Company residence: guidance originally published in the International Tax Handbook
The following reproduces the guidance on the law and the consequences of the law which was originally published in the International Tax Handbook which was withdrawn in October 2008. This guidance is still relevant if considering the central management and control test insofar as it describes the development of the UK rules and summarises relevant case law.
Please note that this material may refer to other chapters in the International Tax Handbook which have been removed.
COMPANY RESIDENCE: THE LAW -
ITH300 Company residence: the law: basic residence rule
There has never been a statutory definition of what makes a company resident for the general purposes of the Taxes Acts. Yet it has long been recognised that the residence of a company is determined according to where its central management and control is to be found. That is still so even though since 1988 a company incorporated in the United Kingdom is, with some exceptions, regarded as resident in the United Kingdom for the purposes of the Taxes Acts. That rule overrides but does not eliminate the test of central management and control.
ITH301 Company residence: nature of a company: company law
This chapter is concerned with the concept of company residence, the development of the central management and control principle and the role played by incorporation. But before these matters can seriously be examined it is necessary to consider the real nature of the company, what it is, how it is created and what are the mechanisms whereby it is managed and controlled; to do that involves company law. That means primarily company law of the United Kingdom. The management and control test is relevant to all companies including those incorporated abroad. We see later (ITH319) how foreign company law is relevant when a company incorporated abroad is being considered. But the case law from which the test derives concerns companies which were incorporated either in the United Kingdom or in countries such as the former Dominions with similar company law. The Companies Acts to which reference will be made are those which run in England and Wales and, for the most part, Scotland. Northern Ireland has equivalent law. Company law is a large subject and for the present purpose our interest can be confined to those aspects of it which are relevant to company residence. Company law, like Income Tax law, has evolved and to understand the judgments in some of the Tax Cases, it is important to know, at least in outline, something of that process of evolution. Most companies have been created through the process laid down in the Companies Acts and the first Act to bear that name became law in 1862. By that time the Income Tax Act had been established for twenty years and it is accordingly necessary to look back to the time before that first Companies Act to understand the state of things when our Income Tax Act 1842 was written.
In the 1842 Act, as in later Income Tax Acts, it was the residence of persons which had to be considered. The idea of corporate personality is very old. It is sometimes expressed by referring to a company as a legal person, that is to say an entity which has legal rights and legal obligations quite distinct from those of the people who make up its membership. While that is a reasonable enough way of expressing the idea it must be remembered that the members, natural persons, are also legal persons. What we really mean when we call a company a legal person is that it has been created by the artifice of law rather than by natural birth. Until 1844 it was very difficult and expensive to acquire corporate personality. It could be done, speaking very broadly, only by Royal Charter or under the provisions of a special Act of Parliament.
ITH302 Company residence: company law: growth of the company
Thus when the Income Tax Act appeared or, more correctly, reappeared in 1842 there were very few true trading corporations and businessmen formed partnerships or resorted to a vehicle known as the unincorporated company. This was a curious entity with some of the characteristics of what we would call a company. In fact it was a sort of half-way house between a corporation and a partnership. It is bodies of that kind which explain the reference in ICTA88/S832 (1), in the definition of `body of persons’, to `any company, fraternity, fellowship and society of persons whether corporate or not corporate’. The definition of `company’ in Section 832(1) dates from 1965 with the introduction of CT and includes a similar reference to unincorporated associations. There are today comparatively few unincorporated associations and they are, generally speaking, members’ clubs such as the local cricket club. The word `company’ has no precise legal meaning and is still loosely applied to partnerships. The Section 832(1) definition of `company’ however states explicitly that the term does not include a partnership.
To us the word company normally means a company incorporated under the Companies Act and we have now a very large number of truly corporate bodies. The Companies Act of 1862, the forerunner of today’s Companies Act, was not entirely an innovation. It consolidated important developments that had taken place after the introduction of our Income Tax Act of 1842. The true father of the modern company was Gladstone who, as President of the Board of Trade, introduced the Joint Stock Companies Act of 1844. That Act drew a clear distinction between partnerships and companies and provided for incorporation (the giving of corporate identity) by registration. Limited liability was not granted but it followed soon in the Limited Liability Act of 1855.
From now on in this book the word `company’ means a company incorporated under the Companies Acts or exceptionally by Charter or Act of Parliament.
ITH303 Company residence: law: company not the agent of its members
Although the idea of corporate personality is old, this country was slow to accept that a company is not the agent of its members. The Companies Act had simplified the procedure for forming a company. `One-man’ companies for the first time became common and there was a reluctance to accept that the founders of such companies could, as it was seen, shelter behind the facade of corporate identity. The question was finally settled by the Salomon [Salomon v Salomon & Co (1897) AC22] case as late as 1897. Salomon and Co Ltd was a little one-man company set up by a Mr Salomon to take over his business as a leather merchant. The company fell on bad times and a debenture holder forced the company into liquidation, a receiver being appointed. There was enough money to pay off the debenture holder but nothing for the unsecured creditors. The Court of first instance and the Court of Appeal held that the company was a mere sham, an agent for Salomon who was the real proprietor of the business and liable for the debts that had been incurred. The Lords reversed this decision unanimously. They held that the business was the business of the company not of Salomon. The Lord Chancellor said.
`Either the limited company was a legal entity or it was not. If it was, the business belonged to it and not to Mr Salomon. If it was not, there was no person and no thing to be an agent at all; and it is impossible to say at the same time that there is a company and that there is not.’
Lord Macnaghten said
‘The company is at law a different person altogether from the subscribers … and, though it may be that after incorporation the business is precisely the same as it was before, and the same persons are managers, and the same hands receive the profits, the company is not in law the agent of the subscribers or trustee for them. Nor are the subscribers, as members, liable in any shape or form, except to the extent and in the manner provided by the Act.
Thus the position of the `one-man company’ was made secure.
ITH304 Company residence: law: company and partnership distinguished
A company, therefore, acts for itself and not as agent or representative of its members. When profits arise they arise to the company and not to the shareholders. The shareholders have no right to them as profit. The rights of the shareholders include the right to a dividend when formally declared. In a partnership, on the other hand, each partner is the agent of the other partners. The profits arise to each partner according to the provisions of the partnership agreement. It is the existence of that agency relationship which distinguishes a partnership from a company.
