Summer Fun  

With the UK in the grip of its best summer since 1976 (although no greenfly invasion just yet) this month we look at a number of issues that are just right for considering while on the beach or in the garden under a shady tree. Well they are if you, like us, find tax fascinating!

First, we consider the ground-breaking U.S. Supreme Court decision in Wayfair that opens up internet businesses to U.S. state taxes. Next is a case study considering the effects of Brexit on a business that provides services rather than goods to the EU. Our third article honours the near mythical summer of 1976 by tipping its sun hat to another near mythical beast making a come-back, the man on the Clapham omnibus. Finally, and as promised in the last MTN, we consider how ATAD I & II might affect funds.

  1. Wayfair = play fair?
  2. Brexit & trade barriers – what you can do if they come down.
  3. The source of interest – an old friend makes a welcome return.
  4. ATAD, a two, ATAD two, three, four.

A Fair Way to Change U.S. Sales Tax?

On 21 June 2018, the U.S. Supreme Court released its much anticipated decision into South Dakota v Wayfair, Inc (Wayfair). While at first blush this decision might appear to concern the application of U.S. sales tax in a Midwestern state, it has potentially far reaching consequences for all non-U.S. online retailers with U.S. customers.

Wayfair in a nutshell

Wayfair considered the ability of South Dakota to collect U.S. sales tax from online retailers. Wayfair was selling to customers located in South Dakota without itself having a physical nexus (i.e. a physical presence such as storage facilities/warehouses) in the state. Wayfair relied on previous court rulings, the most significant being Quill Corp v North Dakota (Quill), to argue that because it had no physical nexus, it did not have to collect sales tax from its consumers.

In an attempt to nullify the decision in Quill, South Dakota introduced an economic nexus test (i.e. no physical presence required) in 2016 (South Dakota Act) that created a sales tax liability if an out-of-state retailer:

  • delivers more than USD $100,000 of goods or services into South Dakota; or
  • engages in 200 or more separate transactions for the delivery of goods or services into South Dakota.

The problem posed to the U.S. Supreme Court was whether Quill was still appropriate in the modern digital age. Decided in 1992, the Judges presiding over Quill could not have foreseen the retail business world of today. There was also political motivation to invite change. The financial consequences of not taxing online businesses were estimated in the Wayfair judgment to deprive U.S. states of between USD $8 – $33 billion per annum.

The Effect of Wayfair

The court in Wayfair overturned Quill, describing that judgment as “unsound and incorrect”. The immediate effect of the judgment is that online businesses must now comply with the South Dakota Act (i.e. apply U.S. sales tax if the “either or” test above is met).

So, what does Wayfair mean for international businesses with customers located in the U.S.? A foreign business that is only making online sales to U.S. based customers and does not therefore have sufficient activity in the U.S. to create a U.S. trade or business with effectively connected income for U.S. Federal Tax purposes (i.e. the U.S. version of a PE), could nonetheless now find itself with a liability for state sales tax purposes. Worse still, it is not inconceivable that U.S. states may now review other state level taxes (e.g. state income tax) where the physical nexus test is used and seek to introduce economic nexus type arrangements.

The OECD and the European Commission have been trying to push through similar arrangements as part of their plan to change the way that the Digital Economy is taxed, although these proposals are designed to tax profits whereas Quill imposes state sales taxes (i.e. consumption). The EC, in particular, is looking at introducing the concept of a ‘virtual PE’ that is triggered where a business selling goods or services to consumers in a EU Member State has over 100,000 users, annual revenues of over EUR €7mn or 3,000 business to user contracts. The OECD, on the other hand, is taking a more leisurely approach to matters and attempting to design a solution that satisfies the 110 states working on Action 1 of the BEPS Project (Addressing the Tax Challenges of the Digital Economy).

If you would like to discuss the implications of the Wayfair judgment, please contact Miles at on +44(0) 20 7534 7181 or Rozi at on +44(0) 20 7534 7186.

Brexit & Trade Barriers

Breaking up is hard to do

A client recently approached us for Brexit related advice on what would happen to their business if Jacob Rees-Mogg gets his way and there is no deal with the EU.

