In this article we look at two recent tax cases and a change in HMRC’s guidance that will affect the UK tax position of offshore trust and company structures, particularly those based in the Channel Islands and Isle of Man.
Free movement of capital – Routier v HMRC
In the case of Routier v HMRC, the UK Supreme Court allowed a donation to a Jersey-based charitable trust to be treated as exempt from UK inheritance tax. However, the judgement has wider implications in relation to the circumstances in which EU law on the free movement of capital can be relied upon.
The case was taken by the executors of Mrs Beryl Coulter, who died domiciled in Jersey in 2007. Mrs Coulter left the residue of her estate, including UK assets valued at £1.7 million, in trust for charitable purposes to build homes for the elderly on Jersey.
HMRC contended that the trust, which was governed by Jersey law, did not qualify for inheritance tax exemption (on the basis that this was only available in the context of UK charities). The executors argued that this constituted an unlawful restriction on the free movement of capital under EU law, ie between EU member states and between member states and ‘third countries’. The Supreme Court agreed with the executors, and Mrs Coulter’s UK assets settled into the charitable trust were therefore treated as exempt from UK inheritance tax.
A number of important points arise from this case:
- EU law must be accorded priority over national law, where the latter is inconsistent with EU judicial principles.
- The ruling restricts the scope of the Dreyfuss decision in the 1950s, which held that only UK trusts could benefit from charitable status. The ruling will not only have relevance for Jersey charitable trusts. Provided a gift of UK property is for charitable purposes (under UK law), it should be exempt from UK inheritance tax wherever in the world the charity is located.
- Finally, the case highlights problems with the current definition of a ‘charity’ contained in UK legislation. This does not extend the meaning of ‘charity’ to bodies established outside the EEA, which would appear to be in contravention of EU law following this ruling.
- It should be noted that the ruling gives a different outcome for the taxpayer to that in Fisher v HMRC, which also considered the EU rules on free movement of capital.
- In Routier v HMRC, the EU rules on free movement did not apply in Jersey, and so Jersey fell to be considered a ‘third country’ for the purpose of a transfer of capital from the UK.
- Conversely, in Fisher v HMRC the territory in question was Gibraltar, which was not considered a ‘third country’ for these purposes because the relevant EU treaty provisions do apply there. However, Gibraltar is not an EU member state in its own right, by virtue of being classified as a dependent territory of the UK. As a result, in Fisher v HMRC EU law guaranteeing freedom of establishment was not deemed to have been restricted, the transfer being regarded as an internal transfer within a member state.
Trust exit charges: Panayi Trusts v HMRC
The case of Trustees of the P Panayi Accumulation and Maintenance Trusts Nos 1-4 v HMRC concerned the application of a UK ‘exit’ charge at the time the trusts ceased to be UK resident, and whether this charge was compatible with EU law.
Mr Panayi and his wife were Cypriot citizens who came to the UK in the late 1940s. Mr Panayi had created four trusts for his children and other family members, which
were UK resident by reason of having UK resident trustees (Mr Panayi, his wife and a UK company). However, when Mr and Mrs Panayi decided to return to Cyprus permanently, the trust administration was transferred to Cyprus and the trusts ceased to be UK resident. HMRC imposed an exit charge, calculated on the basis of the market values of the trust assets on the date the trusts ceased to be UK resident.
The case went all the way to the Courts of Justice of the European Union (CJEU). This ruled that an entity such as a trust, which carries on an economic activity, may rely on the ‘freedom of establishment’ rules in EU law, and that this freedom can be relied upon when there is a tax charge on the trustees becoming non-resident. However, earlier CJEU rulings have also established that an exit charge may be lawful if there is an option to defer payment of the tax. This would be deemed justifiable by the CJEU because, without such a tax, a member state of the EU cannot tax gains on assets held by non-residents, even when those gains arose at a time when the owner was resident.
The appellants and HMRC could not agree on the basis of the deferment, so the case was referred back to the First Tier Tribunal (FTT). This ruled that in cases where a charge arose before the legislation was amended to comply with EU law, an option to defer payment of the exit charge in five equal instalments should be allowed. On that basis, the taxpayer’s appeal against the exit charge was refused.
The ruling confirms that the freedom of establishment rules are not contravened by an exit charge, when that charge comes with an option to defer the payment, thereby cementing the right of HMRC to apply such a charge on trustees becoming non-resident. This principle should apply irrespective of the trustees’ subsequent country of residence.
HMRC has updated its list of qualifying territories. The concept of a qualifying territory is included in numerous pieces of legislation, including:
- The exemption from UK corporation tax on dividends received from companies resident in qualifying territories.
- The exemption from UK transfer pricing rules for small or medium-sized enterprises resident in qualifying territories.
Qualifying territories are broadly those with double taxation agreements (DTAs) containing an appropriate non-discrimination article. A non-discrimination article prevents favourable treatment for the residents/nationals of one jurisdiction over those who are resident in the other jurisdiction which is party to the DTA.
The updated list contains 11 new territories with which the UK now has a DTA containing a non-discrimination article. Crucially, the list does not include some territories that have recently signed new treaties with the UK which contain such articles, including Jersey, Guernsey and the Isle of Man. Moreover, HMRC has removed Hong Kong, the Falkland Islands, the Faroe Islands and Reunion from the list, on the basis that they are not states for the purposes of the legislation.
Where countries have been removed from the list, it is likely that the interpretation of what constitutes a qualifying territory will be applied retrospectively.