The UK Tax Outlook - September 2024

Welcome to the latest edition of our UK tax outlook designed to offer legal and practical insights into UK tax developments that have cross-border interest and relevance for your clients.

In this issue, we reflect on the change of government following the UK General Election in July and the implications this will have for future UK tax law and policy.

We offer our thoughts on two interest withholding tax cases that had very different outcomes for the taxpayer. In the first, HMRC v Burlington Loan Management, the taxpayer was able to establish that withholding tax arbitrage was not, of itself, sufficient to engage the principal purpose test of the UK-Ireland double tax treaty. In the second, Hargreaves Property Management, tax planning to remove a withholding tax obligation on interest paid to connected overseas lenders was unsuccessful.

We review the Court of Appeal's decision in HMRC v GE Financial Investments, a decision on whether stapling a UK tax resident company's shares to a US corporation was sufficient to treat that company as US resident for the purpose of the US-UK double tax treaty.

We also take a look at how UK law and HMRC guidance is developing in relation to a wide anti-avoidance rule in the UK's corporate debt provisions, noting the importance this rule can have when seeking UK tax deductions for interest in debt reorganisations or when financing a cross-border acquisition.

We continue to explore the legal consequences of Brexit. In this edition, we include commentary on accrued EU law rights in the light of the Supreme Court's decision in Lipton v BA Cityflyer Ltd and review new UK legislation intended to maintain the stability of the UK's VAT and excise regimes. We spot an early sign that the incoming Labour Government may be willing to take a different approach to the relationship between UK and EU law than its predecessor (albeit in an unrelated area of law).

Finally, we provide a UK perspective on the EU Foreign Subsidies Regulation that will have significant implications for large UK companies and groups engaged in M&A and joint venture transactions in the EU.

The new Labour Government

Stability and economic growth are the watchwords of the newly elected Labour Government which is committed to tough spending rules. The plan is for "day-to-day" costs to be out of revenue, with a self-imposed fiscal rule that debt as a share of national income can be forecast to be lower in five years' time than in four years' time. The Government's need for revenue to fund its election pledges, as well as funding a £22bn projected overspend it claims to have inherited from the previous administration, means it will face the tricky task of increasing tax collection while not substantially increasing the tax burden.

The new Government hopes that one contributor to tax stability will be a return to a fixed annual timetable of fiscal events. This will comprise a single Autumn Budget (this year's will be on 30 October), accompanied by a forecast from the independent Office for Budget Responsibility (OBR), followed by a restated forecast in the Spring when, if needed, any further (minor) policy changes will be made. History, however, suggests that once in office Chancellors of the Exchequer are reluctant to lose the opportunity Parliament provides for tax policy announcements, so it is an open question whether Rachel Reeves' groundbreaking achievement as the UK's first female Chancellor will extend to keeping to the discipline of a single fiscal event each year. It is noteworthy that the Chancellor has already made a significant statement to Parliament at which she presented the results of a public spending audit and outlined the Government's next steps in fulfilling its pre-election tax promises.

These include a statutory "fiscal lock" that will require significant permanent tax and spend changes to be automatically subject to independent assessment by the OBR. The aim is to give businesses and investors confidence in the stability of the public finances in the event of major fiscal announcements. The draft legislation for this fiscal lock is set out in the Budget Responsibility Bill currently before Parliament.

In the case of corporation tax, the rate will be capped at the current level of 25% for the whole of the next Parliament.

There are some suggestions that the corporation tax rate could be reduced if tax changes in other countries pose a risk to UK competitiveness, although the Government's need for tax revenue must mean that the chances of a rate reduction are slim. The Government hopes that the corporation tax rate cap will offer certainty and allow for long-term planning. To this end, it is expected that existing rules on full expensing and the annual investment allowance will be maintained although, somewhat cryptically, the Labour Party's pre-election manifesto stated that business would be given "greater clarity" on what qualifies for these allowances. Further details may be set out in the business tax "roadmap" that will be accompany the Autumn Budget on 30 October. Otherwise, the Government has been silent on what tax reliefs will continue, although pre-election publications flagged the Labour Party's commitment to stability by maintaining the UK's current structure of R&D tax credits and the patent box.