The client (a UK company) provides business to business services in the UK and EU and was concerned that tariffs and duties would be slapped on their EU invoices once we pull up the draw-bridge and tell M Juncker and his chums to “do one”.

As ever, we had some good news and some bad news. The good news is that there will almost certainly not be any direct monetary tariffs or duties slapped on their business, not through any altruistic bent of European customs officials, but rather because they can’t see the invisible services flowing across their borders, as compared to the goods we export. Instead, and this is the bad news, our client is likely to face a growing number of hurdles and barriers being thrown in their way as each Member State imposes or enacts niggling little things (and some whoppers) to protect their home-grown industries.

At the moment, our client can “passport” into the rest of the EU. They meet the current EU (and UK) requirements and can use that to trade freely in all the other Member States. The problem is, once we become a “third state” that passport disappears, whether it is EU burgundy or Great British blue (or is it black?).

From Brexit day, if any Member State has “extra” requirements then our client will need to meet them. At the moment if, say, the EU standard is 6 months experience for staff, then our client’s staff can work in any Member State as long as the member of staff has that experience – whatever the local requirement. If, however, France requires staff to have 9 months experience then this will now apply rather than the EU standard. So, the specific requirements and conditions of each Member State will have to be met if our client wants to trade there – a significant barrier to entry.

Trading places

Our advice was to set up a subsidiary within a Member State (Ireland) to handle all their EU business. This subsidiary will then be able to trade with the other Member States on EU conditions. Any services between the UK parent and its new subsidiary will have to meet the local conditions, but head office and admin services are likely to be less tightly regulated and the conditions easier to satisfy – plus there will only be one set to deal with.

We have stressed though that the new subsidiary must have substance and be capable of carrying on the business transferred to it. Otherwise, in these post-BEPS days, HMRC and the host revenue authority are going to start jumping up and down (and give HMRC the opportunity to try out the proposed anti-fragmentation rules, if nothing else). Obviously ensuring the Irish subsidiary has the necessary substance will come at a cost, but considerably less than either exiting the EU business or meeting all the Member States’ requirements individually.

One last snag is the loss of the Parent/Subsidiary Directive (PSD). Pre-Brexit, the PSD would have allowed dividends from the subsidiary to be paid to our client free of withholding tax (WHT). After Brexit, this benefit is lost and local rules will again apply. With the UK distribution exemption making WHT a hard cost, the rate in the relevant domestic rules and double taxation agreements (DTA) becomes very important. Fortunately, although Ireland has WHT of 20%, most dividends are exempt as long as the recipient is a company resident in a country with which Ireland has a DTA (here the UK) and it is not owned by Irish residents. That covers our client who is very happy.

If you have any queries regarding Brexit and how it may affect your business please contact Miles at or +44(0) 20 7534 7181 or Andrew P at andy@milestonetax.con or +44(0) 7534 7184.

The Source of all Interest

A simple concept – like explaining the colour blue to a blind man

How do you determine the source of interest for UK tax purposes? This sounds like a simple concept to explain but, here is the acid test, try describing it to someone who is not a tax expert and see how you get on. Actually, scratch that, try explaining it to a tax expert and see how you get on!

HMRC’s guidance describes the issue quite succinctly in their Savings and Investment Manual at page SAIM9090:

“Whether or not interest has a UK source depends on all the facts and on exactly how the transactions are carried out.”

The guidance goes on to say:

“HMRC consider the most important of factor in deciding whether or not interest has a UK source to be

  • “the residence of the debtor and the location of his/her assets.”

It seems to us that the residence of the debtor is one factor and the location of his/her assets another, but hey ho. The guidance then lists some other factors that need to be taken into account the effect of which is that in determining source one has to apply a “multifactorial test”.

It’s all Greek to me

The UK approach is based upon the single UK case that applies for this subject – “the Greek bank case” a.k.a. Westminster Bank Executor and Trustee Company (Channel Islands) Ltd v National Bank of Greece SA (46 TC 472). It might seem quite surprising that such an important subject has, up to now, only had the one precedent. However, as we will come back to, a recent Court of Appeal decision suggests that this may not be so surprising after all.