It is broadly true to say that a partnership does not have, as a company does, distinct legal persona but the presence of legal persona is not in itself conclusive. In Scotland a partnership is a distinct legal entity but there is, at the same time, an agency relationship between the firm and its members and between its members. That agency relationship is the hallmark of partnership and characterises the Scots partnership as a partnership rather than as a company. Considerations of this sort are important when dealing with some unfamiliar European company cum partnership creations. The French Société Civile is one such body and the Société en nom Collectif is another. Broadly speaking we regard the first as a company the second as a partnership. Both have legal personality but in the former case the profits arise to the body itself and in the latter case we take the view that the profits arise to the partners. There is more about how we decide which category is appropriate in chapter 16 (ITH1672 - ITH1675).
ITH305 Company residence: company law: constitution of a company
The Companies Act does not, in itself, create any companies at all. It simply lays down a process by which two or more people may create a corporation by complying with the rules which the Act prescribes; if they do that they can get a birth certificate, a certificate of incorporation that is, from the Registrar of Companies as a creation under the Companies Act. The Companies Act lays down a framework for the government of the company. There has to be a Memorandum which gives the company name and the address of its registered office. The Memorandum also sets out what are the objects of the company and it states the amount of the share capital. There have to be initial subscribers to the company. Then there come the Articles of Association. These are the rules for the internal management of the company and are important for our present purpose. Sometimes it is necessary for these Articles to be registered with the Registrar. The Articles of a company limited by shares do not have to be in any specified form but the Act makes provision for a model set of Articles entitled Table A applicable to both public and private companies limited by shares. A company limited by shares may, if it wishes, register Articles but it is not forced to do so. If it does not register Articles, Table A applies automatically. If it does register Articles of its own, then Table A applies unless it has been specifically modified or excluded.
ITH309 Company residence: incorporation and residence: early days
In the early days we regarded a company as resident in this country if it was incorporated here. Viscount Sumner refers to the matter in the Egyptian Delta Land case (ITH311). He mentions Dowell who was the Board’s Solicitor and whose `Income Tax’ was a standard work. The 1874 edition of Dowell, the first edition, said nothing at all on the subject of company residence. The second edition in 1885 merely said that a company incorporated here was resident here. We clearly started with the idea that residence was determined by incorporation and in the middle of the nineteenth century there was no problem. But as foreign trading became more complex this simple view was questioned.
ITH310 Company incorporation/residence: early days: Calcutta Jute Mills
One of the first cases was Calcutta Jute Mills [Calcutta Jute Mills Company v Nicholson 1 TC83] a company which did what its name implies. It held board meetings and annual general meetings in London in an office lent by a director but everything of a practical nature was in India. It claimed that it was not resident here and that its trade was not carried on here. The judgements in Calcutta Jute Mills are the basis on which our later residence ideas rest and on which the case which became the authority on residence - De Beers - drew heavily (ITH314). The company was an English incorporated company at a time when it would have been exceptional for an English company to have directors and shareholders meetings anywhere but in England. The Judges, while looking at the board of directors and giving much weight to its constitutional role of management in this country, also took into account the fact that annual general meetings were here and incorporation was here. The people in India were mere agents acting solely on behalf of the company to be instructed by the company here; their acts were the company’s acts. The case was decided before the Court of Appeal decision in the Automatic Self Cleansing Filter Syndicate Company referred to in ITH316.
ITH311 Company incorporation/residence: early days: Egyptian Delta Land
After the Calcutta Jute Mills case in 1876 it was many years before another company residence case came before the Courts and it seems to have been generally accepted that a United Kingdom incorporated company was resident here. There was no further litigation until the De Beers case in 1905 and it is important to remember that De Beers was not a United Kingdom incorporated company. The significance or otherwise of incorporation was, rather surprisingly perhaps, not settled until the Egyptian Delta Land [Todd v The Egyptian Delta Land and Investment Company Ltd 14TC119] case in 1928. Then the Lords reversing the lower Courts held that the bare fact of incorporation here did not constitute residence. Both Rowlatt J in the High Court and the Court of Appeal came down quite clearly for the Revenue. The Lords were equally clearly against us.
ITH314 Company residence: true meaning of residence: De Beers
Judges have said many times that in thinking about residence of a company one has to proceed as nearly as possible by way of analogy with a natural person. But in the nature of things a company, an abstraction, cannot breathe or eat or sleep or move about or do the things which would be factors in deciding where a natural person might reside. The Courts decided that the place where a company resides is the place where it carries on its real business. That view of the Courts comes from the Calcutta Jute Mills case as far back as 1TC and was adopted by Lord Loreburn in De Beers [De Beers Consolidated Mines Ltd v Howe 5TC198] where he says
`I regard that as the true rule; and the real business is carried on where the central management and control actually abides. It remains to be considered whether the present case falls within that rule. This is a pure question of fact, to be determined, not according to the construction of this or that regulation or by-law, but upon a scrutiny of the course of business and trading’.
That statement by the Lord Chancellor is a statement of the law. Years later, Lord Radcliffe said [Bullock v The Unit Construction Company Ltd 38TC738] that on the whole he regretted that we did not have a statutory definition of residence. He felt nevertheless that the De Beers judgment must be treated today as if the test laid down there was as precise and as unequivocal as a positive statutory injunction. We treat Lord Loreburn’s words as if they were statute law.
ITH315 Companies: true meaning of residence: De Beers: question of fact
Although the test laid down by Lord Loreburn in De Beers is treated as if it were statute law, how it is to be applied in a particular case involves a question of fact. That cannot be too heavily emphasised. If the Commissioners have understood the law, there is very little hope of getting a decision by them reversed in the Courts. For that reason, in a difficult question of company residence, it is sensible to get early advice from Head Office. If the case is a really important one, the likelihood is that we shall ask the Solicitor to act for us and if that is to be so, it is only right for the Solicitor’s office to see the papers and to be able to give advice at the earliest possible opportunity.
ITH316 Company residence: legal power to manage and control
In seeking an answer to the question where the exercise of management and control lies, the first natural step is to ask who, in law, has the right and duty to exercise it. A company being an abstraction cannot itself do any real acts at all. The abstraction can act only through the agency of other people. The company cannot be identified with its shareholders unless exceptionally there has been some sort of fraud on the public; that was established by Salomon’s case.
When looking for the source of the exercise of formal power, the possibilities are
- The meetings of shareholders, which are formal meetings whether
- General or Extraordinary: such meetings have a formal voice.
- The board acting as agent for the company.
At the turn of the century, around and after the time of Salomon’s case the view in law was that
- The shareholders in General Meeting were the company.
- The directors were the agents of the company.