The pledge to maintain personal tax rates is likely to increase UK dependence on "fiscal drag", namely maintaining income tax allowances and thresholds at their current levels so that more taxpayers are brought into charge over time. Before the election, it was widely reported that the Labour Party would maintain its predecessor's policy of freezing personal income tax allowances and thresholds until at least 2028. The Institute of Fiscal Studies predict that this will result in 14% of UK adults (7.8m people) paying income tax at the higher rate by 2027/28.

Additional revenue is to come from reducing the "tax gap", the UK tax authority's estimate of the difference between the amount of tax that it should be able to collect and the amount of tax that it actually collects. HMRC will be given more money to build capacity and improve tax collection by increasing the number of compliance personnel, investing in IT, and improving its service to taxpayers.

The Chancellor has acknowledged that some taxes will need to be increased in the October Budget. How this will be done without breaking promises on tax rates is unknown. Changes to dividend tax allowances or extending the scope of NICs have been mooted, and the Government has said little about capital gains or inheritance tax (beyond nondom rules and carried interest discussed below) so revenueraising changes to these taxes are possible. It is worth noting that the Government appears to have resiled from earlier plans to re-instate the pensions lifetime allowance - an upper limit on the total value a private pension can reach before higher tax rates apply on fund withdrawals. There will, however, be a review of the pensions "landscape", so the Government may seek to raise revenue from other alterations to the UK's pension tax regime, possibly by restricting higher rate tax relief on pension contributions.

The tax changes that the new Government intends to implement include the following.

• Abolishing the non-dom tax regime. The former Conservative Government planned to replace the non-dom regime with a new four-year residence-based regime, with effect from 6 April 2025. Abolishing the non-dom regime has long been a key policy of the Labour Party and the new Labour Government is committed to implementing these reforms (although some deviation from the original proposals is expected in order to tighten the new regime still further). The policy is in line with the direction of travel of other European jurisdictions - Portugal, Italy and the Netherlands for example have all recently restricted the generosity of their equivalent regimes. We have produced some detailed commentary on the UK proposals and what they may mean for non-UK domiciled individuals.
  
  
• Inheritance tax will move from a domicile-based tax to a residence-based system from 6 April 2025. Full details have not yet been confirmed, but current proposals suggest that an individual's worldwide assets will fall within the scope of UK inheritance tax once such individual has been UK resident for ten years, and once within the scope of UK inheritance tax will remain so for ten years after the individual ceases UK residence. This will have significant consequences for long-term UK residents and their trusts.
• Certain anti-avoidance legislation (including that related to transferring assets abroad and settlements) will be reviewed in order to "modernise" and ensure it is "fit for purpose". The Government has indicated that any changes to anti-avoidance legislation proposed by the review are unlikely to be implemented before the start of the 2026/27 tax year.
• Closing the carried interest "loophole" which Labour describe as the ability of private equity executives to treat performance related pay as capital gains taxed at capital gains tax rates (which for these purposes will generally be 28%). In a call for evidence, the Government states its belief that the current tax regime "does not appropriately reflect the economic characteristics of carried interest and the level of risk assumed by fund managers in receipt of it". That wording may indicate a willingness to maintain capital gains treatment in situations where fund managers put their own capital at risk. The Government has promised to engage extensively with all interested parties. All submissions needed to be received no later than 30 August. Further announcements will then be made at the Budget on 30 October. Read our two notes on the carried interest tax reform.
• Increasing the rate of the Energy Profits Levy to 38% from 1 November 2024. Although supposedly a temporary windfall tax on oil and gas companies, the levy will now apply until 31 March 2030 unless oil and gas prices fall below certain thresholds before then.
• Ending the VAT exemption and business rates relief for private (fee-paying) schools from 1 January 2025. From then on, all education services and vocational training supplied by a private school will be subject to VAT at the standard rate of 20%. As business rates are a devolved tax, the business rates policy change will only affect private schools in England and Wales.

However, there is not yet any detail of what the replacement system will look like or when it will come into force, beside an intention to "raise the same revenue... in a fairer way". It is not unfair to say that this will be difficult.