In Ardmore Construction v HMRC [2018] EWCA 1438 (Court of Appeal), Arden LJ agreed that the test to be applied was the “multifactorial test” set out in the Greek bank case. However, she found that this did not help the Court reach a decision as to what factors will determine the issue as different cases will throw up different indications.

The man on the bus rides again

Arden LJ therefore “built” upon this test by suggesting a “practical approach”. Would a practical person regard the source of the interest to be in the UK or elsewhere? What is the underlying commercial or practical reality of the source of the interest? As an aside, we wonder if Arden LJ considered using some older formulations for these propositions? First, what would the man on the Clapham Omnibus think? Then it is a matter of substance over form!

In Ardmore, this approach effectively sunk the taxpayer. They were relying upon a legalistic approach that may have stood a chance in 2005 when the loans were granted, but in 2018, the near circular flows of money (the original £2.7m went round the houses 3 times to generate £5mn in interest) meant that the taxpayer had in effect lost before they began.

What do we take away from this case? To a certain extent, Lord Hailsham in the Greek bank case applied common sense in reaching his decision and Lady Justice Arden has done near enough the same thing, holding that you must take a practical approach when considering the source of interest.

We believe this approach is why there has only been the one precedent from the UK courts on the issue. If you were to ask the man on the fabled bus where the source of interest was if you have a company resident and trading in the UK, borrowing money to use in its UK business he will almost certainly say the source of any interest will be in the UK. It will be very difficult to persuade him that it is elsewhere.

If you want to know more about the source of interest and how it may affect you please contact Zoe at or +44(0) 20 7534 7183 or Andrew P at andy@milestonetax.con or +44(0) 7534 7184.

ATAD I & II and Funds

This article is part of our ongoing series on how Alternative Investment Funds (AIFs) – hedge funds, private equity funds and investment trusts – may be affected by BEPS and the EU’s Anti-Tax Avoidance Directives I & II (ATAD I & II).

In our last issue, we examined the OECD’s rather pragmatic approach to treaty eligibility (Action 6) for AIFs in recognising that collective investment vehicles have to pool their investors’ cash somewhere and – all other things being equal – it makes commercial sense for them to do so in a jurisdiction that provides access to a wide treaty network. We should add that the OECD recognised that their approach could lead to the risk of treaty benefits being available in circumstances where they might not have otherwise arisen.

The OECD could have adopted a robust technical approach and linked a fund’s treaty eligibility to each of its individual investors’ treaty eligibility (the equivalent beneficiary test).  For example, where 80% of a fund’s investors were treaty eligible – had they invested directly – then the fund would only qualify for 80% of available treaty benefits. In our view, that would be a death knell for the funds industry by forcing them to accept only treaty-eligible investors and closing the gates on everyone else. In short, the OECD’s pragmatic approach to treaty eligibility for AIFs was welcomed in the alternative investment space. So far, so good…

In this issue, we consider whether the EU’s ATAD I & II might adversely affect AIFs. As ATAD I & II are EU directives they do not, by themselves, have the force of law with each member required to pass legislation to adopt the provisions into domestic law.  As we will see, this could be a critical factor.

Given that ATAD I & II extend the BEPS Actions (and require domestic adoption), Ireland, Luxembourg and the Netherlands have the most to lose from strict implementation. Our focus in this issue is on Ireland and how it might (or be required to) implement ATAD I & II vis-à-vis their section 110 company regime.  As expected, given the importance of the investment sector to the Irish economy, there has been vigorous debate on implementation mechanics with final wording only available once Ireland issues its budget / finance bill in autumn 2018.

ATAD I must be transposed into each member states’ domestic law by 31 December 2018 and will have effect from 1 January 2019, while for ATAD II the respective dates are 31 December 2019 and 1 January 2020.  Given these deadlines, we plan to cover the Luxies and the Dutchies approach too.  Look out for those thoughts in our blog.

The starting point…

The diagram below shows a plain vanilla Irish Qualifying Investor Alternative Investment Fund (QIAIF) (marked 1 in the diagram) structured as an Irish Collective Asset Management Vehicle (ICAV).  An ICAV is a body corporate (but not a company under Irish company law) that is Irish resident but exempt from Irish tax on investment income and gains.

