT and stamp duties). Andrew has a sophisticated understanding of UK tax law as a result of his time at HMRC Solicitor’s Office and as a drafter of UK tax law. While at HMRC, Andrew worked on the policy behind diverted profits tax.
E: [email protected] T: +44 (0)20 7490 6191
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PM-Tax | Recent Articles
The European Commission has ruled that Apple’s Irish tax benefits are illegal State aid and that Ireland should recover €13bn in back taxes. Heather Self and Caroline Ramsay consider the ramifications of the European Commission’s ruling on Apple’s tax agreement with Ireland.
How did Apple structure its business in Europe and allocate profits, and what aspects did the Commission find objectionable?
The key to the Apple structure was two ‘non-resident’ companies, incorporated in Ireland but controlled and managed in the US, and so not resident for tax purposes in either country.
For a non-resident company with operations in Ireland, tax is levied only on the profits attributable to the Irish activities. Apple said, and the Irish tax authorities agreed, that those profits amounted to some €50m per annum, even though the total profits of the companies were billions of dollars.
The Commission said that this allocation of profits did not reflect economic reality, since the notional ‘head office’ (to which the rest of the profits were allocated) had no employees and no real activity. They therefore held that the full amount of the profits should be taxable in Ireland.
In what way were the Irish tax authority rulings selective in nature?
In order for there to be State aid, government resources must be used to give an advantage to a company in a way which is selective in nature, and which potentially distorts competition within the single market.
We will need to see the full Commission decision to understand their reasoning for the key criterion of selectivity. Both Ireland and Apple have said that the ruling simply applied the law, and did not give any selective advantage. In a US Treasury Department paper published on 24 August 2016, a highly technical analysis argues that the EU Commission has elided the criteria of whether there is an economic advantage, and whether there is selectivity, when previously these two aspects have been considered entirely separately.
The question of selectivity is likely to be at the heart of any appeal by Apple and Ireland.
What was the distortion of competition (affecting trade between Member States) – did the Commission/EU courts set the bar too low in this regard?
The distortion lies in the fact that Ireland has encouraged foreign investment to its territory and ultimately done so at the expense of neighbouring European member states who may also have wanted to attract Apple. The EU Commission believes that by granting such tax advantages to Apple, the EU single market has been artificially distorted.
The size of a proposed settlement is a preliminary indication that competition would have been distorted. The threshold for State aid is very low and any financial advantage of more than €200,000 over a three-year period is considered to be enough to distort competition in the single market.
During the 1980s and 1990s, and indeed up to the time of the global financial crisis, Ireland was extraordinarily successful in attracting inward investment, particularly from US companies. The low tax rate of 12.5% was a legitimate tool used by Ireland, but the Commission now considers that Ireland went beyond that and used its resources to give State aid to Apple.
How likely is it that the ongoing State aid investigations into McDonalds and Amazon will follow along the lines of this decision and others (eg, Fiat and Starbucks) and lead to a similar outcome?
The decisions in Fiat and Starbucks were for much lower amounts ($20m to $30m) and were based on a highly technical reanalysis of transfer pricing rulings. It seemed that the EU Competition authorities wanted to substitute their own judgment for that of the tax authorities in the Netherlands and Luxembourg, and potentially devise new transfer pricing rules which went beyond the well-accepted Organisation for Economic Co-operation and Development (OECD) principles.
Will Apple get a second bite?by Heather Self and Caroline Ramsay
This Q&A was published on LexisPSL on 13 September. For a free trial click here.
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PM-Tax | Articles>continued from previous page
Will Apple get a second bite? (continued)
In Apple, the Commission has gone further and said that the allocation of profits does not reflect economic reality, primarily because very large amounts have escaped tax altogether. This is a worrying indication for the McDonalds and Amazon cases, which have similar features in Luxembourg—McDonalds has a US branch which is not subject to tax, and Amazon pays a royalty to a Luxembourg partnership which is not taxed in either Luxembourg or the US.