Finally, details of Labour's international tax policy are thin but they include support for:

• implementation of the OECD's global minimum tax (Pillar Two);
• international efforts to make sure multinational technology companies pay their "fair share of tax", which suggests continued support for the UK's existing digital service tax and the ongoing work towards international agreement on Pillar One; and
• a carbon border adjustment mechanism.

UK withholding tax on interest – two recent cases

Burlington Loan Management – application of the principal purpose text

In HMRC v Burlington Loan Management the taxpayer was able to establish that the presence of UK withholding tax arbitrage was not, of itself, sufficient to engage the antiabuse provisions in Article 12(5) of the UK-Ireland double tax treaty.

The facts of the case were straightforward. Burlington Loan Management (Burlington), an Irish tax resident company, took an assignment of a debt claim from a Cayman Islands company (SICL). As a result of the assignment, Burlington became entitled to receive payments of yearly interest from a UK resident company. UK domestic law required the UK payee to withhold income tax from the interest payments, subject to the provisions of any applicable double tax treaty. There is no protection from withholding in the UK-Cayman treaty, but the UK-Ireland treaty provides that interest that is beneficially owned by a resident of a contracting state can only be taxed in that state. That meant that the UK had taxing rights only if it could be shown that a main purpose of the assignment was to take advantage of the withholding tax exemption in the UK-Ireland treaty.

The parties were unable to resolve the question whether income tax should be withheld from the interest payments and the matter eventually came before the Upper Tribunal. The Tribunal held that the anti-abuse article should not be limited to transactions involving artificial steps or arrangements, but that the presence of withholding tax arbitrage did not, of itself, mean that the main purpose test in the double tax treaty was satisfied. The fact that Burlington only paid the price it did because it expected to be able to receive interest payments free from withholding did not mean that there was a main purpose of taking advantage of the UK-Ireland treaty.

Hargreaves Property Holdings – structuring to remove a withholding tax obligation

Hargreaves Property Holdings Ltd v HMRC concerned tax planning put in place by Hargreaves Property Holdings (Hargreaves), a UK tax resident corporate borrower and the parent company of a property investment group. The aim of the planning was to remove the obligation to withhold tax from interest paid on loans to connected overseas lenders, while still receiving a corporation tax deduction for the interest expense.

The facts were not disputed. Hargreaves financed its activity with loans. Following tax planning advice, changes were made to the terms on which the loans were advanced. These included changing the governing law and jurisdiction clauses from England to Gibraltar and making the loans (principal and interest) repayable at 30 days' notice (in the case of the lender) or at any time by Hargreaves. Shortly before each interest payment was due, the lenders assigned their right to receive interest to third parties, typically to a UK tax resident company, Houmet Trading Ltd. Hargreaves then paid the interest and principal to Houmet. The original lender then advanced a new loan to Hargreaves and the process repeated.

The UK tax authority, HMRC, took the view that the tax planning did not work, and that Hargreaves should have withheld income tax from the interest payments. Hargreaves appealed and the case eventually ended up in the Court of Appeal for decision on whether interest payments to Houmet were exempt from withholding because:

• a UK resident company was "beneficially entitled" to the income (s933 ITA 2007); and/or
• the withholding tax obligation only applies to "yearly" interest, and each loan lasted for less than a year (s874 ITA 2007).

Hargreaves lost on both grounds. The Court of Appeal considered that the phrase "beneficial entitlement" should be construed with regard to the case law on the concept of beneficial ownership and carried out a detailed review of the UK case law. The Court stressed that as it was concerned with domestic tax legislation, the "international fiscal meaning" of beneficial ownership as set out by the Court of Appeal in Indofood was not relevant.

On the first point, the Court reiterated that the purpose of the obligation to withhold tax from UK source yearly interest is to provide a tax collection mechanism since HMRC will not ordinarily be in a position to collect tax directly from non-UK residents.

In many cases, bringing interest in account for corporation tax purposes will also satisfy the requirement of beneficial entitlement because the recipient will meet the test of having the "benefit of ownership" of that income. Nevertheless, to establish that Houmet was beneficially entitled to the interest income (and therefore that the exemption from withholding applied) UK case law required Houmet to demonstrate that it had some of the "benefits of ownership".