All ICAV investments are held via an Irish “section 110 company” (marked 4 in the diagram) funded by a Profit Participating Note (PPN) that sweeps the vast majority of profits out of Ireland as interest payments.  The Irish s.110 arrangement qualifies for Ireland’s double tax treaty (DTT) network while facilitating a virtually tax neutral pass-through.

As is common, the ICAV has US taxable investors (marked 2 in the diagram) as well as US non-taxable investors and non-US investors (marked 3 in the diagram) that invest indirectly through a ‘blocking’ corporate entity (required for US tax purposes).

The ICAV / s.110 / PPN funding arrangements escape Irish interest withholding tax with the PPN interest payment deductible against Irish profits provided certain conditions are satisfied.  To qualify for the withholding tax exemption, the recipient of the PPN interest must be:

  1. resident in a jurisdiction that has concluded a DTT with Ireland; and
  2. that jurisdiction must tax the receipt of foreign interest (the ‘subject to tax’ test). Note that it does not matter for the subject to tax test whether the actual recipient is itself ‘subject to tax’ (i.e. a pension fund).

Further, the PPN interest will be tax deductible (which is critical for the Fund) where, in addition to the two tests above, the recipient does not ‘control’ the paying company.  For this reason, most s.110 entities are ‘orphans’ where voting rights and economic entitlement are separated.

As will be evident, these s.110 / PPN structures facilitate tax frictionless transfer of investment yields to investors. All jolly friendly!


ATAD I sets the minimum standards that each member state must follow when implementing the 15 BEPS Actions in their domestic law.

Article 4 of ATAD I may cause a degree of consternation. This imposes a general interest deductibility limitation where an entity’s net borrowing costs exceed 30% of EBITDA.  The limitation applies to the quantum of deductible borrowing costs that exceed taxable interest and other economically equivalent taxable revenues (with this latter phrase not defined!).

Were Ireland to apply Article 4 to funds, the domestic definition of ‘other economically equivalent taxable revenues’ included when implementing ATAD into domestic law will be critical to the ICAV / s.110 / PPN arrangements and the Irish funds industry.

Let’s take a worst case example.  A debt fund uses the ICAV / s.110 / PPN structure to acquire distressed debt at a large discount (€100 face value acquired at €20).  The fund subsequently on-sells the debt for €80, making a gain of €60. Under existing arrangements, the €60 gain (less a small taxable margin) is paid as tax deductible PPN interest.

If PPNs are defined to fall within the scope of Article 4 or the €60 gain is excluded from the definition of ‘economically equivalent taxable revenue’ the deduction for the PPN interest would be limited to €18 (30% *£60) with the €42 balance subject to 25% Irish tax (the rate for non-trading income).  While the €42 can be carried forward, in fund arrangements, the result is an annual dead weight tax cost. Bye, bye funds industry.

However, let’s take a step back and paint a more likely picture.  ATAD I specifically provides (perhaps through gritted teeth) that financial undertakings ‘present special features’ on which international and EU bodies have yet to reach final agreement.  As such, in recognition, Article 4(7) allows member states to exclude financial undertakings from the scope of the interest limitation rule.  Is that a sigh of relief I hear?


ATAD II extends BEPS Action 2 in applying a new ‘third country’ requirement in unwinding tax mismatches (read advantages) that arise because of differences in the characterisation of payments made between different jurisdictions. For example, the payer’s jurisdiction may treat a payment as tax deductible interest while the recipient’s jurisdiction may treat it as a tax exempt dividend (a deduction – no inclusion scenario).

The result is that for co-investment / sub-participation arrangements, additional care (and compliance information) will be required to support / evidence the domestic withholding filing position.  Given the inadvertent risks that can arise in these arrangements, this should be closely monitored.

Stay tuned…

A clear picture will emerge on whether the domestic pressure and / or the adoption of ATAD I & II into Irish domestic law will create adverse issues for the s.110 regime once Ireland issues its budget / finance bill in autumn 2018.   Watch this space.

If you would like further information about ATAD, please contact Andy M on or +44(0) 20 7534 7182 or Geoff on or +44(0) 20 7534 7188.