That idea implied that the General Meeting was the voice and the soul of the company and that the directors were there to act, to some extent at least, at its bidding. In nearly every case we meet in practice the constitution of the company, its Articles that is, will provide that the power of management lies with the board; it is in the terms of Table A delegated to the directors as a board. The board, therefore, appears very strongly as the source of management and control. Indeed it is and there has been one very important development. It is still the case that the shareholders in general meeting are the voice of the company. But until about eighty years ago it was also the idea that the directors, while formally endowed with the power of management, were subject to the control of the General Meeting. The General Meeting could, and sometimes did, tell the directors what, in important matters of policy, they were to do. That position was changed in 1906 by a Court of Appeal decision in the Automatic Self- Cleansing Filter Syndicate Co v Cuninghame [(1906) 2Ch34 ]. That decision was followed two years later by the Stanley case mentioned in chapter 2 (ITH223).
ITH317 Company residence: legal power to manage/control: with directors
Those decisions established that directors, while agents of the company, cannot be ordered about by the General Meeting. It follows that the power of management and control lies in the hands of directors and not with the General Meeting. The General Meeting can replace the directors or it may alter the Articles but it is very rare indeed to find the shareholders reserving for themselves the right to manage and control. This doctrine was expressed by a judge [Greer LJ (Shaw & Sons (Salford) Ltd v Shaw) (1935) 2KB113] in 1935 as follows
`A company is an entity distinct alike from its shareholders and its directors. Some of its powers may, according to its Articles be exercised by directors; certain other powers may be reserved for the shareholders in General Meeting. If powers of management are vested in the directors, they and they alone can exercise those powers. The only way in which the general body of the shareholders can control the exercise of the powers vested by the Articles in the directors is by altering the Articles or, if opportunity arises under the Articles, by refusing to re-elect the directors of whose actions they disapprove. They cannot themselves usurp the powers which by the Articles are vested in the directors any more than the directors can usurp the powers vested by the Articles in the general body of shareholders.’
Of course the shareholders in General Meeting have rights and duties apart from those of appointing and dismissing the directors. They approve the accounts and pass the dividend and have a voice in such matters as issuing new capital, in the reduction of capital and in changes of the objects clause of the Memorandum or changes in the Articles. These things do not constitute the management and control of the business. They are rather keeping a critical eye on the interests of the shareholders. Modern lawyers writing on the subject speak of the `organic theory’. By this they mean that the General Meeting and the board are both organs of the company and that each is the company in its own field of authority.
ITH318 Company residence: power to manage/control: managing director
The board is thus emerging as something more than an agent and it is becoming in its own field the company. Of course the board of directors can still appoint agents and as long as they are mere agents they do not, by the bare fact of being there and fulfilling their agencies, detract from the management and control of the board. There is, however, one special case and that is where the board under the authority of the Articles appoint a managing director. In such cases one has to look very carefully at what the powers of the managing director are. One distinguished writer [LCB Gower. The Principles of Modern Company Law] on the subject has said that if the service agreement with a managing director purports to confer exclusive powers on him without expressly reserving a right of supervision, he thinks that the board could not interfere with a managing director’s exercise of his powers during the subsistence of the service agreement. The writer concludes that in that situation the directors are in effect substituting a managing director for themselves as one of the primary organs of the company. Certainly there is all the difference in the world between a managing director in that sense and a manager who happens also to be a director.
ITH319 Company residence: legal power to manage/control: foreign law
We have looked at company law in the United Kingdom or countries with similar law. But the question of legal power is also applicable to companies incorporated in other countries. And, although the formal set-up may be different, the study made in this chapter of the constitution of a United Kingdom company gives an idea of the sort of approach which is needed for foreign companies. The method of governing a company is, in some countries, significantly different from that in the United Kingdom. For example, a German private company (GmbH) is managed by one or more managers but some decisions are reserved to shareholders.
Two-tier boards - a supervisory and a management board - are common in continental Europe and we usually find central management and control in the managing board. There is something about this in INTM120120. There is also a fair amount of information available in International Division. While it cannot pretend to be expert in such a specialised area it is always ready to assist and to obtain advice in worthwhile cases. In really important cases our Solicitor might find it necessary to seek advice from somebody skilled in the appropriate law.
ITH323 Company residence: legal control overridden: Unit Construction
So far in this chapter emphasis has been placed on the constitutional position established by the company’s Articles. Who are the people who are lawfully entrusted with the exercise of management and control? Ever since the De Beers case the Courts have stressed that residence is a question of fact. Nevertheless the Revenue view had been that in looking at the acts which constitute management and control one should look only at those acts which are intra vires the Articles - at those acts which are constitutional. This view was held to be wrong in the Unit Construction [Bullock v The Unit Construction Co Ltd 38TC712] case, a case decided in 1959 which, in the context of a century of litigation is recent. Here, the Lords, overruling both lower Courts, dismissed the argument that `only constitutional, and therefore authorised, management and control are relevant to an enquiry as to the residence of a company’.
The facts were briefly that a United Kingdom parent company had three African subsidiary companies incorporated in Kenya with boards of directors consisting of local people and carrying on ordinary trading activities in Africa - things like merchanting, mining, leather business and a variety of real trading activity. The Articles of the companies provided that their boards could meet anywhere other than in the United Kingdom. The day-to-day management of the businesses was abroad since in the nature of things it could hardly have been elsewhere, but it is quite clear from the stated case that the boards of directors of the African subsidiaries were standing aside in all matters of real importance, and that the real control and management was being exercised by the board of directors of the parent company in London. Viscount Simonds put it very neatly when he said
`The business is not the less managed in London because it ought to be managed in Kenya.’
So there are two questions.
- Where and by whom according to the constitution of the company and the law of the land ought this company to be managed and controlled.
- Exceptionally, if the people lawfully charged with management and control did not exercise it, who did?
And these questions apply equally to companies incorporated outside the United Kingdom.
ITH327 Company residence: difficulties: central management/control test
It is now possible to look at the heart of our difficulties over the central management and control test. If, as is usual in this country and in many others, the directors of a company have the constitutional power to manage and control, they can exercise that power in truth and fact by doing very little indeed. They can appoint agents and servants to attend to the day-to-day running of affairs on the spot and they can exercise their management and control perhaps from far away. Nothing in the Unit Construction case changes that: what Unit Construction says is that if the directors stand aside and allow others to manage and control, it is those people to whom one must look in reaching a conclusion. The clearest example in Case Law of the minimal activity required to establish management and control is Ogilvie v Kitton [5TC338] the case of the gentleman in Aberdeen with a shop in Canada mentioned in chapter 2 (ITH211). It is not indeed a residence case but concerned with the Case I/Case V argument. It is nevertheless wholly relevant to the point.
