The property trading activities of UK residents being taxable whereas similar activities undertaken by non-residents were only taxed if the trade was carried on through a “Permanent Establishment” being, in simplistic terms, a physical presence (people and premises of the business) in the UK. Much to HMRC’s frustrations, this requirement for a PE gave (non-residents and many UK residents) substantial planning opportunities for trading and developing land in the UK.
As a result, in March 2016, HMRC published a technical note explaining how new anti-avoidance provisions would be introduced to counter such planning. Draft clauses were issued on and effective from the 5th July and are to be introduced in the Brexit-delayed Finance Bill, soon to be the Finance Act, 2016.
The problem for HMRC
Under the existing rules it is difficult to demonstrate the existence of a PE, either in the form of people, businesses and premises carrying on an activity on behalf of the non-resident in the UK, or of a UK agent of the non-resident who habitually exercises contractual authority on behalf of the non-resident. Without these territorial links to the UK HMRC were unable to tax the resulting profits.
This seems surprising given that UK land is, by its very nature, physically part of the UK and therefore a UK PE of a property trade might reasonably have been expected to be identifiable. Frustratingly for HMRC, non-residents and others have successfully (de facto if not de jure) structured their UK property transactions to avoid the creation of a taxable PE, often by utilising (abusing in HMRC’s view) certain Tax Treaties. These are typically those entered into with certain “Islands”, where the definition of a PE may be more restrictive and a PE arising under UK tax rules is not recognised for the purposes of the Treaty. In other cases, where a taxable PE has resulted, the non-resident developer may have entered into arrangements to “envelope”, or fragment, the profits derived from such transactions such that the vast majority of the profits generated escape the territorial scope of UK tax.
The core change is conceptually quite simple, even obvious: that is to abandon the requirement for a connecting factor in the form of a PE in the UK. Instead, the location of the land, which if in the UK, will now provide the connecting factor.
Clearly HMRC, having struggled under the existing rules to police the territorial scope of UK taxation with respect to property trading, were determined to arm themselves with every legislative advantage. As a result, the definition of a trade of dealing in, or developing, UK land is to be widened. It now extends to any activities where a gain is realised from a disposal of land, or of any property deriving its value from land, in circumstances where the land is acquired or developed with a view to making profit on its disposal.
The extension of the charge to any property deriving its value from the land includes a shareholding, interest in a partnership, or interest in a trust. This addresses HMRC’s concerns towards structures where land is held (enveloped) in another structure, typically a company. Similarly, HMRC’s concerns over fragmentation, in which profits are diverted from the land dealer, or developer, to an associated entity outside the scope of UK taxation, are to be restricted by rules which effectively restore such profits to the person disposing of the UK land.
The changes give a new and special status for a trade of dealing in, or developing, UK land by a non-resident and come as a result of considerable legislative effort. In addition to the clauses introduced into the Finance Bill 2016, HMRC had already taken the opportunity of amending the tax treaties with Guernsey, Jersey and the Isle of Man to recover taxing rights over UK land.
With UK tax rates falling, and post-Brexit, destined to fall further (although we will need to see whether this commitment to deliver a 15% corporation tax rate continues with the new Chancellor), the payback from structuring to avoid the scope of UK taxation was already seeing decreasing returns. Therefore, these kinds of efforts seem to be disproportionate in relation to the risk involved. There is also the question of effectiveness. These new rules certainly extend the boundaries of UK taxation, although such limits are only applicable if you can collect the tax within them. Whilst the existence of a PE is now irrelevant in determining the charge to UK taxation on land dealing and development transactions, a PE did provide a UK presence against which HMRC could enforce collection of the tax due. This nexus has now been broken and it remains to be seen how effective these new rules will be in increasing the tax collected on such transactions. What is certain is we now have a legislative minefield: although perhaps providing a deterrent to those who would otherwise stray into that territory is HMRC’s real objective.
Neil Simpson, Tax Partner at haysmacintyre