It therefore seems highly likely that the Commission will also find that there has been State aid in the cases of McDonalds and Amazon.
The Commission makes clear that the amount the Irish authorities have to recover from Apple would reduce if other countries were to require Apple to pay more taxes. Is this scenario likely – and how would it work in practice?
In an interesting part of its press release, the Commission suggests that other countries could make claims for tax from Apple.
There are two main possibilities. The first is that the countries where the customers are located could claim that Apple should have recorded more profits there. This seems unlikely to result in material recoveries, for a number of reasons. First, there would be nothing to stop such countries challenging Apple’s tax position in the past (and indeed, Italy succeeded in recovering some €300m last year). More importantly, the local activities are primarily the retail and distribution of Apple products, and arguably contribute very little to the overall value chain.
The Irish non-resident companies, by contrast, are responsible for procuring the goods (from Chinese manufacturers) and, crucially, have a cost-sharing agreement with Apple in the US in relation to R&D. Under the agreement, around 60% of the R&D costs are borne by the Irish entity. The transfer pricing between the US and Ireland was apparently the subject of an advance pricing agreement (APA), with the facts being fully disclosed to the US tax authorities. Given that the R&D is actually conducted in the US, which retains legal ownership, there would seem to be a real possibility that the APA could be revisited, leading to additional tax being paid in the US rather than Ireland.
Where do these cases (and, if followed, the AG’s Opinion in Santander and World Duty Free cases) leave the ability of national governments to set their own tax policy?
The AG’s opinion in the Santander and World Duty Free appeals suggests a significant widening of the interpretation of a selective advantage. It is interesting that the US Treasury paper of 24 August 2016 also focused on this point.
If the AG’s opinion is upheld, and if the EU Commission continues to see itself as the main arbiter of whether tax should be paid in Europe, the principle of national sovereignty on tax could be seriously undermined. Furthermore, trade negotiations between the EU and the US on the Transatlantic Trade and Investment Partnership (TTIP) are already stalling, and a major transatlantic tax dispute would not be helpful to economic growth.
Does this sort of action threaten to undermine the whole concept of an APA?
Stability and certainty are important factors in attracting business investment. The current approach of the EU Commission is undermining that, particularly in those cases (Starbucks and Fiat) where they appear to be second-guessing the detailed judgment of national tax authorities.
Businesses with favourable rulings in the past need to reassess the impact of these decisions. Those planning new transactions should consider the State aid implications at an early stage, and may prefer to use a structure with a higher tax cost but a more robust overall risk profile.
Caroline Ramsay leads Pinsent Masons’ State aid practice. She is recognised as a leader in the State aid field and advises government, private sector ‘aid recipients’ and also EU institutions. She advises in both a transactional advisory capacity (opinion work) and also representing clients in contentious State aid challenges
E: [email protected]: +44 (0)141 567 8653
Heather Self has over 30 years of experience in tax. She advises companies on a wide range of tax disputes and is a former group tax director at a FTSE 100 company. She also worked at HMRC on complex disputes with FTSE 100 companies. She is a member of the CBI Tax Committee and a former chairman of the Chartered Institute of Taxation technical committee.
E: [email protected]: +44 (0)161 662 8066
See Heather Self’s opinion piece for more thoughts on the Apple case.
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PM-Tax | Recent Articles
John Christian considers the new rules in relation to the taxation of transactions in UK land.
New rules came into effect from 5 July in relation to the taxation of transactions in UK land. They were originally announced as aimed at countering structures involving offshore developers, but the rules as enacted in Finance Act 2016 have a much wider scope. How they may apply to development situations previously regarded as investment, and to UK taxpayers is unclear.
