Corporate residence - new developments
Though this will not come as a surprise to many commentators, the judgment provides a welcome clarification of the test for corporate residence in the context of increasing HMRC interest in this area.
What was the issue?
Development Securities plc set up a number of Jersey subsidiaries in June 2004 in order to participate in a tax scheme recommended by a major accountancy firm.
The purpose of the scheme was to increase available capital losses relating to interests in UK real estate held by Development Securities that had decreased in value. It involved the Jersey companies acquiring assets for more than their market value and then becoming UK resident by appointing UK based directors in place of Jersey based directors.
Crucial to the scheme’s success was the fact that the Jersey companies were resident in Jersey for UK tax purposes from incorporation until after they had acquired the assets at an overvalue.
To defeat the scheme, HMRC argued that the Jersey companies had always been UK resident on the basis that the central management and control of those companies took place in the UK and not in Jersey, where the majority of the directors were based. The First-tier Tribunal agreed, finding that the Jersey directors had abdicated their responsibilities as directors of the Jersey companies and simply followed the directions of Development Securities, their UK resident parent, in entering into a scheme that was without commercial rationale from the perspective of the Jersey companies.
The test for corporate residence
The Upper Tribunal confirmed that the correct starting point for considering where a company is tax resident is De Beers Consolidated Mines v Howe (Surveyor of Taxes). This test boils down to where “real control” of a company is exercised.
The Upper Tribunal then explored how this test should be applied to a special purpose vehicle or other wholly owned subsidiary, which was incorporated to fulfil a particular function under the instructions of a parent. Here, the Upper Tribunal emphasised Park J’s judgment in Wood v Holden as authority for drawing a distinction between influence over a subsidiary and control of a subsidiary.
This distinction is a fine one. In the context of a subsidiary carrying out the instructions of a parent the application of the corporate residence test will often focus on whether the subsidiary’s board had regard to their duties as directors and exercised proper judgement to ensure the proper governance of the subsidiary or, by contrast, abdicated their responsibilities as directors in favour of the parent, as HMRC argued in this case (see also Untelrab Ltd v McGregor (Inspector of Taxes)).
Criticism of the First-tier Tribunal’s decision
The First-tier Tribunal undertook an exhaustive analysis of the facts. The Upper Tribunal took a different approach, focusing on the key decisions, and asking where and by whom they were made. It found the key decisions were made by the board in Jersey. Crucial to this was the fact that the Jersey directors clearly turned their minds to the relevant issues during the (lengthy) board meetings in Jersey, during which, for example, the directors took additional tax advice by telephone from their tax advisers.
Although it was common ground that the scheme was artificial in nature, the Upper Tribunal criticised the First-tier Tribunal for focusing on the argument that the Jersey companies’ actions were somehow uncommercial and so had to be contrary to the interests of the Jersey companies.
Firstly, the planning involved no commercial disadvantage for the Jersey companies. Although the Jersey companies had acquired assets at an overvalue they had also been provided with the funds to do so.
Secondly, and more importantly, the First-tier Tribunal failed to take into account the actual duties the directors owed to the Jersey companies. Under Jersey law a director had a duty to act in the best interests of the company, which included considering the interests of the members, employees and creditors of the company. The Jersey directors decided that because the scheme was in the best interests of its shareholder (Development Securities) it was also in the best interests of the Jersey companies, having considered the appropriateness of the scheme in the context of their duties as directors. This, the Upper Tribunal argued, was entirely consistent with the directors exercising central management and control over the Jersey companies.
The fact that the directors were entrusted with a specific task by Development Securities before the Jersey companies were incorporated, and resigned once this task was completed, was simply irrelevant.
Ultimately, the Upper Tribunal found that the First-tier Tribunal’s conclusion that the Jersey directors had abdicated their responsibilities and so central management and control rested with Development Securities as parent was “an impossible one”. Based on the facts found by the First-tier Tribunal, the Upper Tribunal concluded that the Jersey directors gave proper consideration to the instructions of their parent company in the context of their duties as directors and so exercised central management and control of the Jersey companies at the board meetings held in Jersey.
The Upper Tribunal’s judgment merits reading in full. It includes a discussion of the possibility of dual-residence for companies, confirms that HMRC v Smallwood (the authority for trust residence) has no bearing on corporate residence and quotes favourably the following extract of Lord Neuberger’s judgment in Secret Hotels 2 Ltd v HMRC:
“…one must be careful before stigmatising the contractual documentation as being “artificial”, bearing in mind that EU Law, like English law, treats parties as free to arrange or structure their relationship so as to maximise its commercial attraction, including the incidence of taxation…”
Does this reveal a shift of judicial attitude in favour of taxpayers?
Probably not. Whilst the clear restatement of the underlying case law is welcome, the Upper Tribunal still criticised the scheme as being artificial and seemed to question the decision by HMRC not to pursue an argument against the efficacy of the scheme under the Ramsay and Furniss v Dawson principles.
In addition, the Upper Tribunal let stand the First-tier Tribunal’s finding of fact that one of the directors of the Jersey companies, who was also the company secretary of Development Securities, had abdicated their responsibilities as a director in favour of Development Securities. Ultimately this was not relevant since it was found that the Jersey directors actually exercised management and control in Jersey.
What lessons can be learnt?
Company residence should remain a concern where there are UK shareholders, directors or possibly shadow directors. HMRC will no doubt be looking more closely at company residence in other situations and so it is vital to ensure the right processes are in place to ensure the best possible chance of withstanding any challenge.
Despite the fact that the first instance decision has been overturned, the detailed findings of fact still raise some useful points for overseas directors to consider:
- Try to get terminology right – the loose use of words such as instruction or direction rather than advice, recommendation or request can have a significant impact.
- Make sure that the rationale for entering into a transaction is discussed and recorded in the board minutes, as well as a consideration of the relevant duties of the directors and the decisions taken under local law.
- Ensure that the directors have sufficient information properly to make any decision.
- If the benefits of a transaction include tax benefits, obtain advice on the benefits and risks.
- If action is to be taken in the UK between board meetings, the offshore board should authorise this in advance and should still make a final decision on any significant aspects.
- Be prepared for a forensic analysis of company records. In this case, the review was conducted by the First-tier Tribunal in minute and painstaking detail. The level of disclosure required can come as a surprise.