Developments in UK Jurisprudence
Income tax consequences of pension-related payments in E.ON against HMRC
E.ON v. HMRC concerned a major UK electricity and gas company that made certain lump-sum payments, called "benefit payments", to some of its employees in return for agreeing to the changes E.ON then made to its future pension system rules and regulations Working conditions. These Facilitation Payments can be received in cash or, alternatively, paid into the Group Voluntary Additional Contribution Pension Facility (AVC).
E.ON argued that the bribes were exempt from income tax and social security as they were not “from” employment within the meaning of Section 9 of the Income Tax Act 2003 and Section 3 of the Social Security Contribution and Benefits Act 1992. Since HMRC did not agree to this position, they left the case before the First-Tier Tax Tribunal ("FTT").
The FTT sued the company and ruled that the relief payments were subject to income tax and social security contributions because they came “from” employment. The main reasons for this conclusion can be summarized as follows:
i the payments were made as an incentive for employees to agree to a change in their future terms of employment,
ii The payments were not made to compensate for the loss of pension rights (which in the company's view was not related to the employment relationship) because the existing pension rights remained – essentially only the ratio of employer and employee contributions to the pot changed, from which the pension benefits were paid, and
iii The payments were part of an agreement between E.ON and employees, under which E.ON undertook not to change the pension regulations for five years and a series of “employment commitments” with a term of two years. As such, the relief payments replaced the lower earnings workers would suffer if they wanted to maintain the same level of pensions. According to this characterization, the bribe payments replaced income and as such were taxable and subject to NICs.
It was clear to the court that the payments made could not be separated from the rest of the package, which contained specific commitments for E.ON on working conditions and thus came "from" employment relationships.
Mixed partnership rules examined by the higher court on appeal
The FTT decision in the Walewski v. HMRC case was upheld by the Higher Court (“UT"), Confirming that the rules for mixed partnerships in Section 850C of the Income Tax (Trading and Other Income) Act 2005 ("ITTOIA“) Should apply. We reported on the FTT decision in our Tax Round Up from February 2020.
As a reminder of the facts in this case, Mr Walewski launched a Luxembourg equity fund managed by two UK limited liability partnerships (AAM and AF) of which he was a member. A UK company (W Ltd) was also a member of AAM and AF. Mr. Walewski was the only employee and director of W Ltd. Mr. Walewski appealed against HMRC's decision to assign him the profits of AAM and AF under Section 850C of ITTOIA, where those profits were transferred to W Ltd. were paid out. The FTT agreed with HMRC and found that the W Ltd allocated profits of £ 20 million should be allocated to Mr Walewski as a member of AAM and AF as the profits were not made by W Ltd and were only allocated to her so that Mr Walewski these profits (via an offshore trust fund to which W Ltd distributed the money).
In making this decision before the UT, Mr. Walewski argued that Section 850C of ITTOIA should not apply because: (i) Mr. Walewski was not an affiliate of AAM and AF at the time the W Ltd winnings were allocated to him, and (ii) the FTT found the false statement that Mr. Walewski spent half of his working hours through W Ltd.
After examining the grounds for the complaint, the UT rejected Mr Walewski's complaint on the grounds that:
i Mr. Walewski did not have to be a partner in a partnership at the time the profit was allocated to W Ltd, as long as Mr. Walewski received a profit participation, and this was in accordance with the legal interpretation of § 850C of the ITTOIA, and
ii The FTT found that Mr Walewski's services were completely unclear and fluid and that W Ltd was nothing more than a corporate hull, and UT agreed with this finding.
Perhaps this is not a surprising result and underscores the importance of having clear evidence and convincing explanations of the purpose and activities of all elements in a corporate structure.
UK based partner in a Delaware limited partnership refuses double taxation relief
In the GE Financial Investments v HMRC case, GEFI, a UK resident taxpayer, was a member of a Delaware limited partnership ("DLP") Who was engaged in credit financing activities. As a result of the commingling of GEFI shares with the shares of D LP's US resident general partner, GEFI was subject to US tax on its worldwide income in addition to UK tax on D LP's share of the profits.
GEFI called for a double tax break in the UK of around £ 125 million on US tax it had paid over six tax years. HMRC refused to grant discharge after investigating GEFI's tax returns.
On appeal from GEFI, the FTT found that GEFI was not entitled to double taxation relief because:
i GEFI was not treated as US taxable under Article 4 of the UK-US Double Taxation Convention (and consequently no Article 24 double tax relief was available to GEFI); and
ii GEFI did not do business in the US through a permanent establishment (and therefore could not argue that the UK should not tax the portion of its US profits under Article 7 of the UK-US Double Taxation Agreement).
In making its decision on (i), the FTT examined various tax authorities (including the OECD comments) as to whether GEFI could be treated as a US tax resident as its shares were linked to the shares of another US company. However, it concluded that the stock pinning mechanism does not require sufficient territorial linkage or association with the US to treat GEFI as a US tax resident. In addition, it was insufficient that GEFI was treated as a US worldwide income tax payer for these purposes.
When examining (ii), i. H. Whether GEFI was doing business in the United States, the FTT was referred to several "business" cases. Because GEFI was involved in D LP, which issued and administered a series of loans totaling over $ 2.82 billion, received significant amounts of interest, and made distributions to partners, GEFI ran an effective business. From the FTT's point of view, however, these were not the only factors that needed to be considered. It was also necessary to check that the activities were actively pursued with reasonable continuity and regularity, that they had sound and recognizable business principles, and that they were activities that were usually carried out by those who wished to benefit from them.
