UK: British Tax Review: Double Tax Relief—Sections 57–59

This article was first published in the British Tax Review.

The three sections on double tax relief in the Finance Act 2008 (FA 2008) implement running repairs to anti-avoidance rules. All three sections have to be seen in the context of developments in tax structuring over the last 20 years or so. Whether they are successful in combating the schemes at which they are aimed is not a question that can be answered immediately. However, because section 58 uses HMRC's ''nuclear option'' of fully retrospective legislation, it may have a deterrent effect beyond the specific structures it purports to close down.

Section 57

On July 14, 2006, Evans-Lombe J. handed down his judgment in the case Legal & General Assurance Society Ltd v Revenue and Customs Commissioners.¹ He upheld the decision of the Special Commissioners which was partly in favour of the taxpayer. Legal & General carried on pensions business in the United Kingdom and through a permanent establishment in France (among other places). It contended that it was entitled to set off credit for the French tax paid by its permanent establishment against the UK corporation tax which was payable on the total profits from its pension business. In other words, it could set French tax off against the tax on profits from UK activities. HMRC countered that foreign tax could only be set off against corporation tax paid on that part of the profits of pensions business that were subject to the foreign tax.

Legal & General won on this point (although not on two others). The judge felt that each party's interpretation of the double tax treaty could be supported, but that the taxpayer had the better case. This was partly because HMRC were asking the double tax treaty to do some of the work in restricting the availability of credit for foreign tax that section 797 of the Income and Corporation Taxes Act 1988 (ICTA 1988) appeared to be doing. The judge also thought that HMRC's reading required that the words ''any income or chargeable gain'' should be interpreted differently in section 797(1) from their meaning in section 793(1).²

Even before the decision went against them, the Government had already inserted section 798A(2) into ICTA 1988 as part of the double tax relief reforms included in the Finance Act 2005. The new section made explicit that credit for foreign tax is only available against UK corporation tax that is specifically charged on the foreign profits in question. For some reason, however, no similar provision was included in section 798 ICTA 1988 which does the same job with respect to income tax as section 798A ICTA 1988 does for corporation tax. Section 57 FA 2008 corrects this oversight by inserting subsection (1A) in section 798 ICTA 1988. The new subsection uses very similar language to section 798A(2) ICTA 1988 to achieve the same restriction for credit for foreign tax against income tax.

Section 58 and section 59

Section 58 FA 2008 uses a sledgehammer approach to tighten up another aspect of the double tax relief anti-avoidance rules. In thewell known case Padmore v IRC,³ theCourt of Appeal, affirming the High Court's decision, found that the taxpayer was exempt from tax on his foreign income from a Jersey-based partnership. This was because the UK-Jersey double tax treaty exempted a Jersey resident enterprise from UK tax, except for business carried on through a permanent establishment in the United Kingdom. In the context of the treaty, ''enterprise'' was held to include a partnership, which was consequently exempt from UK tax. Even before the case was decided, the Government had changed the law (now in section 858 of the Income Tax (Trading and Other Income)Act 2005 (ITTOIA 2005)) to make clear that, whatever the double tax treaty might say, a UK-resident partner's income from a foreign partnership was subject to UK tax. Controversially, this provision was made retrospective, excepting only appeals already in train at the time the change was announced.

Schemes have now come to HMRC's attention that attempt to circumvent section 858 ITTOIA 2005 by using a trust structure. The partners in the foreign partnership are trustees of trusts of which UK taxpayers are the beneficiaries. Thus, it is claimed that section 858 ITTOIA 2005, which refers to the partners only, should not apply to the beneficiaries of the trust. If the scheme works, the situation prior to Padmore would prevail and the income of the partnership should be exempt from UK income tax. The new section 858(4) ITTOIA 2005 states that the partners of a foreign partnership are deemed to include anyone entitled to a share of its income, which would include beneficiaries of a trust the trustees of which were themselves partners. Other amendments apply the same rule to corporation tax and capital gains tax.

What makes section 58 FA 2008 unusual is that the Government has again opted to make its effect retrospective. The debate in the Public Bill Committee on the relevant clause of the Finance Bill saw the Minister, Jane Kennedy, struggling slightly when asked why a retrospective provision was required. She explained:

''As I understand it, a number of people are proposing to use the scheme and some tax advisers will recommend the use of it unless we act to make it clear that the scheme does not work.''⁴

While this justifies introducing anti-avoidance legislation it does not explain why it has to be retrospective. Pressed further, she said, ''I hope I get this right. It is because HMRC has not consistently made the case throughout the time period that the scheme does not work,. . .''.⁵ This reply raises some interesting possibilities. Could it mean that HMRC made concessions that they later came to regret and that the only way out of the hole they had dug for themselves was to use retrospective legislation? And is HMRC's previous lack of consistency the reason that a number of people are now proposing to use the scheme? Professional bodies were less than impressed that retrospective legislation was being used. During the debate we heard that the Chartered Institute of Taxation thought it was ''extreme and unjustified''; the Law Society believed it was ''wrong in principle''; and the Institute of Chartered Accountants in England and Wales warned, ''it sends out a very damaging signal about the stability of the UK tax system''. The Minister could only promise to check the representations she had received.⁶

Whatever the justification of the extreme measure in section 58 FA 2008, HMRC would probably not be displeased if it is regarded as a warning shot across the bows of taxpayers who are thinking of using particularly aggressive planning schemes and of the practitioners who devise them.

Section 59 FA 2008 is not retrospective. It is intended to ensure that other schemes, not using partnerships, cannot succeed in exploiting the language of double tax treaties to exempt UK residents from UK tax. A new section 815AZA ICTA 1988 is introduced to state that the permanent establishment article in a double tax treaty is not to be read as preventing the income of a UK resident from being chargeable to tax. It is not clear if HMRC are aware of any schemes that will be closed down by this section, or whether it is being introduced as a precautionary measure.

Footnotes

1 Including capital gains relief. ITA 2007, s.74A(10) defines capital gains relief for the purpose of this section. The definition of sideways relief is in ITA 2007, s.60(4).

2 Discussed in the note below, ''Non-active partners—section 61''.

3 See HM Treasury, Finance Bill 2008, Explanatory Notes, note on cl.57 and Sched.21, available at: www.hm-treasury.gov.uk./media/0/0/financebill2008 explanatorynotes.pdf (accessedAugust 20, 2008).

4 By FA 2008, Sched.21, paras 6(1) and 6(2), ITA 2007 s.74A, and related provisions apply to a loss for 2007–08, or a subsequent tax year, unless that loss is made for a tax year the basis period for which ended before March 12, 2008. Paragraph 6(3) deals with the case where the accounting period straddles March 12, 2008 by having a special rule for pre-announcement loss. Paragraphs 6(4) to (10) provide the steps for calculating the pre-announcement loss for an individual's basis period that straddlesMarch 12, 2008.

5 FA 2007, s.26 and Sched.4 notedA. Shipwright, ''Restrictions on trade loss relief for partners—section 26 and Schedule 4 [2007] BTR 454.

6 Not partners by definition and so outside the section. Some of the schemes marketed relied on close collaboration between a number of sole traders so raising the issue of partnership.

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