The Court of Appeal noted that the lower courts had received very little evidence about Houmet and its role in the arrangements. No explanation was provided for its role in the structure or of the reasons for the assignments to it. Hargreaves, on whom the burden of proof lay, was unable to do anything more than assert that Houmet did not act as a fiduciary. It could not establish that the assignments and loan repayments conferred any benefit of ownership on Houmet. There was no evidence that Houmet could have used the funds received or that it derived any meaningful profit from its participation in the arrangements. As a result, Houmet's involvement was entirely ephemeral, apparently without commercial, practical, or real effect. It was therefore correct to conclude that Houmet was not beneficially entitled to the interest assigned to it.

On the second point, the Court of Appeal noted that there is extensive UK case law authority that whether interest is "yearly" or "short" depends on a business-like rather than "dry legal assessment" of a loan's likely duration. In this case, while the loans could be repaid at short notice, the pattern was for repaid loans to be routinely replaced by a further loan from the same lender for the same or a larger amount. A replacement loan was never declined. The loans were in the nature of long-term funding, with a permanency that "belied" their apparent short-term nature. It made no difference that an individual loan happened to last for less than a year. In reality, the lenders provided long-term funding and the interest paid on that lending was yearly interest.

HMRC v GE Financial Investments - stapled company not entitled to double tax relief

We have written previously about decisions of the lower courts in GE Financial Investments v HMRC and the question whether a UK incorporated company, GE Financial Investments (GE), was entitled under the UK-US double tax treaty to a UK credit for US tax paid. GE successfully persuaded the Upper Tribunal that it was entitled to credit because it was a US resident for the purposes of the treaty. The Court of Appeal has now reversed that decision.

The treaty relief claim arose because GE's shares were "stapled" to a US corporation, meaning GE and the US corporation's shares had to be traded together. This meant that GE was treated as a domestic corporation for US tax purposes, subject to US federal income tax on its worldwide income. The question was whether the share staple was sufficient to treat GE as US resident for the purpose of the UK-US treaty. (There was no debate about UK residence - as GE was UK incorporated it was automatically resident here). The relevant treaty article provides that legal persons are a resident of a contracting state if they are liable to tax there "by reason of domicile, residence, citizenship, place of management, place of incorporation or any other criterion of a similar nature". The Upper Tribunal found that share stapling was a sufficient connecting criterion. The Court of Appeal disagreed.

The Court of Appeal set out the principles of treaty interpretation from the Vienna Convention on the Law of Treaties as it had recently articulated them in Royal Bank of Canada v HMRC: (see the discussion on this case in our previous newsletter). It emphasised that the primary means of ascertaining the object and purpose of a treaty will generally be its text, read in the context of relevant surrounding circumstances. In the Court of Appeal's view, the words "by reason of" in the article made clear that liability to tax for treaty purposes is the consequence of having the requisite status. This was determined by considering whether the taxpayer was included in one of the specified categories, which had been drafted as a list of specific connecting factors followed by an express ejusdem generis provision. Each of the listed categories amounted to a type of substantive factual or legal connection between the taxpayer and the contracting state, strongly indicating that for another factor to be something of a similar nature it would also need to be a connection of similar character or quality. The Court of Appeal considered that GE's status as a stapled entity did not amount to a criterion of a similar nature to that of domicile, residence, place of management etc.

The Court of Appeal also considered a second line of argument - whether GE would also be entitled to a credit against UK tax for US tax paid if it was carrying on business in the US through a permanent establishment there. GE lost on this issue before the Upper Tribunal and the Court of Appeal upheld that aspect of the Tribunal's decision. The point is nevertheless of interest because both parties accepted that the relevant provision of the UK-US double tax treaty required the Court of Appeal to consider whether GE's activities could amount to a business under UK domestic law. In handing down the Court's decision, Lady Justice Falk commented that it was "not obvious" that UK tax law principles should be applied without any reference to the broader principles in play when interpreting double tax treaties. However, given the common ground between the parties, she elected not to develop the point further, and endorsed the decision of the lower courts that GE was not carrying on a business. The Court of Appeal's comments on the meaning of "business" in UK domestic law could have implications well-beyond the question of whether a permanent establishment is created.

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