Turning up the heat

Ben Gilbert, PwC senior tax manager, says that Her Majesty's Revenue and Customs ("HMRC") are increasing challenges with regard to corporate tax residence

Corporate tax residence is currently a hot topic, as HMRC seek to maximise tax receipts during the current difficult economic times.  We have noticed an increase in corporate tax residency challenge following HMRC’s success in the recent Laerstate case.  Laerstate was an important tax case as it is the most recent corporate residency case and it reaffirmed many existing residency principles. 

In brief, the Laerstate case concerns corporate tax residence, in particular, the meaning of acts of central management and control and the circumstances in which it should be concluded that a company’s directors are not exercising that central management and control themselves.  The tribunal concluded that Laerstate, a Netherlands incorporated company, was UK tax resident for the period in dispute, because the company’s shareholder, who was himself UK resident, exercised central management and control.  The case is now finally decided in favour of HMRC following the recent decision by the taxpayer not to appeal against the First Tier Tribunal’s decision.

PwC has noticed a marked increase in HMRC’s challenge of corporate tax residence in recent years in terms of both the number of challenges and their severity; HMRC are increasingly using their Special Investigations unit to deal with these enquiries.

Why corporate tax residence is so important

Corporate tax residence is the concept by which the taxing rights over a company’s profits and gains are determined.  Different jurisdictions have different ways of defining corporate tax residence, which creates further complexity for companies operating in more than one jurisdiction.  For the purpose of this article, I will focus on the UK and its definition of corporate tax residence.

Corporate tax residence is of importance as a company needs to ensure that it is only subject to tax in the jurisdiction it is intends to be taxed in; failure to get this right could result in multiple tax liabilities in multiple jurisdictions.

When is a company Jersey, Guernsey and UK tax resident?

Jersey

A company which is incorporated in Jersey or centrally managed and controlled in Jersey, shall be regarded for Jersey income tax purposes as a Jersey resident company, unless in the case of a Jersey incorporated company: 

  1. the company is centrally managed and controlled outside of Jersey in a country or territory where the highest possible rate of tax payable on any part of a company's income is equal to or exceeds 20%, and;
  2. the company is resident for tax purposes in that country or territory.

Therefore unless points 1 and 2 apply, a Jersey incorporated company would be considered Jersey tax resident. 

Guernsey

Broadly, all Guernsey registered companies are regarded as residents in the Island unless granted Exempt Company status.  Additionally, a company will be treated as a resident in Guernsey (irrespective of its place of incorporation) if shareholder control is exercised by persons resident in the Island.

UK

A company will be UK tax resident if it is incorporated in the UK.  Additionally, for those companies not incorporated in the UK, they will be considered UK tax resident if they are centrally managed and controlled in the UK.  Central management and control means the highest level of decision making and not, for example, operational control, although clearly these can go hand in hand.

The directors of a company would normally be considered to be exercising the highest level of control; however, as the Laerstate case has demonstrated, this is not always the case.

As can be gleaned from the corporate residency tests outlined above, a Jersey or Guersey company’s residence can inadvertently move to the UK relatively easily, i.e. by UK resident directors making decisions in the UK.

What are the implications of being UK tax resident?

The implications of being UK tax resident are that the company concerned falls into the UK corporate tax net, i.e. the company’s worldwide income and gains will be taxed in the UK.  The impact may be less now than in the past given recent and proposed changes that exempt most foreign dividends and potentially branch profits from taxation, nevertheless there are likely to be adverse implications for a company unintentionally becoming UK resident, particularly if it is resident in a lower tax jurisdiction, like Jersey or Guernsey.  It could also result in multiple tax filing requirements.

Action points to minimise risk of inadvertently becoming UK tax resident

To minimise the risk of inadvertently becoming UK tax resident, a Channel Islands company should undertake the following:

  • Ensure that the central management and control of the company is undertaken in the company’s territory of residence, either Jersey or Guernsey.   By central management and control, HMRC would look at the highest level of decision making. 
  • As the highest level of decision making is usually undertaken by the directors of a company, as a minimum, the meetings of the board of directors should be held in the company’s territory of residence.  Attendance by telephone should be limited, and when undertaken, care should be taken to ensure the majority of the directors are present in person in the territory of residence of the company and that the decisions are taken there.  HMRC have been known to check travel details of directors to validate the location of directors for board meetings.
  • Where the Jersey or Guernsey company is a subsidiary of a UK parent company, ensure that the central management and control of the Jersey or Guernsey company is not usurped by its UK parent company, e.g. the board of directors of the offshore company should not merely ‘rubber stamp’ decisions of its parent company.
  • In the Laerstate case, the tribunal sought to introduce a concept of a minimum level of information that would enable the directors of a company to consider whether or not they should make a decision.  Although this concept has not been supported by the courts, it is prudent to ensure that board minutes properly document the information the directors have used to consider and then make decisions.
  • Related to the point above, care should be taken to ensure that the board meetings are properly documented, i.e. detailed notes taken contemporaneously, outlining the matters for consideration of the board, the information provided in the board pack to enable them to make their decisions and which directors were present.      
  • There are other steps that can be taken that not only help to maintain offshore management and control but also lessen the likelihood of investigation.  For example, having a majority of Jersey / Guernsey (or non UK) directors on the board.

What if HMRC have already challenged a company’s residence?

Do not panic!  As mentioned above, PwC have noticed an increase in HMRC challenge to corporate tax residence, but this does not mean the challenge cannot be successfully rebuffed.  The location of central management and control is a question of fact, and the more evidence the company has to support its case, the stronger its position in the event of a challenge.  There is no one size fits all solution to corporate tax residence investigations, as the facts differ in each case.  It is imperative that timely advice is sought, indeed, in addition to the tax dispute resolution experience of the PwC Jersey and Guernsey tax teams, our network firm in the UK has a specialist Tax Investigations team, which includes ex HMRC employees, who deal with these types of investigations on a daily basis. 

Conclusion

A company can very easily inadvertently become UK tax resident; by following the few simple steps outlined above, this can be avoided.  Our experience informs us that many companies seek tax advice on corporate tax residence matters prior to establishing an offshore business, however, few seek further advice on implementation and maintenance of these structures.  It is often during the implementation phase and thereafter that mistakes are made with regard to residence. 

Remember, prevention is the best cure to corporate tax residence ills!