After reviewing D LP's activities, the FTT concluded that the granting of five subsidiary loans (including three from D LP) over six years was more of a sporadic, passive, or isolated activity, although the activities could be considered severe on a regular basis and continuous activities. FTT also pointed out that there was an apparent lack of strategic direction for D LP by its general partner's directors.
This is a highly complex case that deepens the interpretation of double taxation treaties. Adding to the complexity of the case is the fact that even the UK and US tax administrations failed to find common ground under the mutual agreement procedure set out in Article 26 of the UK-US double taxation treaty. Although the case has a specific set of facts that are limited to an international tax framework, it will be of assistance in the UK Revenue Court's interpretation of the term "business" as this important term is used in other areas of UK tax law.
Other UK tax developments
Pension Tax Avoidance – Spotlight 58
On the subject of pension-related payments (a topic this month), HMRC released one of its "Spotlights" series on areas it focuses on from a tax avoidance perspective – Spotlight 58. It describes an example of tax avoidance arrangements where owner-managed companies use the Grant directors monetary rewards to avoid income tax and social security contributions while enjoying corporate tax breaks.
These arrangements typically include a company entering into an unfunded pension obligation in favor of the company's director. This would immediately result in an expense that leads to a reduction in the corporation tax payable by the company. The company would then transfer the pension obligation to an employee of the director (e.g. a relative). It is then asserted that paying under this obligation would not result in income tax or social security contributions. In Spotlight 58, HMRC made it clear that it would view these agreements as tax avoidance agreements and attempt to challenge them.
Spotlight 58 is a new reminder that HMRC will look very carefully and try to question what it perceives as fabricated agreements to take advantage of existing tax breaks.
Review of the tax year end by the Office of Tax Simplification ("OTS")
As part of the ongoing UK tax simplification work, the OTS published a proposal on June 4, 2021 to move the tax year end for individuals from April 5 to March 31.
The move to March 31st aims to modernize the UK tax system by aligning the tax year for individuals with the tax year for UK companies and the closing date of the UK financial year on which the UK Government prepares its financial statements.
As part of this review, the OTS will conduct a cost-benefit analysis and consider the practical and administrative implications of this step for HMRC and taxpayers. The OTS report with its results will be published in summer 2021.
Decommissioning of punch press machines
HMRC has announced that as of July 19, 2021, they will no longer use the traditional stamp printing machines that were used during the 300 year life of the UK stamp duty. Instead, HMRC will put an electronic process in place on all remaining transactions that require physical stamps, including levies on shares transferred via a share transfer form. The change in approach was prompted by the current pandemic situation, in which the HMRC operated a digital process. This is widely viewed as a welcome simplification of procedure, but the end of a piece of British history. Interested parties can contact HMRC if they want to take one of the decommissioned 685kg punch presses back into their possession.
Royal approval of the Finance Act 2021
On June 10, 2021, the 2021 Finance Act received royal approval and became the 2021 Finance Act.
EU case law
Tax avoidance and use of mailbox companies
The EU Commission has started a new consultation on tax avoidance and the use of shell companies. The aim of the consultation is to collect data and evidence that could be used to shape new rules in the EU to combat letterbox company abuse and tax avoidance arrangements. The consultation is open to all stakeholders, with the EU Commission particularly interested in the views of EU tax administrations. The consultation is open for submissions until August 27, 2021.
Public EU country-by-country reporting by large multinational companies
The EU Council reached preliminary political agreement on a proposed new directive on disclosure of income tax information by certain multinational companies.
The directive would require multinational companies with total consolidated sales of more than € 750 million, whether or not they are headquartered in the EU, to publicly disclose certain information about income taxes paid in EU member states and certain non-cooperating jurisdictions do. The information will be limited to what is necessary for effective public scrutiny. The policy requires reporting within 12 months from the date of the balance sheet for the financial year concerned.
Sales tax effects of renting real estate on the term "permanent establishment"
In the Titanium v. Tax Office Austria case, the ECJ ruled that Titanium, a real estate management company from Jersey that rents real estate in Austria, does not have a VAT branch in Austria.
This decision was referred by the Austrian court to the ECJ in connection with the Austrian tax authorities' allegation that Titanium has a permanent establishment in Austria for VAT purposes because it rents real estate in Austria. Titanium had no activities (other than rental), physical presence or staff in Austria, but instead hired a local management company to assist Titanium in managing the rentals. Titanium was ultimately responsible for making decisions about renting properties or terminating a lease.
In its ruling, the ECJ found that the term “permanent establishment” implies a certain degree of stability, which results from the constant presence of the human and technical resources necessary for the provision of services. A structure without staff cannot fall under a “permanent establishment”. Consequently, the ECJ took the clear view that Titan could not be treated as a "permanent establishment" if it did not have the human resources in Austria that would enable it to act independently.
This is a useful choice for companies operating across borders within the EU as it provides useful guidance to determine whether or not a company with limited presence has a “permanent establishment”.
Other tax developments
Global G7 tax treaty
It was recently announced that the G7 finance ministers agreed on a global tax reform. This groundbreaking reform targets large multinational corporations to ensure they pay their fair share of the economies of the countries in which they are based and operate and is an integral part of the ongoing OECD BEPS 2.0 initiative.
The reform has two pillars. Under the first pillar, the largest and most profitable multinationals have to pay taxes in the countries in which they operate (not just where they are headquartered). The multinationals with profit margins above 10% would be affected and 20% of their profits above the 10% margin would be reallocated and taxed in the respective country in which they operate.
Under the second pillar, countries would have to levy at least 15% of the global minimum corporate income tax. The agreement aims to create a level playing field for international companies and reduce tax avoidance.
The European Tax Observatory ("ETO“Has since estimated the monetary value of these proposals in its most recent report. The ETO report states that a minimum rate of 15% could generate additional revenue of 50 billion euros.