Tax Bulletin: Current Rates: June 2008 (June 2008)

Remittance Basis

A mountain of amendments has been tabled to the Finance Bill proposals on the remittance basis. Some serious criticism has been made of the Chancellor's proposals, both by the House of Commons Treasury Committee and by the House of Lords – but I don't think anybody is taking any notice. The amendments are nearly all highly technical and designed to make the legislation coincide with explanatory notes provided by HMRC.

However, there is one substantive change that relates to the circumstance in which a service is provided in the United Kingdom and paid for out of foreign income or gains. Under the original proposals this would represent a remittance of the income or gains used for this purpose. A government amendment has been introduced so that when the service is provided in the United Kingdom but relates wholly or mainly to property situated outside the United Kingdom, this will not be regarded as a remittance if payment for the service is made outside the United Kingdom.

This is in response to suggestions that the original proposals would have a detrimental effect on UK service providers such as payments to UK advisers for managing assets. However, it will still be regarded as a remittance if fees are paid to UK service providers in respect of the management of UK assets, and there is continued concern that this will positively encourage people not to invest in UK assets or to engage UK advisers.

This does not sound like a big issue to me because, generally, payment for such advisory services will be made out of capital so that no problem arises.

The government seems to have accepted that this tiny point could be detrimental to the UK and feel the need to make some change – but there are a few hundred more pages of the Finance Bill that are even more damaging but nobody is proposing to do anything about them.

Inheritance Tax

The recent case of DWC Piercy deceased v HMRC SpC 687 concerned the question of whether a shareholding in a company owned by the deceased at the date of his death qualified for business property relief. The company was a property company, and HMRC considered it disqualified from business property relief by reason of its investment properties. Section 105(3) IHTA 1984 provides that the relief does not apply if the business carried on by the company consists wholly or mainly of making or holding investments.

HMRC argued that although the company had in the past carried out many development projects, its business had changed from being an active property developer to one that mainly let its properties to generate income. The amount of the company's rental income was substantially greater than the realisation profits, and the company's business should be regarded as one of making and holding investments.

The executors claimed that the company was a property development company whose land was held as trading stock and there had never been any appropriation of land as an investment.

One can see the force of the HMRC argument but, crucially, for the company's business to be mainly that of making or holding investments, it had to have some investments.

The case report reveals that the deceased's son, a director in the company, gave compelling evidence about how the company's business had always been (and remained) that of a development company, marshalling sites for development with a view to the sale of the finished developments. He explained the reasons why the company's developments had slowed down in recent years, but although a number of properties had been let, no land had been appropriated from stock to fixed assets, nor had the company's business changed from being that of a trader. With such evidence, accepted in full by the Commissioner, the arguments of HMRC were doomed.

HMRC had always treated the company as a trading company, but this did not influence the Commissioner. He explained that corporation tax and inheritance tax do not go hand in hand and whether HMRC had in the past failed to take appropriate points when dealing with the company's corporation tax affairs was of no particular significance.

It is interesting to note that HMRC considered the preponderance of rents over realisation profits to be decisive. It is difficult to see how this can really be the case. On the "balance of activities" test put forward in Farmer v IRC (1999), it is necessary to look at all the activities, and no one of them can be decisive. The facts in this case were, of course, crucial, and the existence of a substantial preponderance of rental income certainly gave HMRC some weight on their side of the scales, but the taxpayer was able to show that all the other activities outweighed this single aspect.

Corporation Tax

The case of Barkers of Malton Limited v HMRC SpC 689 was concerned with the ability of a company to transfer its trade to another company under Section 343 Taxes Act 1988 and for the successor company to continue to benefit from the accumulated trading losses.

Section 343 allows the successor company to be treated as continuing to carry on the trade and to obtain relief for losses brought forward, providing that there is at least 75 percent common ownership before and after the trade and that the successor company carries on the relevant trade.

In this case, the only question for consideration was whether or not the successor company continued to carry on the trade in question.

The background is not really relevant, but the business had been failing and needed to be separated from a valuable property, so the trade was transferred to a subsidiary and then on to another company. Unfortunately, the first transfer took place at 9 a.m., and the second transfer took place at 10:30 a.m., and HMRC took the view that during this period of 90 minutes, the transferee did not carry on the trade. Although there is no particular time period during which the trade had to be carried on, there was no evidence of any trading activity undertaken by the transferee; it incurred no expenditure, it had no receipts and it did not enter into any transactions during this period. Furthermore, the company's tax adviser stated in the corporation tax return that the company did not trade. Under these circumstances the Special Commissioner concluded that it did not carry on the trade and the losses were ineligible for relief.

