Update:corporation tax

The ruling in Gaines-Cooper (R on the application of Davies, James & Gaines-Cooper) v HM Revenue & Customs [2010] EWCA Civ 83 is one of those rare tax cases that has attracted national attention.

The case concerned residence of individuals for tax purposes. The underlying problem is that there is no statutory definition of non-residency for tax purposes. To help people, Inland Revenue published guidance, known as IR20 (and since replaced by HMRC6) setting out its views on non-residency.

IR20 set out that there are two ways to become non-resident, either to leave the UK to take up foreign employment for a full tax year or to leave the UK 'permanently or for an indefinite period'. Although there were issues on the former method discussed in the case, the real issues of interest are on the latter.

The guidance then set out a 'days test' which said that, if the taxpayer was non-resident, to remain non-resident the taxpayer had to limit visits to the UK to a certain number of days each year (less than 183 days in any particular tax year and less than 91 days per tax year on average).

The first question was what was required for a person to become non-resident under the 'permanent or indefinite period' head. Was it sufficient for the taxpayer to leave the UK and satisfy the days test? Was it necessary, as HMRC contended, for there additionally to be a 'clean break'? If HMRC was right, mere lack of physical presence in the UK would not be sufficient, there had to be evidence of an intention to leave permanently '“ so that, for example, retaining a house in the UK, having children at school in the UK and retaining golf club membership would all indicate a lack of intention to leave permanently and therefore the taxpayer would continue to be tax residence although physically outside the UK.

The Court of Appeal held that HMRC was right, a clean break was necessary, the days test only indicated how to avoid becoming resident once non-resident, not how to become non-resident in the first place. It also decided that such a position was entirely consistent with the guidance in IR20, as IR20 had referred to leaving permanently or indefinitely which indicated a clean break was necessary.

The court then went on to look at a further argument that the Inland Revenue had around 2002 changed its practice. It was alleged that prior to 2002 the Inland Revenue had not insisted on a clean break and had operated on the basis that satisfaction of the days test would be sufficient to establish non-residence. The court found that the Inland Revenue had not changed its practice or misled practitioners. At most, the Inland Revenue had changed the rigour with which it enforced the law.

To add to the confusion, the First-tier Tribunal decided a few weeks later in Turberville v HMRC [2010] UKFTT 69 (TC) that the taxpayer was not resident despite retaining accommodation in the UK. It was a question of looking at all the facts in the round, no one fact was decisive.

Two points stand out for practitioners. First, great care needs to be exercised if advising someone on becoming non-resident. The only safe option is for the taxpayer to cut all ties with the UK, which may prove unattractive to many. Second, there will be people who thought they were non-resident who are actually tax resident and may be getting questions from HMRC soon. Despite the judgment in Gaines-Cooper, there were many advisers who, prior to 2002, took the view that Inland Revenue practice was that a clean break was not necessary. They may have advised clients to go non-resident based solely on the days test. That argument will not now stand up in the light of Gaines-Cooper. If there was no clean break, those clients may not only have been tax resident in the year they first went abroad but also in all subsequent tax years. The potential tax bills may therefore be substantial.

Entrepreneur relief and SDLT changes

Many will be aware of the tax proposals made in the Labour government's last Budget and will also be aware that, with the dissolution of Parliament, many of those proposals were never put into effect. However, a Finance Act was passed, a mere 161 pages which went through all stages in the House of Commons in four hours. It may therefore be useful to review which issues of practical importance to practitioners which were announced in the Budget did and did not make it into the Finance Act.

The key issues that did make it into the Act were the changes to entrepreneurs' relief and the changes to Stamp Duty Land Tax (SDLT) on residential property.

Entrepreneurs' relief has the effect of reducing the effective rate of CGT on qualifying gains from 18 to ten per cent. The relief only applied to the first £1m of gains for each taxpayer (this being a lifetime allowance, not an allowance for each transaction). There are a number of qualifying conditions, primarily to ensure that the taxpayer has a material interest in a trading business for at least a year. For shares, for example, the taxpayer must hold shares representing at least five per cent of the ordinary and voting share capital in a trading company.

For disposals after 5 April 2010, the lifetime allowance increased from £1m to £2m. How significant this could be is debatable given that the Budget notes estimate the cost of this change in the current financial year to be only £5m.

