The MO 

The pre-Christmas edition!

We bring you some pre-Christmas crackers in this November edition of the MTN and hope that, at least for a moment or two, we help take your mind off the omnishambles that is Brexit.

We start with a look at, what is in the current climate, one of the rarest of birds: the (temporary) easing of taxing legislation that allows the “cleansing” of mixed funds by UK non-domiciles. Next, we look at a joint announcement by the three Crown Dependencies regarding their new corporate substance requirements and, as the weather turns decidedly colder, we thought we’d look to the warmer climes of Cyprus and the interaction of their Tonnage Tax with the UK tax system. Now if that doesn’t float your boat we don’t know what will!

  1. The perils of putting things off – ignoring the remittance basis mixed fund rules can lead to an administrative nightmare.
  2. Substance in the Crown Dependencies – Working together to keep the EU happy.
  3. The Cypriot Tonnage Tax and UK companies – potentially a case of actual double taxation.

Speaking of Brexit, Zoe is currently working on a paper that summarises the pitfalls of PM May’s Brexit plan. More on this next month…

The UK

The perils of putting things off…

One of the idiosyncrasies of the UK tax system is the common law concept of “domicile”. If you are tax resident in the UK, you are taxed upon your worldwide income. However, if you are also not domiciled in the UK (i.e. you’re a “non-dom”), you are only taxed on UK source income or foreign source income that is remitted or enjoyed in the UK. By way of simple example, the interest accruing on your foreign bank account will not be liable to UK tax provided it remains outside the UK.

That the UK taxes on the remittance basis is actually not unique, as a number of other jurisdictions have similar regimes, think the Beckham Law in Spain, for instance. If you qualify for this regime, non-Spanish income is exempt from Spanish tax (ironically Mr Beckham would no longer qualify, as professional footballers are amongst those who cannot take advantage of the regime). Other jurisdictions that have favourable tax regimes for offcumdens (as they say in Yorkshire) that spring to mind include, Malta, Switzerland, Hong Kong, Italy, France, New Zealand, Singapore and Israel.

What is unique is the UK concept of domicile itself. As with many fundamental concepts of UK taxation, it is not defined by legislation, taking its meaning from case law. Two ways of describing it are, “where your heart is” or “where you want to be buried” and stands in contrast to the physical presence needed for tax residence.

The benefits of the remittance basis of taxation have been steadily eroded over the past 10 years or so, culminating with domicile being put on a quasi-legislative footing from 6 April 2017, when the concept of deemed domicile was extended from Inheritance Tax to Income Tax and Capital Gains Tax. A person will now be considered to be deemed domiciled in the UK if they have been tax resident in the UK for 15 out of the last 20 tax years, preceding the year under consideration. The basis being, that after 15 years, you have established enough of a connection with the UK such that, although your heart may not be in Scunthorpe, Nether Wallop or Wetwang, it certainly looks fondly upon them.

The 2008 changes

The first set of major changes to the remittance basis were introduced in 2008 and along with it a Frankenstein’s monster. The focus of the legislation were “mixed funds” – generally bank accounts of a non-dom that included both “clean capital” (not taxable in the UK) and accrued income and gains (taxable if remitted). As the funds in the account are considered as being one pool, when a withdrawal is made there is no telling, in reality, whether the money withdrawn is clean capital or taxable income. Case Law had come up with a work-around based on the assumption that a person will always try to preserve capital and, therefore, income and gains should be taken as withdrawn first, with any income that has suffered UK tax taken to be remitted before any other income.The 2008 changes introduced legislation to put this on a statutory footing, and also introduced a yearly order. Now, when a person makes a remittance from a mixed account, they are deemed to have remitted:

  1. Employment income (which can include UK employment income) not subject to a foreign tax (that is, amounts not appropriate to any of ‘2’, ‘3’ or ‘6’ in the list below).
  2. Relevant foreign earnings (not if subject to a foreign tax – refer to ‘6’).
  3. Foreign specific employment income (not if subject to a foreign tax – refer to ‘6’)
  4. Relevant foreign income (not if subject to a foreign tax – refer to ‘7’).
  5. Foreign chargeable gains (not if subject to a foreign tax – refer to ‘8’).
  6. Employment income subject to a foreign tax.
  7. Relevant foreign income subject to a foreign tax.
  8. Foreign chargeable gains subject to a foreign tax.
  9. Any income or capital not included in one of the previous eight categories.