Offshore developers
The March 2016 technical paper announcing the changes focussed on structures involving non-residents which carried on trading activities but were not subject to tax. The features of these structures which the changes aimed to counter were avoidance of a UK permanent establishment, allocation of risk and profit to non-UK companies through development contracts and other arrangements (called ‘fragmentation’ in the paper) and realisation of profit through selling non-UK companies which owned the land rather than a sale of the land itself (referred to as ‘enveloping’).
New rules
The new rules apply for corporation tax and income tax and to gains realised after 5 July 2016 with forestalling provisions applying from 16 March 2016.
Non-UK residents
Non-UK residents are subject to UK tax on profits from a trade of dealing in or developing UK land without the requirement for the trade to be carried on through a UK permanent establishment. The only connecting factor for non-UK residents who are carrying on a land dealing or developing trade as defined in the new rules is that the land is UK land. This applies whether the trade in dealing or developing land is established on general case law principles or profits are deemed to be trading profits within the new rules.
Trade of dealing in or developing UK land (a ‘development trade’)
The definition of disposals of land which are deemed to be part of a development trade is the core of the new regime.
The definition is modelled on the circumstances to which the transactions in land rules applied (now repealed and replaced by these rules) but with the key change of the ‘sole or main object’ test being replaced by a main purpose test. In summary a profit on disposal of UK land will be treated as profits of a development trade where:• the main purpose, or one of the main purposes, of acquiring the
land was to realise a profit or gain from disposing of the land (condition A);
• the main purpose, or one of the main purposes, of acquiring any property deriving its value from land was to realise a profit or gain from disposal (condition B);
• the land is held as trading stock (condition C);• where land has been developed, the main purpose, or one of the
main purposes, of developing the land was to realise a profit or gain from disposal of the land when developed (condition D).
Fragmentation
In outline, the fragmentation rules apply to any profit made by an associated person who has made a relevant contribution to the development of land by another. The profit made by that person is allocated to and taxed on the person who makes the disposal of land. A “relevant contribution” is wide and includes the provision of any services and a financial contribution including the assumption of a risk. It includes a loan from an associated person.
Enveloping
In outline, a profit from the disposal of any property deriving at least 50% of its value from UK land is treated as a trading profit within the rules where it is part of an arrangement the main purpose, or one of the main purposes of which, was to deal in or develop UK land and realise a profit.
This will catch for example a disposal of shares in a property owning company if the other conditions are met, but the scope of ‘property’ is wide and is not limited to shares or similar interests.
Transactions in UK landby John Christian
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Transactions in UK land (continued)
In any event, it will be essential to retain real time evidence of investment intention given the importance of that evidence in any dispute with HMRC
Although originally targeted at offshore developers, the new rules will also need to be reviewed in relation to land transactions (particularly involving development) for UK investors whether tax paying or exempt. As the application of the rules will give rise to a trading profit, this would be taxable on some UK tax exempt investors (such as pension funds and charities).
Acquisitions of corporate vehicles also need to be reviewed in the light of the new rules. The buyer inherits the purposes for which the vehicle acquired and/or developed the asset and sellers will be very reluctant to give comfort on that aspect given the unclear scope of the new rules.
The fragmentation rules will also need to be reviewed where non-UK parties provide finance or services into a land development including where that development is by a UK taxpayer. Even the common situation of joint venture equity or debt provided by a shareholder/partner into a development structure requires an assessment of the new rules.
Many of these issues would be addressed by clarification from HMRC in relation to development situations and particularly how the main purpose test is likely to be applied in practice where a development is sold after a period of income generation.
John Christian is a Partner in our corporate tax team and heads the firm’s real estate tax team. He specialises in corporate and business tax, with a particular focus on the real estate sector and advises major investors, developers and funders on UK and cross-border real estate transactions and structuring. He is a Fellow of the CIOT.
E: [email protected] T: +44 (0)113 294 5296
Practical issues
Final guidance from HMRC on how these new rules will be applied in practice is awaited and it is understood that draft guidance has been prepared which leaves a number of aspects unclear.