The difficulty can be put in this way - just as Calcutta Jute Mills can be managed and controlled in the United Kingdom so can an English trading company be managed and controlled in a tax haven. The law sets no minimum standard of participation in the affairs of the business to establish management and control. Lord Sumner said in the Egyptian Hotels Case (again on the Case I/Case V point - see ITH343) that it was not enough that the proprietors had the legal right to intervene. There must be actual participation and then come the very important qualifying words `though it may not go beyond passive oversight and tacit control’ [6TC551].
ITH328 Company residence: looking at the command structure
Unit Construction reaffirms that it is all a question of fact and that constitutional propriety is irrelevant. It is necessary to look for the place where the real heart of the company is. That involves looking at the command structure. In the majority of cases there is no problem, for most companies are here and here only. They are making things and doing things and they do everything here. Such a company may have all its levels of management in one place or they may be in different places but as long as all are in this country it does not matter, there is no effect on residence. But the problems start to emerge when different levels of management can be seen in different countries.
ITH329 Company residence: command structure: three levels of management
There might, for example, be a company engaged in some real activity in which it would be possible to detect at least three levels of management. Starting at the bottom there might be
- shop floor or on the spot management;
- what might, in every day language, be called the Head Office; the place where one would expect to find the executives and senior staff who actually make the business tick, the people directly giving the orders that govern the company’s operations;
- the central policy core of the whole enterprise - and this is the difficulty. It may be indistinguishable from (ii) above or it may not. It may be a passive sort of body merely keeping its eye on things or it may be a very active body.
ITH330 Company residence: executive/non-executive directors
The way in which United Kingdom public companies actually go about organising themselves has changed over the years. At the time of some of the older tax cases our whole social pattern was very different from today’s. Then, the men at level two - the action men - would probably have been people like the chief general manager and his immediate management colleagues who would not have been members of the board at all. The board would have consisted wholly of non- executive directors. Later, senior managers became board members and indeed the managing director or chief executive may have near absolute power.
That is a great change; such people are seen, and see themselves, as rare and valuable and will not be given orders by a non-executive board. But the practice of appointing non-executive directors did not disappear and indeed became more customary in the later years of the twentieth century. These directors are not necessarily mere ciphers, and a board which includes both executives and non- executives may well exercise central management and control. Some so-called non-executives may in fact act more like executives. In this respect titles can be misleading and should not be regarded as conclusive of the true role taken by an individual.
ITH331 Company residence: command structure: pinnacle doctrine
The pinnacle doctrine It is quite apt to think of the central management and control doctrine as the pinnacle doctrine - one looks at the very top of the pyramid of control. There is nothing conceptually wrong with that, indeed it is an idea which, in theory, is reasonably easy to apply. Putting aside the exceptional cases of dual residence in the special sense described in ITH338, a pyramid has only one top. There is no doubt whatever that in the past the non-executive directors who sat on the board did hold the reins though active intervention by them in the working of the company may have been a rare thing. Theirs was the power and everybody knew it. Even with the increasing power of executive directors it is difficult to find the pinnacle of control anywhere other than with the board combining executive and non-executive directors. That is level three management. With modern means of communication it is easy to move that sort of pinnacle about. The board does not have to be tied to the operational base. It is less easy, though not impossible, to move level two around.
ITH334 Company residence: the reality
It has been said that the management and control test is bad because it leads to the nonsense of directors flying to Jersey for board meetings. That device is no longer of use to a United Kingdom incorporated company which is resident here anyway. But it is quite easy for a company operating here to incorporate in Jersey and claim to be managed and controlled there with only a minimal tax cost in Jersey provided the shareholders are not resident there. So the criticism is still relevant.
On the face of it the point is a valid one. But criticism of that kind is concerned as much with questions of fact as of concept and the two things must be kept separate in our minds. There is, in principle at any rate, no reason why a business which is visibly in this country should not be managed and controlled from, let us say, Jersey. But if the directors of that company are working in this country on a regular basis and probably living here as well, it may be highly unlikely that they will be doing anything more in Jersey than reaffirming decisions already taken here. If that is so the mere fact of having board meetings in the Channel Islands is irrelevant. The question is, where do the people concerned exercise management and control. If they really do it in this country and go through a meaningless form of words in Jersey, that will achieve nothing for them but, of course, it leaves the Revenue with the difficult burden of proof.
It may help to put the problem into a context which is very familiar. A small grocery store is run by a man A and his son A junior. There is a grandfather, once sole proprietor, who no longer takes an active part in the business but owns the property and makes his views known on important matters. A company is formed with A as chairman and managing director, the son as sales director and grandfather as a mere shareholder. Every year A and his son spend holidays in Jersey. It is very unlikely that any body of Commissioners would accept that by holding their only board meetings when they are in Jersey they had made the company resident outside the United Kingdom. Both level two and level three management are exercised by A and his son and they are clearly based in the United Kingdom.
But an alternative scenario has grandfather as both major shareholder and chairman with A and his son as full-time working directors. Grandfather takes no part in the day-to-day running of the business but takes a keen interest in its success and his word on important matters carries great weight. Here level three management emerges as something quite distinct from level two which remains with A and his son. Level three may be found either with grandfather alone or with grandfather and his sons acting as a board depending on the extent of grandfather’s real power. If grandfather moves to Jersey, level three management may genuinely move with him, either because he alone exercises central management and control from Jersey or because the board meetings, at which he plays an important part, are held there. Grandfather’s move to Jersey may, however, have Jersey tax consequences for the company if he retains his shares because some tax advantages may be lost if the company is owned by Jersey residents.
ITH335 Company residence: parent subsidiary relationship
The next difficulty in identifying real management and control is concerned essentially with the parent subsidiary relationship. A parent company is merely a shareholder and may have no constitutional right to run the business of the subsidiary; but such parent companies do increasingly exercise influence in the management of their subsidiary companies. The Royal Commission of 1920 observed this and the problem has got a great deal worse since then. The question always is whether the influence exercised by the parent amounts to the management and control of the business of the subsidiary. Unit Construction wanted its African subsidiaries to be resident here - there were losses that could be relieved. For many years the Revenue had taken the view that that was an exceptional case, and it relied on some words of Lord Cohen in his judgment where he said
`the facts of the case before your Lordships are most unusual. It is surely exceptional for a parent company to usurp the control; it usually operates through the boards of the subsidiary companies, and had the Commissioners found in the present case that that was what had in substance happened, it may well be that your Lordships could not have disturbed that finding’. [38TC744]
The Department adopted its line for good reason. First, there was some support for it in Lord Cohen’s words. We did not want to argue that large numbers of overseas subsidiaries of United Kingdom parent companies were resident here. When such subsidiary companies make profits one often finds that after Double Taxation Relief there is very little United Kingdom tax left. Further, we did not want to argue that large numbers of United Kingdom incorporated companies, being the subsidiaries of foreign parents, were not resident here: they were quite prepared to be treated as resident and their tax planning was on that basis.