This is a simplified list (can you see the bolts beginning to appear on the monster’s neck yet?) and once you have completed it for the latest year, if the amount remitted exceeds the amounts under 1 to 9, you move back to the next year and start at 1 again!If this wasn’t bad enough, where there have been payments from the account that have not been remitted to the UK, say, spent abroad, or transferred to another bank account (an offshore transfer), the amount withdrawn is taken to be made up of a pro-rata amount of all the differing deposits into the account. This is not too difficult if there have been only two deposits, one of clean capital and one of income, but what if there have been, say, 17? Even worse, what if there have been 17 offshore transfers? Every time an offshore transfer occurs this computation has to be re-run. The longer you put off doing these computations, and the more offshore transfers there are, the bigger the administrative headache.Given the overbearing complexity of the 2008 changes, we’d wager a fiver that many non-doms with mixed funds decided not to remit because they reasonably concluded that life is way too short!

There is another way!

All of this fuss and bother could have been avoided, if the account had only been segregated into three separate accounts containing clean capital, taxable income and capital gains respectively. Using separate accounts the non-dom can remit money from the clean capital account until that is exhausted and not pay any UK tax upon the remittances, then remit from the capital gains account before remitting from the income account, which will probably lead to the highest UK tax bill. Simples!

Light at the end of the tunnel

Feeling the pain of the poor, beleaguered non-dom, Parliament saw fit to take a fresh look at the problem of mixed funds (albeit for a limited time only). If you had claimed the remittance basis prior to the 6 April 2017, you were given a two-year window to “cleanse” your mixed funds. You do need to be able to identify the different types of funds in the account (being clean capital, income and gains), which may require you to carry out the nightmare computation outlined above, but once you have, and you are able to transfer the different elements into the respective accounts, you will, hey presto, have cleansed it. You can then decide which of the accounts to make remittances from, in order to take best advantage of the remittance basis.There are a couple of quirks:

  1. the cleansing process is not available to anyone who was born in the UK and had a UK domicile of origin; and
  2. the cleansing must be completed by 5 April 2019, so the clock is ticking!

If you want to know more about domicile, residence or the remittance basis please contact Miles at miles@milestonetax.com or +44 (0)20 7534 7181 or Andrew P at andy@milestonetax.com or +44 (0)20 7534 7184.

The Crown Dependencies

Economic Substance

Following our article last month on the new substance requirements being introduced in by Jersey, we were delighted to see Guernsey and the Isle of Man following down the very same path (which at least saves us from a laborious compare and contrast analysis).

Key principles

The legislation is aimed at reassuring other jurisdictions that companies active in certain business areas and located in the islands are not mere “brass plates”, but have the level of substance commensurate with their reported economic activity. If the relevant company does not have the required substance, it faces dire consequences. More on that later.

The companies must:

  • be directed and managed;
  • conduct Core Income Generating Activities; and
  • have adequate people, premises and expenditure

in the relevant island.

These requirements apply to companies in a number of “geographically mobile business sectors” such as:

  • financial services (banking, insurance, etc.);
  • headquarters;
  • holding companies;
  • distribution and service centres;
  • shipping; and
  • intellectual property (IP).