A key change (not announced in the March 2016 technical paper) was to apply a main purpose test to the four conditions in the definition of a development trade, rather then the ‘sole or main object’ test applying in the former land in transactions rules. This is a particular issue in relation to the commonly encountered situation where an asset will be developed (new build or refurbishment) held for rental income and then eventually disposed of. In many cases, disposals in such cases would not have amounted to trading on the facts and the ‘sole or main object’ test in the transactions in land rules would not have applied given the object to obtain income.
Under the new rules, there is the much more difficult factual test to apply of whether the gain on disposal was a ‘main purpose’ of the investment. The main purpose test is a much lower threshold particularly given recent case law, (such as Lloyds Bank Leasing and the Ladbroke case) and the willingness of HMRC to take a very wide view of main purpose tests in other contexts.
It remains unclear whether the distinction between trading and investment transactions remains (with the new rules being deliberately widely drafted to catch disguised trading cases), or whether the main purpose test is intended to shift a much wider category of development transactions into being taxed as a trading profit, and in practice limit the circumstances where investment treatment would be accepted. This would have major implications for overseas investors into the UK given that the government’s policy is clearly that gain on commercial property investment made by non-UK residents should remain outside the scope of UK tax.
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PM-Tax | CommentPM-Tax | Cases
Dollar made pay day loans which were exempt supplies for VAT purposes. It paid referral fees to lead generators. It had accounted for VAT under the reverse charge in respect of supplies made to overseas lead generators but subsequently tried to recover the VAT paid on the basis that the supplies were exempt intermediary services under Para 5 Group 5 Schedule 9 VATA 1994.
People looking for loans would find their way to a lead generator’s (leadgen’s) website and complete an online application form. When the form was submitted the leadgen would electronically pass on the application form within seconds to one of its customers, one of which was Dollar. If the application form was passed to Dollar, and it chose to accept and pay for the lead the borrower would be presented with a page of Dollar’s website offering the loan including the terms of the loan.
The leadgen chose which customer to refer the loan to by checking whose lending criteria the application satisfied and then sending the referral to the lender paying the highest referral fee. If a lender rejected the application the leadgen passed the application to the lender paying the next highest fee.
In the FTT Judge Barbara Mosedale decided that the supplies made by the leadgens did fall within the intermediary exemption. She said introducing two parties, one looking for a financial product and a person providing it could be an intermediary service but the exemption does not include advertising or acting as a mere conduit and so an intermediary who carries out introductory services must do more than merely advertising or acting as a mere conduit. She said the extra services could be assessing the suitability of the service provider to provide the loan or the suitability of the borrower to receive the loan.
Judge Mosedale considered that in this case the leadgens were making a real assessment of suitablilty – even though this was done electronically in seconds. Although Dollar’s lending criteria were simple, they were not the same as all other lenders and were not so simple that no real filtering took place. She said that the leadgens applied all the criteria necessary for Dollar to determine whether to offer a loan bar the credit checks which for regulatory reasons Dollar had to do for itself. The supplies therefore fell within the exemption.
The VAT status of some supplies made to Dollar by another company, Allsec, were also in dispute. This company phoned borrowers who had been offered loans by Dollar to try to persuade them to take up the offer (conversion services) and engaged in livechat with customers looking at the website.
Judge Mosedale said that Allsec’s supplies in relation to conversions and livechat did not fall within the exemption as there was no introduction and no negotiation of terms and Allsec did not act as Dollar’s agent. She said: “it is clear that the carrying out of back office-type functions, which the lender could do itself but has chosen to outsource, is not exempt intermediation”.
Comment
The case is interesting because the judge found that some of the services – although performed very quickly and electronically were sufficient to fall within the exemption
Read the decision
Dollar Financial UK Ltd v HMRC [2016] UKFTT 598 (TC)
Services of lead generators for a payday lender fell within intermediary VAT exemption.