But it became clear that Unit Construction was not so exceptional after all. It may be exceptional for the directors of a company to stand aside completely. It is, however, not unusual for directors to act in accordance with the wishes of the parent. We took advice about the matter and the advice was that the test should properly be whether the local directors apply their minds to `suggestions’ from the parent and form an independent judgment before implementing their parent’s wishes or whether, on the other hand, they merely `rubber stamp’ and carry out without serious question the higher policy wishes of the parent company.
ITH338 Companies: dual residence: domestic law
A limitation of the central management and control test formulated in De Beers is that it points to a single country of residence - there can be only one pinnacle. Yet the courts have recognised that, like a natural person who divides his time between two homes, a company may have two places of residence. A judge has said [Swedish Central Railway Co v Thompson 9TC352] that it is rather easier to think of a company having two places of residence than it is of a natural person. Since a company is an abstraction, it is in a sense more mobile. It exists only as an idea and, therefore, one may find it easier to think of it moving or as being in two places than a natural person with bodily limitations.
We are not concerned here with a company which is managed and controlled in the United Kingdom but is also subject to worldwide tax in another country because it is resident there under their rules, for example because it is incorporated there. That is also described as dual residence and elsewhere in this book the expression `fiscal dual residence’ is used to distinguish it. We are looking at a company whose management and control appears to be in two countries or to be peripatetic. The difficulty then is how to apply the De Beers test.
Divided central management and control was considered by the Court of Appeal in the Union Corporation [34TC207] group of cases, although the House of Lords decided the cases on another issue and did not consider the question. Drawing on the judgment in an Australian case, Sir Raymond Evershed’s view was that the final and supreme authority cannot be divided between two places. But that is not required for dual residence. The situation can arise where some part of the superior or directing authority may be found in two countries at the same time. The company is resident wherever `to some substantial degree’ acts of controlling power and authority are exercised.
That conclusion is not entirely easy to reconcile with the idea that central management and control is to be found at the pinnacle. It is easier to understand that the pinnacle may move from place to place, for example where there are ambulatory board meetings. But if one thinks of the pinnacle as the top cone rather than the very top point then that cone can be divided even if one part carries with it the top point.
Lord Radcliffe in Unit Construction makes a valuable contribution towards reconciling the cases on dual residence although dual residence was not an issue in the case. From him we learn that there is one class of case where the De Beers test cannot be applied - that is where it is not possible to find central management and control in one country alone. What test is then applicable remains, to some extent, an open question. Where there is a genuine division of the top-most layer of central management and control between identifiable places, we can follow the criteria adopted by the Court of Appeal in Union Corporation and cited by Lord Radcliffe - establishing in which of those places acts of controlling power and authority are exercised to some substantial degree. However, where there is not that kind of division but rather the company is peripatetic in the sense that relevant acts of control and management are exercised at different times at perhaps a variety of different locations, it is considered that the Courts have not yet fully addressed the question.
ITH339 Companies: dual residence: peripatetic companies: reports to HO
Although this is a somewhat esoteric subject, it may sometimes be relevant to arguments about the residence of tax haven subsidiaries. It matters not if a company is resident elsewhere if it is also resident here. International Division would like to see any such cases of peripatetic companies which are claimed to be non-United Kingdom resident but where it is suspected that some part of the top- most layer of central management and control is in the United Kingdom - even though this might amount only to passive, but conscious, oversight.
ITH343 Company residence: Case V trade: UK central management control
Some early cases in which consideration of management and control played a part were concerned not with residence but with whether the trade carried on by the company was within Case I or within Case V. One such case was The San Paulo Railway Company Ltd described in chapter 2 (ITH209).
The test of residence is - where is the real business carried on? When looking at the Case V/Case I argument, the question is - is the trade carried on wholly abroad? If a company is resident in the United Kingdom because the central management and control of its business is here, can it have a Case V trade? Usually the answer will be `no’. But there is one case which suggests that it can. It is the Egyptian Hotels [Egyptian Hotels Ltd v Mitchell 6TC152 and 542] case. That company succeeded as narrowly as possible in establishing a Case V trading source while at the same time remaining resident in the United Kingdom (The House of Lords being evenly divided, victory went to the company). It is important to remember that residence was not an issue in the case and that Egyptian Hotels Ltd was incorporated in the United Kingdom. Although Egyptian Hotels was heard some six years after De Beers which is the great authority for the management and control test, there was, as has been said, still some idea that if a company was incorporated here it was resident here. There is no reason why a company which is resident by reason only of incorporation here should not have a Case V trade. The short answer to the apparent contradiction in the Egyptian Hotels case is that under the central management and control test (and ignoring the 1988 incorporation rule) we would probably today regard the company as non-resident.
ITH344 Company/foreign partnership: Case V: UK central management control
However, business has a wider meaning than trade. There is one situation where a company managed and controlled in the United Kingdom may reasonably have a Case V trade. That is where the company is a partner in a partnership but the business of the partnership is managed and controlled abroad. Since 1965 the question of Case I or V for companies has been significant mainly for loss relief. Before that companies benefited from the remittance basis for Case V trades. With the introduction of corporation tax such sources were moved to the Case I basis. It is important to note that they were not actually put into Case I. What ICTA88/S70 (2) says is that where a company is chargeable in respect of a trade under Case V the income shall be computed in accordance with the rules applicable to Case I. So loss relief is still governed by Case V rules. ICTA88/S393A (3) prevents sideways relief for Case V trading losses. Chapter 16 on foreign partnerships considers in more detail companies as partners in partnerships managed and controlled abroad.
ITH347 Company residence: proposed new management test
The central management and control test can be of advantage to the Revenue in the battle against tax haven subsidiaries. We look at this in the next chapter. But in the climate following the abolition of exchange control in 1979 the disadvantages of the case law test were considered to outweigh any advantages. Wholesale migration of United Kingdom resident companies was not a danger whilst the requirement for Treasury consent was still in place - see chapter 4 (ITH401). But there were other possibilities of exploitation and no guarantee that the requirement for Treasury consent would continue forever.
So in 1981 proposals were made for a statutory definition of company residence which were designed to solve the problems inherent in the test of central management and control. The aim was for a definition which would have allowed us to look at the place where, in every day language, the Head Office was to be found rather than a remote place where ultimate policy decisions might be taken. The very pinnacle of control would have been ignored. In the case of the United Kingdom subsidiary of a United States parent company, for example, the purpose was to look at the activity of the United Kingdom board even though it might act under the de facto control of the United States parent. What was really being attempted was to cut level three - where it was distinguishable - out of the reckoning.