For this last category, the company will have to consider if it has “high risk” intellectual property. This is, in effect, all IP that was not created by the company in, say,  Jersey. Where a company has high risk IP it will be considered “guilty until presumed innocent” as it will be taken to have failed the substance requirements until it proves otherwise. To rebut this presumption, the company will need to meet a high evidential burden by having detailed plans setting out the commercial reasons for the IP being in the relevant island, solid evidence that company’s decisions are being made in that island (and not just rubber stamping decisions made elsewhere), and information about local employees such as their experience, employment terms and qualifications.

To add another level of confusion, the directed and managed test is different to the central management and control and place of effective management tests used for tax residence. It is based on the number of board meetings, with the majority to be held on the relevant island. The records of the meetings must be kept on the island too (we presume to help with the exchange of information with other jurisdictions) and the directors must have the necessary knowledge and experience for their positions. If a company is used as a director, then the knowledge and experience test applies to its officers.

The requirements relating to the core income relating activities will be set by legislation. Fortunately, not every core activity will need to be carried on in the island; back-office functions can be done elsewhere and the company can engage external specialists, but the level of the income declared in the island must match the core activities carried on there.

If core activities are outsourced then the company must show it is able to adequately supervise the outsourced activities and the core activities must still take place in the island. Companies that fail the substance requirements, i.e that have greater income than the numbers of their staff etc suggests they should have, face sanctions including penalties and the threat of being struck off. As all of the Crown Dependencies take their responsibilities very seriously, we see this as a real, rather than idle, threat. Where the parent company of the failing company is in the EU, then the islands’ Competent Authority will make a spontaneous exchange with the Competent Authority of the relevant Member State (plus the UK!)

If you would like more information on Jersey’s substance requirements, please contact Miles at miles@milestonetax.com or +44 (0)20 7534 7181 or Andy M at andrew@milestonetax.com or +44 (0)20 7534 7182.

 

Cyprus

Oil & Water

We were recently asked to advise on a matter that we hadn’t previously come across (and as such it reminded us why we love international tax so much – you learn something new (almost) every day!).

The question was: If I have a UK incorporated company that owns a vessel subject to the Cypriot Tonnage Tax, is it better for the company to be UK resident or Cypriot resident and, if UK resident, what about a permanent establishment (PE) in Cyprus?

The vessel owning company had to be UK incorporated for commercial reasons (in case you were wondering why not just use a Cypriot company?) and was within the Cypriot Tonnage Tax regime as it owns a Cypriot registered vessel. We, therefore, had to consider what the tax implications were for the three options:

  1. UK resident, no Cypriot PE;
  2. UK resident, with a Cypriot PE; or
  3. Cypriot resident.

When is a Tonnage Tax not a Tonnage Tax?

As soon as we started looking at option 1, we realised that this was an interesting case, and it was going to fall outside of the normal run of international taxation. The critical point being that the UK’s Tonnage Tax is not a tax at all. It is just a different way of computing a company’s profits for Corporation Tax. This compares to the Cypriot Tonnage Tax which is a tax in its own right and a company within the regime obtains an exemption from Cypriot Corporation Tax on its shipping income. This leads to actual double taxation for two reasons, both of which are linked to the UK/Cyprus double taxation agreement (DTA), which, of course, is designed to avoid this.

Article 2 of the DTA (Taxes Covered) of the current UK/Cyprus DTA applies to UK Income Tax and Corporation Tax, and Cypriot Income Tax. Cypriot Corporation Tax is also covered because Article 2 provides that the DTA extends to identical or similar taxes introduced after the date of the signature of the DTA (notably, Cypriot corporation tax was introduced in 2002). As an aside, the new UK/Cyprus DTA, that entered into force on 18 July 2018 (and effective from 2019), now lists both UK Capital Gains Tax and Cypriot Corporation Tax (but still no mention of Cypriot Tonnage Tax).

Whilst the company will be exempt from Cypriot Corporation Tax on its shipping profits, the issue is whether Cypriot Tonnage Tax is an identical or similar tax to Cypriot Income Tax (or Corporation Tax for the new treaty) such that it is within Article 2? Although UK Tonnage Tax is within the treaty, by virtue of it being part of the UK’s Corporation Tax regime, our view is that the Cypriot version is not.