SDLT changes have been implemented as announced in the Budget. First, the nil rate band is extended up to £250,000 for 'first-time buyers' who buy before 25 March 2012. The definition of first-time buyer is restrictive. If a buyer, or any of the buyers where the property is bought jointly, has had a major interest in residential property at any time anywhere in the world. Second, there is a new five per cent rate for residential properties over £1m, but this only applies from 6 April 2011.

One of the main changes that did not make it into the Finance Act was the change to the rules regarding furnished holiday lettings (FHL). FHL currently enjoy an advantaged tax position in that for certain tax purposes they are treated as a trading business, rather than property letting. This rule was due to be abolished from 6 April 2010. However, after opposition, the abolition was withdrawn from the Finance Bill and the rule remains in place for the moment.

The Corporation Taxes Act 2010 came into force on 1 April 2010. This is part of the tax rewrite process and so there are no substantive changes to the law. However, references to various statutory definitions with which commercial lawyers will be familiar will change as a result. In particular: section 840 ICTA (control) becomes section 1142 CTA; section 416 ICTA (control '“ close company legislation) becomes sections 450 and 451 CTA; section 839 ICTA (connected person) becomes sections 1122 and 1123; and section 414 (close company) becomes section 439 to 447.

Construction industry schemes

Bells Mills Developments Ltd v Revenue & Customs [2009] UKFTT 390 (TC) is a cautionary tale for anyone involved in advising clients who might fall within the construction industry scheme (CIS). In broad terms, CIS covers payments by 'contractors' under construction contracts. The definition of contractors is, however, wider than might be understood in the construction industry. As well as businesses involved in the construction industry, it includes any business that on a three-year average has spent more than £1m on construction operations. It therefore covers many developers and property investors.

If in CIS as a contractor there are obligations to make returns to the HMRC and make deductions on account of tax from payments to sub-contractors. This case was about failure to make returns. There is a fixed £100 penalty for failure to make a return on time. That does not appear much until it is appreciated that returns have to be made monthly and that the penalty increases by £100 per month for the first year and therefore the penalties can add up very rapidly if no returns are made. In this case, the fixed penalties had run up to £19,400, and then HMRC added a further £19,500 in discretionary penalties for the returns being more than a year late. The First-tier Tribunal held that it could not interfere with the £19,400 of fixed penalties but reduced the discretionary penalty to £1,100. So, the taxpayer was left with penalties to pay of £20,500.

The real significance of this, however, is that these penalties were payable despite the fact that there was no tax at stake. The taxpayer had only ever employed one sub-contractor who was entitled to gross payment. Therefore, the taxpayer was not liable to account for any tax. The message is clear, if someone falls within CIS they must register and do and continue to do returns even if all the returns are nil returns, otherwise they must expect a substantial penalty.

Retrospective anti-avoidance legislation

Retrospective legislation is, it is generally accepted, a 'bad thing'. However, it has recently been increasingly threatened and used against tax avoidance schemes. For example, the government formally announced in 2004 that it retained the right to use retrospective legislation (backdated to the date of the announcement) against schemes designed to minimise tax and NIC on employment income, which were very popular at the time.

In Huitson, R (on the application of) v Revenue and Customs [2010] EWHC 97, the High Court considered the argument that retrospective legislation of this type was contrary to the European Convention on Human Rights, particularly article 1, 'peaceful enjoyment of possessions'.

There is little doubt that the taxpayer had used a wholly artificial arrangement to reduce his income tax liability. For example, the structure involved establishing an Isle of Man resident trust and an Isle of Man partnership, though the taxpayer had no other connection with the Isle of Man. The scheme relied on the double tax treaty with the Isle of Man to relieve the taxpayer from any charge to tax on certain income.

HMRC did not accept that the scheme worked, but introduced retrospective legislation to make it absolutely clear. The taxpayer claimed the legislation was disproportionate (in that it did not strike a balance between the taxpayer's fundamental rights and the rights of the community) and it therefore breached the European Convention on Human Rights.

The High Court disagreed. It looked at the purpose of double tax treaties. They were designed to ensure that taxpayers did not pay tax twice on the same income or gain. It was not designed to allow taxpayers totally to avoid tax on income. Therefore, it was a legitimate government policy to ensure that double tax treaties were not used totally to avoid tax, especially when the method used was highly artificial. That policy was of such importance that it could justify retrospective legislation.

Although the case is limited to its particular facts, it is a reminder that, whenever a client is minded to use a tax avoidance scheme, one of the risks of which they should be advised is that of retrospective legislation.