ITH348 Company residence: proposed new test: place/effective management
The proposed definition was intended to be broadly on the lines of `place of effective management’. This is the criterion used in many of our double taxation treaties as a `tie-breaker’ in cases of fiscal dual residence. Its context in treaties is explained in chapter 5 (ITH515). But as the present chapter is so much concerned with company management it is appropriate to explain here what we think the term means.
At one time the view of the United Kingdom was that our domestic concept of central management and control meant the same thing as place of effective management and there was a note to this effect in the Commentary on the 1977 OECD Model Double Taxation Convention (see chapter 5). We no longer believe that necessarily to be so and the note does not appear in the 1992 edition of the OECD Model. The place of effective management is generally understood to be the place where the Head Office is: the Head Office in the sense of - not the registered office - but the central directing source. The place where one would expect to find the finance director, for example, the sales director and, if there is one, the managing director. The company records would normally be found there together with the senior administrative staff.
If that Head Office were to be, let us say, in the Netherlands the place of effective management would not be altered if the directors chose to hold their occasional formal meetings in Belgium. Many other countries have a management type test of residence (as well as an incorporation type test). We think our revised idea of effective management and the attempted 1981 definition are nearer at least to our European Community partners’ management tests than is central management and control. Nevertheless it is not that easy to divorce effective management from central management and control and in the vast majority of cases they will be located in the same place.
ITH349 Company residence: proposed new management test: abandoned
That kind of approach to a new test would have linked residence to a less mobile level though it was never supposed that it would have solved all the problems. It may have solved some of the loss-making problems like Unit Construction itself, but it certainly would not have solved all of them. The essential object of the proposed statutory definition was to make the law consistent with what in fact we had been doing for a long time. In the event it proved peculiarly difficult to devise a test which would cut out top level management - level three - but not end up at too low a level. In draft legislation it was suggested that `immediate day-to-day management of the business as a whole’ might identify the level of management to which residence should be attached. What was intended was the type of day-to-day management exercised by a managing director but the expression `day-to-day’ was criticised as possibly implying too low a level of management. The difficulty of providing a sufficiently precise definition, which would not require a long period of litigation before the Courts could determine its meaning, was one of the reasons which caused the attempt at a statutory definition to be abandoned - at least for the time being. However, in 1985 an echo of the draft legislation found its way into what became ICTA88/S812 (7) - part of the suspended anti-unitary tax legislation held as a sword of Damocles over companies connected with the unitary states in the United States (see chapter 5 ITH539).
ITH350 Company residence: first Statement of Practice
The development of the case law on residence has proceeded in steps separated by many years and marked by the major cases referred to in this chapter. In the words of Viscount Sumner the Courts then tread again the weary road of the Tax Cases. The subject is nevertheless of continuing importance to the Department, an importance which has been heightened by the challenge of the tax planner.
Following the decision not to legislate in 1981 the Revenue issued a Statement of Practice with a view to clarifying the current state of the law. It was SP6/83. The Statement was perhaps most important for its recognition of the possible significance of the Unit Construction decision on the residence status of subsidiary companies. It was, however, accompanied by a Press Release making plain that the Department did not intend to embark on a general review of the residence status of existing companies.
ITH356 Company residence: incorporation rule
When reform of the residence law was first mooted in 1981 there was a tentative suggestion that incorporation in the United Kingdom should make a company resident. This suggestion did not survive the first round of consultations. But only a few years later FA88/S66 introduced the rule that companies incorporated in the United Kingdom are to be regarded as resident there for tax purposes. Before coming to the reasons for this change we look briefly at how the rule fits in with company law.
A company which is incorporated in the United Kingdom is domiciled there. Under company law relating to the United Kingdom a company cannot move its place of incorporation or registered office out of the country in which it is domiciled whilst at the same time retaining its identity, except by Private Act of Parliament. Some countries - Switzerland and Spain are examples - have procedures whereby a foreign incorporated company can reincorporate in those countries and retain its identity although Switzerland may now require the procedure to be recognised by the company’s country of origin. In English law an English company which uses those procedures and is struck off the English register ceases to exist. The company, now foreign incorporated, is considered to be a different company.
ITH357 Company residence: incorporation rule: reasons for the rule
Three factors contributed to the coming of the incorporation rule. One was the possible threat posed by the Treaty of Rome to the provision in what became ICTA88/S765 that United Kingdom resident companies could not lawfully cease to be resident without Treasury consent. This provision was repealed when the incorporation rule became law. Section 765’s role in migrations has been mentioned in chapter 1. It is considered in more detail in chapter 4 together with the Treaty of Rome problem.
The second factor was the growing use by non-residents of United Kingdom incorporated but non-resident companies in order to avoid other countries’ tax or for even more nefarious purposes. This practice is also looked at in chapter 4.
The third factor, not unconnected with the second, was that in not having an incorporation rule of residence the United Kingdom was out of line with most other countries in Europe and indeed in the developed world. Most of the countries have a residence type rule equivalent to our incorporation rule though in some civil law countries it takes the form of the `seat’ test which comes to much the same thing. Very broadly speaking, a company formed under the laws of a country which has a `seat’ test must designate its seat of central management and administration in its registered `Articles’ and it is generally difficult for such a company to have its designated seat outside the country in which it was formed.
ITH358 Company residence: incorporation rule: effect of the rule
The incorporation rule takes precedence over the case law rule for United Kingdom incorporated companies. But it does not displace the case law rule which remains the rule of residence. Nor was there any attempt to enshrine the case law rule in statute so there is still no comprehensive statutory definition of residence. The case law rule is the only rule for companies incorporated outside the United Kingdom. If residence outside the United Kingdom is mentioned without any qualification, for example in ICTA88/S293 (2) `resident in the United Kingdom and not resident elsewhere’, then, even for a United Kingdom incorporated company, `resident elsewhere’ means centrally managed and controlled elsewhere. Nor does the incorporation rule displace the tie-breaker in a double taxation agreement which may award residence to the other country for the purpose of the agreement.
ITH359 Company residence: incorporation rule: exceptions
There was no consultation before the 1988 change. To have introduced the incorporation rule with immediate effect for all companies would have been too draconian. A five year period of grace was given to companies which were incorporated and had carried on business before 15 March 1988 (Budget Day) but were not resident immediately before that date.