The Cypriot Tonnage Tax legislation (helpfully translated into English by the Cypriot Department of Merchant Shipping) makes clear that the tax is not Income or Corporation Tax but “…an annual tax referred to as Tonnage Tax, which is calculated on the net tonnage of the ships…”.

It is not, therefore, a tax on profits or income. It is not even a turnover tax. It is a tax based upon the amount of cargo a ship can carry. It is not identical or similar to Cypriot Income Tax and, therefore, not within the scope of the DTA. This means that relief under Article 8 (Business Profits) or Article 10 (Shipping & Air Transport) is not available since both articles give the UK sole taxing rights. This is because the UK is already getting sole taxing rights as far as taxes covered by the DTA are concerned! Cyprus is imposing a tax outside of the DTA.

To compound matters:

  1. credit relief is not available in the UK under the DTA for Cypriot Tonnage Tax paid as the Tonnage Tax is not within Article 2 of the DTA and so falls outside of Article 24 (Elimination of Double Taxation); and
  2. unilateral relief is also not available in the UK as that is limited to taxes on income or chargeable gains and correspond to Income Tax, Corporation Tax of Capital Gains Tax and, as mentioned above, Cypriot Tonnage Tax does not correspond to an income tax.

What about PE?

If the company is UK resident with a Cypriot PE then matters get worse. Not so much from a tax point of view but administratively. All of the income of the company will still be taxable in the UK (foreign branch exemption is not available for many shipping companies) and the company will be paying Cypriot Tonnage Tax, but with a PE the company will have to deal with two fiscal authorities, or possibly three if you count the Cypriot Department of Merchant Shipping as a fiscal authority (they administer the Cypriot Tonnage Tax). Plus, the company will have to split its profit between the UK head office and the Cypriot PE along transfer pricing lines, although all the income will remain taxable in the UK.

Cyprus it is then

Our conclusion on this matter was for the company to be Cypriot resident, taking itself outside of the UK tax net. This is not without its difficulties though. As a UK incorporated company, it will be automatically tax resident in the UK and will only cease to be so if it is also resident in another territory, that territory has a DTA with the UK that contains a residence tie-breaker and the tie-breaker awards residence to the other territory.

To be resident for the purposes of the UK/Cyprus DTA the company must not only be resident in Cyprus due to its management and control being exercised in Cyprus, but it must be liable to taxation in Cyprus. There is a separate debate to be had as to whether the “taxation” the DTA refers to is just the taxes covered by the DTA or more widely, but thankfully for the company it is still liable to Cypriot Corporation Tax, just not on its shipping profits.

The company is, therefore, able to take advantage of the DTA’s tie-breaker. This is currently based upon the place of effective management, but the new DTA that comes into effect from 1 April 2019 for UK Corporation Tax, replaces this with an agreement between the Competent Authorities. We would not expect this to be a problem, if the ship is registered in Cyprus and the management and control of the company is in Cyprus, the only link to the UK is the brass plate and we would expect the UK to cede residence. It would, though, be another administrative hoop to jump through. This is on top of the need to obtain HMRC’s agreement to the company’s migration.

Conclusion

This issue goes to show that you cannot assume double taxation relief will be due for a foreign tax even if it looks and sounds like a UK tax. Although the UK and Cypriot Tonnage Taxes are both calculated on the same basis and neither can be considered a tax upon income, because the UK version is within the UK’s Corporation Tax regime it is within the UK’s DTA network, whereas, because the Cypriot Tonnage Tax is a tax in its own right it is outside.

If you have any queries the operation of the UK double taxation agreements or concerning company migration to or from the UK, please contact Zoe at zoe@milestonetax.com +44 (0)20 7534 7183 or Andrew P at andy@milestonetax.com or +44 (0)20 7534 7184.