Cases
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PM-Tax | Cases>continued from previous page
Cases (continued)
The Durham Company Limited (t/a Max Recycle) v HMRC [2016] UKUT 417 (TCC)
Commercial waste collection by local authorities not subject to VAT.
The business of the Durham Company (Durham) included the collection and disposal of trade waste, upon which it was required to charge VAT. It applied for judicial review of the lawfulness of the VAT treatment being afforded to local authorities (LAs) carrying out trade waste collection and disposal services. Trade waste collection services to business customers carried out by an LA is treated as “activities in which it is engaged as a public authority” within the meaning of section 41A(1) VATA 1994 so that VAT is not payable. However, the legislation goes on to provide that LAs will be regarded as taxable persons in respect of those activities where their treatment as non-taxable persons would lead to significant distortions of competition.
Durham claimed that it was competing for business against LAs and the VAT treatment made the LAs’ services cheaper. It argued that a LA which has chosen effectively to ‘go into the business’ of providing trade waste collection services, doing so in competition with private sector operators, is not acting in its capacity as a LA, but rather is engaging in an activity which is equally open to a private sector operator under the same (or essentially the same) legal conditions.
The case was transferred from the High Court to the UT for a decision on the preliminary issue of whether the collection of trade waste from business customers by the LAs constituted activities in which they were engaged as a public authority.
Section 45 Environmental Protection Act (EPA) 1990 requires LAs to collect commercial waste from premises, if requested to do so by the occupier and subject to payment of a reasonable charge.
Warren J said that section 45(1)(b) EPA 1990 was capable of constituting a special legal regime and so any activities carried out by an LA pursuant to that special legal regime fell within the VAT derogation. LAs were subject to restrictions (such as in relation to where they could dispose of the waste) that did not apply to commercial providers. He said that Durham could only succeed on its application for judicial review on the basis of the competition proviso or if it could show that the LAs in question were operating beyond their powers and so could not rely on section 45(1)(b) EPA 1990. Although Warren J expressed doubts on the limited evidence presented to him as to whether the activities of all the LAs were covered by the statutory powers, he said that it was not appropriate for this matter to be decided on a preliminary hearing.
Comment
Although the preliminary issue was decided in favour of the local authorities, this is unlikely to be the end of the matter. In answering the preliminary question, the judge did not decide whether the particular local authorities operating in the same areas as Durham, were acting as public authorities.
Read the decision
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PM-Tax | Cases>continued from previous page
Cases (continued)
The Union Castle Mail Steamship Company Ltd v HMRC [2016] UKFTT 526 (TC)
Debit for derecognition of financial asset did not constitute a loss.
Union Castle appealed against the disallowance of a £39 million deduction it had claimed in respect of a debit arising from the derecognition of a financial asset relating to derivative contracts. Union Castle had acquired FTSE put options for commercial purposes. Its parent company Caledonia decided it would be more tax efficient for it to hold the options. Deloitte suggested that a tax efficient way to achieve this would be a series of steps that had been disclosed under the DOTAS rules. Union Castle issued a new class of shares to Caledonia with dividend rights that would effectively transfer the economic benefit of the derivatives contracts. As a consequence of issuing the shares Union Castle was required to derecognise 95% of the value of the options for accounting purposes thereby crystallising an equivalent tax loss.
The FTT had to decide:• Whether the £39 million accounting debit fairly represented a
loss arising to Union Castle from its derivatives contracts for the purposes of para 15 schedule 26 Finance Act 2002;
• In the case of a debit falling within para 25A schedule 26 FA 2002 whether it is still necessary to meet the requirements of para 15 before it can be brought into account for tax purposes; and
• Whether, if Union Castle would otherwise be entitled to a deduction in respect of the accounting debit, the deduction should nevertheless be eliminated or reduced by a transfer pricing adjustment.