During the course of the Finance Bill representations were made on behalf of companies which had been resident but had migrated, or were about to migrate, with Treasury consent. In response to these representations, a category of indefinite exceptions to the incorporation rule was created for companies which migrated with Treasury consent, so long as they continued to carry on business and their central management and control remained outside the United Kingdom. Most of these companies would have had specifically to apply to the Treasury for consent and their reasons for migration would have been scrutinised. But some companies controlled by non-residents were entitled to migrate under the benefit of a general consent which did not require them to make a specific application. These companies only qualify for indefinite exception if they are also liable to tax in another country on a basis intended to be the equivalent of taxation on worldwide income. The aim of this latter provision was to cut down as far as possible the number of companies with operations based in tax havens which would be entitled to indefinite exception.
ITH360 Company residence: second Statement of Practice
There was some doubt outside the Revenue (and even within it) as to the meaning of some expressions used in the 1988 provisions, particularly `carrying on business’ and `taxable in a territory outside the United Kingdom’. A revised Statement of Practice on Company Residence was issued in 1990 (SP1/90) which explained the Revenue’s interpretation. The Statement included the previous Statement on the case law rule which was unchanged, except for an amendment in paragraph 19 of the Statement to suggest that there may be cases where it is not possible to identify any one country as the seat of central management and control. We looked at this possibility in ITH338 on dual residence under domestic law.
ITH365 Company residence: incorporation rule/treaty non-residents
The incorporation rule was introduced primarily as a protection against exploitation of the case law rule and the misuse of United Kingdom incorporation. But it is hardly surprising that such a major change in the law had some less desirable repercussions. These appear in what we call Treaty Non-Resident companies - TNRs. These are companies which are resident both in the United Kingdom under its domestic law and in another country under that country’s law and the tie-breaker in the Double Taxation Agreement between the two countries awards residence for Agreement purposes to the other country. There is more in chapter 5 about residence for treaty purposes (ITH514). The most common tie- breaker awards residence to the country in which the company’s place of effective management is to be found. Even when the case law rule was the only residence rule of the United Kingdom it was possible for a company to be a TNR. It could be centrally managed and controlled here and effectively managed elsewhere. But the incorporation rule increased the scope for TNRs because a company can be incorporated in the United Kingdom and yet conduct its business wholly overseas.
ITH366 Company residence: the problem
The problem of the TNR is that for treaty purposes it is non-resident and we cannot tax its income or gains unless the treaty allows us to. If a company incorporated here has all its management and operations abroad there will be little, if anything, that the United Kingdom can tax under the treaty. But before 1988 United Kingdom domestic law assumed that if a company was resident here it was liable to tax on its world-wide income and gains. So some provisions will not work as intended if the company is resident but not liable. For example, the capital gains provisions allow transfers of assets between resident members of a group on a no gain no loss basis on the assumption that the gain will be taxed when the asset is sold outside the group. But without specific provision to the contrary, an asset could be transferred to a TNR on that basis but the treaty could prevent our taxing the gain when the TNR sells the asset. Examples of other anomalies requiring special treatment for TNRs are to be found in other group situations where a TNR can be treated as a group member for the purpose of intra-group payments of dividends and interest. And, without specific provision to the contrary, a TNR could not be a controlled foreign company nor count as a non-resident in the income tax anti-avoidance provisions against transfers of assets found in ICTA88/S739 - ICTA88/S746.
ITH367 Company residence: legislation against treaty
Starting with 1988 there had been legislation which was either aimed specifically at preventing possible avoidance through TNRs or which, in introducing new provisions for companies in general, took account of TNRs. These provisions are briefly considered in Chapter 4. But by 1993 it was realised that there were many other opportunities for tax planners to exploit the mismatches attributable to a company being resident under domestic law while not resident for treaty purposes. So rather than continue to tackle the problem piecemeal it was decided to go for a general solution and deem such a company to be not resident in the United Kingdom for all purposes. The legislation is in FA94/S249 - FA94/S251.
ITH368 Company residence: general solution
FA94/S249 provides that a TNR company is not resident for United Kingdom tax purposes. This rule applies from 30 November 1993 so that all companies which were TNR at that date are regarded as having migrated on that date. Any company which becomes a TNR after that date effects an actual migration, rather than just a treaty migration.
A company does not have to make a claim under a treaty before the new rule applies. This is to stop companies moving in and out of United Kingdom residence depending on whether a claim is made for a particular year. The residence tie- breaker in most treaties applies an objective test - often the location of `effective management’ (ITH348). If under that objective test, residence has been or would be awarded to our treaty partner then Section 249 applies. In a few treaties - for example, in the agreement with Canada, where the tie-breaker can only operate upon agreement between the two authorities, the new rule cannot run until that agreement has been reached. The new rule has no application where treaty residence would be awarded to the United Kingdom (because then there is no mismatch between the treatment under domestic law and under the treaty) or where the treaty does not contain a tie-breaker, for example, in the case of the treaties with the USA, the Isle of Man and the Channel Islands.
ITH371 Company residence: European company
In the late 1980s a European company statute was drafted as a blueprint for a European company. Whenever a new European creature is created there are problems in deciding to what extent our existing tax law can be applied and what new provisions are necessary. Just how this creature will fit into our company and tax law, in particular with the rules for residence, will become clear only when the statute is in its final form and any necessary company and tax legislation is in place.
ITH400 Company residence: consequences of law
This chapter considers certain consequences of the company residence rules. Some adverse consequences have led to anti-avoidance legislation which is described at the relevant points. Others continue to be exploited.
We have seen in the preceding chapter that the central management and control test allows residence to be moved easily and to be divorced from both the place of effective management and the place of incorporation. All the situations we look at in connection with this test - in ITH401 - ITH442 - reflect one or other of these factors.
The consequences of the incorporation rule are considered in the latter part of the chapter.
ITH401 Companies: Treasury consent: migrations/transfers of business
Subsection 1(a) and (b) of ICTA88/S765 and its predecessors required companies to have Treasury consent to a migration or to a transfer of business to a non-resident. Provisions (a) and (b) of subsection 1 were repealed by FA 1988 with effect from 15 March 1988. However, for nearly forty years (a) was the major obstacle in the Taxes Acts to companies moving their residence out of the United Kingdom without regard for loss of tax to the Exchequer. Consent for transfer of business was a necessary corollary to prevent the transfer of the whole of the business to a newly formed non-resident company thus defeating the purpose of the Section. But since 1965 the charge on capital gains has provided some compensation to the Revenue for transfers of business.