Unlawful Dividends

It may be remembered that in 2003, the case of IRC v Richmond and Jones (re Loquitur Limited) dealt with the payment of a dividend by a company that had failed to provide adequately for its tax liabilities.

The company had sold its business at a substantial capital gain and made a rollover relief claim to eliminate the tax on the disposal. A dividend was paid to its shareholders that exhausted all its assets and the company went into liquidation. HMRC challenged the rollover relief claim and applied for an order for recovery against the directors on the grounds that the dividend was unlawful.

You can pay a dividend only out of profits available for distribution, and in making that calculation, it is necessary to make all proper provisions for liabilities. The relevant accounts for determining the position are the company's last accounts, and if they do not show sufficient distributable profits, interim accounts must be prepared for the period in which a distribution is proposed to enable a reasonable judgement to be made. In the case of Loquitur, interim accounts were prepared, but they did not make provision for the corporation tax payable on the capital gain, and the court found that their failure to do so was unreasonable. The dividend was therefore unlawful and the directors were liable to make good the money that had been misapplied.

The position has been reviewed in the more recent case of Re Paycheck Services 3 Limited, in which a dividend was paid on the basis of accounts that did not adequately provide for the company's corporation tax liability. The company had claimed the small-companies rate of corporation tax for the relevant year but, before the dividend was paid, had received counsel's opinion that the smallcompanies rate did not apply and the company had significantly underpaid its liability to corporation tax. The company had no money, having paid away all its profits in dividend, so HMRC commenced proceedings against the directors on the basis that the dividend was unlawful.

The court decided that the dividend was indeed unlawful, but the directors claimed that they ought to be relieved from liability under Section 727 Companies Act 1985 on the grounds that they had acted honestly and reasonably and, having regard to all the circumstances, they ought fairly to be excused. The court said that in addition to showing that they had acted honestly, it was also necessary for the directors to show that they had acted reasonably in authorising the payment of the dividend on the basis of the interim accounts. After having received counsel's opinion on the matter, they could not have had any reasonable grounds forignoring the liability to corporation tax, and in all the circumstances it would not be a proper exercise of the court's power to relieve them from liability.

Transfer Pricing

On 10 June HMRC published some additional guidelines for the conduct of transfer pricing enquiries. This is intended to supplement the existing guidance, which is contained in the International Tax Manual. Most of it is concerned with procedural issues such as risk assessments and the agreement of timetables. They are very keen on agreeing a timetable for the completion of such enquiries, which in most cases would be expected to be a maximum of 18 months. It seems a bit odd to specify an intended deadline on the completion of enquiries by a tax authority – but never mind. Naturally enough, they suggest that a much longer period would be necessary in cases of high risk, which they specify as transactions with a precedent value and which involve transactions with low tax jurisdictions. They also regard as high risk cases in which the taxpayers' behaviour is inconsistent with their low risk guidelines – which seems like a complicated way of saying that a case will be high risk if they say it is.

However, they do confirm that when a case is so complex and high risk that a longer time scale will be required, this judgement will be made at the commencement of the enquiry – but, of course, it will be reviewed as necessary during the course of the enquiry.

It is not at all clear why these guidelines are thought to be necessary, having regard to the substantial amount of guidance which they already provide on the subject, and there are different views about whether this is a good idea. Nevertheless, it could be helpful because the HMRC transfer pricing group has an increasingly wide remit, and is concerned not only with normal transfer pricing issues but also thin capitalisation and the determination of the profits attributable to a permanent establishment.

Inheritance Tax

HMRC have also issued guidance on the new rules for the transfers of unused nil rate bands. The idea behind the transferable nil rate band is that when a surviving spouse dies, the nil rate band available at his or her death will be increased by the proportion of the nil rate band that was not used on the death of the spouse. This applies when the death of the surviving spouse occurs after 9 October 2007. The death of the first spouse can have occurred at any time – but for civil partnerships, the first death must have occurred after 4 December 2005, when the Civil Partnerships Act came into force.

It is important to recognise that the unused nil rate band can be transferred only from one spouse to the survivor, when the relationship is brought to an end by the death of one party to the relationship. When a marriage has come to an end by divorce and one party subsequently dies, the relief will not be available.

The guidance note is comprehensive, going on for 22 pages (including 24 examples) and contains detailed guidance on the time limits and the circumstances in which late claims may be admitted. Every conceivable circumstance is covered in the examples including multiple marriages, spouses with different domiciles, conditionally exempt property and more. This is a very helpful document that should answer most of the questions likely to arise on the application of these new rules, but it does pose the question: Why do they have to make a relieving provision so complicated in the first place?

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