On the loss question, the FTT declined to follow the reasoning in Abbey National Treasury Services v HMRC (ANTS) and so considered afresh whether there was a loss, if so, whether it arose “from” a derivative contract; and whether it satisfied the “fairly represent”
requirement. Judge John Brooks found for HMRC that there was no loss as Union Castle received the cash benefit under the derivative contracts and gave it away. He said that the debit could not be a loss for Union Castle as after the issue of the shares it was entitled to exactly the same amount as it was before the issue of those shares. There had not been a diminution in the resources of Union Castle and therefore no real loss.
Although that decision was sufficient for the appeal to fail, the judge gave his view on the remaining issues, in case there was an appeal. He said that if there had been a loss it would have been, albeit indirectly, “from” the derivatives and would have satisfied the fairly represents requirement. He also agreed with the taxpayer that it was unnecessary in the case of a debit falling within paragraph 25A for the requirements of paragraph 15 to have to be met before it can be brought into account.
On the transfer pricing point, the Judge said that he considered that the issue of bonus shares did not amount to “provision” for the purposes of schedule 28AA ICTA and so the transfer pricing provisions did not apply.
Comment
Schemes like this have now been blocked by specific rules and the fairly represents requirement has been removed. However the case is of interest because it is another example of the tribunals being reluctant to uphold tax avoidance schemes and it is interesting that the judge disagreed with the analysis in the ANTS case.
Read the decision
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PM-Tax | Events
Events
Managing Your Diverted Profits Tax Risk – Roundtable Discussion
We are holding a roundtable event to discuss how organisations are managing the risks associated with the diverted profits tax (DPT).
The roundtable discussion will be led by Andrew Scott, former Director of Business Tax at HMRC’s Solicitors Office, who joined Pinsent Masons earlier this year. During his time at HMRC, Andrew worked on the development and design of the diverted profits tax and was also a member of HMRC’s governance boards for the resolution of complex, high-profile disputes, including those involving diverted profits.
During the session, our panel of expert speakers will lead a discussion to provide you with:• A high-level analysis of the DPT regime; • An analysis of what decisions must be taken before deciding whether to notify HMRC; • An understanding of how businesses should engage with HMRC in case of an enquiry into DPT risk; • A best-practice guide to preparing for an investigation by HMRC.
Our panel of expert speakers at the session will also include Head of Tax, Jason Collins and Heather Self, a Partner in our Tax team.
The private roundtable will take place at our offices in the City and will be an opportunity for Tax and Finance Directors to have an open discussion on their approach to DPT risk.
Date: Monday, 10 October 2016
Time: Registration 4:00pm; Seminar 4:30pm; Close by 6:00pm
Venue: Pinsent Masons LLP, 30 Crown Place, London EC2A 4ES
Places are limited so if you are interested in attending please contact Sonia Soowambar.
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PM-Tax | Wednesday 5 October 2016
Tell us what you thinkWe welcome comments on the newsletter, and suggestions for future content.Please send any comments, queries or suggestions to: [email protected]
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PM-Tax | Events
Failure to prevent the facilitation of tax evasion – webinar
As part of a series of free webinars, Pinsent Masons will be running a webinar on the proposed new offence of failing to prevent the facilitation of tax evasion.
Jason Collins and Tori Magill from the Pinsent Masons tax team will discuss how in-house compliance, legal and tax teams should prepare for the new proposed failure to prevent the facilitation of tax evasion offence. Under this offence, organisations will be liable for the acts of their staff and other associated persons who knowingly facilitate tax evasion, including for tax liabilities in another country.
Companies will have a defence if they implement and operate procedures to try to prevent facilitation. At this webinar, Jason and Tori will talk you through how the offence will operate and what “reasonable procedures” you can implement to ensure compliance.
Date: 3 November
Time: 1pm – 2pm
You attend the webinar online with a PC and a telephone and are able to ask questions of the presenters.
The webinar is free, but due to WebEx capacity restrictions, spaces may be limited and are allocated on a first come first served basis.
Register here.
Events (continued)
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