ITH402 Companies: migrations/business transfers: Treasury consent: why needed
The reasons for the introduction of the Treasury consent requirement in 1951 were mentioned in chapter 1 (ITH127). The post war improvement in communication had led to greater mobility and some important companies transferred their management and control abroad. The Revenue regarded such action as tax avoidance. The Royal Commission of 1953 disagreed but the decision to enact what became Section 765 was pragmatically based. The country simply could not afford the loss of tax which wholesale migration would have led to and decided to hold on to what it held. (continued) 402-403 Company residence. Some consequences of the law
The difficulty our predecessors had in framing this provision was discussed in Chapter 1. In the climate of emergency at that time no alternative was seen to what has come to be known as the `turnstile’ - the requirement that Treasury consent be sought. The Treasury would rely on the Revenue for advice. The 1951 provision for Treasury consent extended to the issues and transfers of shares and debentures in non-resident subsidiaries of United Kingdom resident companies. This requirement survives in subsection 1(c) and (d) of Section 765 which we look at in Chapter 13.
ITH403 Companies: migrations/business transfers: Treasury consent: later need
It became clear some years after the Treasury consent provisions were enacted that it would no longer be possible or necessary to resist the migration of the type of company at which the section had originally been aimed. The intention had been to keep resident in the United Kingdom companies whose main trading activities were overseas where tax rates were low so that substantial United Kingdom tax would continue to be paid. But as former colonies became independent, political pressure grew for these companies to be wholly established locally. At the same time overseas tax rates increased with a consequent increase of credit against United Kingdom tax. The terms of reference of the Advisory Panel, which was set up to advise the Chancellor on cases where refusal was contemplated, no longer justified refusal of consent for these companies to cease to be resident.
However, we continued to need subsections l(a) and (b) to prevent loss of tax from migrations in rather different circumstances. Absolute freedom in the residence field might have had some very undesirable consequences.
- Take the case of the United Kingdom company whose business was here in every way. Without 1(a) such a company could have run its operation here as a branch of a tax haven resident company. If it did, it would have had all sorts of problems, but it might not have been beyond the wit of the tax planners to surmount them.
- After the tax haven legislation was enacted a United Kingdom company whose interests were mainly overseas could simply have moved offshore to avoid the legislation.
- There would have been companies who would migrate just before realising substantial capital gains - possibly becoming resident again later.
ITH404 Companies: Treasury consent: migrations: Daily Mail Trust
One company which nearly succeeded in migrating to avoid a charge on capital gains was the Daily Mail and General Trust plc. This was an investment holding company whose main interests were in the United Kingdom. The company wanted to transfer its central management and control to the Netherlands before a reorganisation in the course of which it intended to sell part of its assets which would yield substantial capital gains. It applied for Treasury consent. When the Revenue and Treasury raised objections the company claimed, on judicial review [Regina v HM Treasury ex parte Daily Mail and General Trust plc (1987) STC157 (1988) STC787] that the requirement for Treasury consent was contrary to Article 52 of the Treaty of Rome. This Article prohibits restrictions on the freedom of establishment of nationals, including companies, of a Member State in the territory of another Member State. The English court referred the matter to the European Court of Justice. The European Court was clear that the Article applied to restrictions on nationals leaving to go to another Member State as well as restrictions on those coming in but, somewhat to the surprise of experts in European law, the Court decided that Article 52 did not confer a right on a company incorporated in one Member State to transfer its central management and control to another Member State.
The Daily Mail decision was something of an anti-climax. While the case was going through the European Court procedures, fundamental changes in United Kingdom law on company residence and migrations took place and the requirement for Treasury consent to migrations and transfers of business was abolished.
We have seen in the preceding chapter that it was in 1988 that the incorporation rule of residence was enacted and that the possible threat from the Treaty of Rome was a contributory factor. One obvious result of the rule was that, broadly speaking, it stopped United Kingdom incorporated companies from migrating, although FA94/S249 has changed the position again. We look at other implications later in this chapter.
ITH407 Company residence: exit charge
With the demise of Treasury consent to migration it was necessary to do something to mitigate the potential loss of tax from the migration of United Kingdom resident but non-United Kingdom incorporated foreign companies. There was no way and possibly no reason to compensate for loss of tax on income. If sources of income are removed from the United Kingdom tax jurisdiction as a result of a genuine transfer of central management and control we arguably have no claim on that income. If the migrating company is a subsidiary of a United Kingdom parent, the tax haven legislation may protect the Revenue from loss of tax on income which can be seen as avoidance. The loss of tax on capital gains is a different matter. Gains have accumulated whilst the company is resident. So in 1988 what is now TCGA92/S185, introduced a charge on these accumulated gains - an `exit charge’. To the extent that the charge acts as a deterrent to migration it also helps to prevent a loss of tax on income.
The exit charge is imposed by the common convention of deeming chargeable assets to be disposed of and immediately reacquired at their market value. In this case the disposal is deemed to take place immediately before migration. It follows that if the company becomes resident again the base value of assets held since before migration will be market value at migration. The charge is waived for assets situated in the United Kingdom which are left in a United Kingdom trading branch or agency because the gains on these remain within the charge under ICTA88/S11 (2)(b). The waiver extends to assets used for exploration or exploitation activities in the designated area of the Continental Shelf.
ITH408 Company residence: exit charge: roll-over relief
The Section also prevents a migrating company from claiming roll-over relief under TCGA92/S152 on charges on assets disposed of before migration if the new assets are acquired after migration and are not held by a United Kingdom branch or agency. Nor can a gain on a deemed disposal on migration be rolled over under Section 152. We take the view that since the deemed reacquisition on migration is of the same asset, that cannot satisfy the condition required for a roll-over claim that the acquisition must be of a different asset.
The 1988 exit charge provisions included another important occasion of charge in TCGA92/S186. But this charge mainly, though not exclusively, affected companies made resident in the United Kingdom by reason of incorporation and will be looked at later in this chapter (ITH450). In this part of the chapter we are looking at the consequences of the central management and control test of which the exit charge can be seen as one. It is primarily necessary because of the mobility available to companies under that test.
ITH409 Company residence: exit charge: postponement of charge
The exit charge is imposed on all migrating companies. But a charge on deemed disposals can be an onerous burden on a company without liquid assets, and if a company is trading it may not easily be able to dispose of the assets used in its trade. Moreover, a company could simply choose to remain resident but sell its trade to a new non-resident subsidiary and take advantage of the postponement of charge available in TCGA92/S140. So ICTA88/S187 permits some companies to claim postponement of the exit charge on gains on assets which are outside the United Kingdom and are used in a trade carried on abroad. These assets are designated `foreign assets’.
The right of postponement is, however, limited to direct 75 per cent subsidiaries of United Kingdom resident companies. The restriction is necessary because it would be impossible to keep track of a migrating company which retained no links with the United Kingdom or to make the charge stick when the conditions for postponement ceased to apply. However, many migrations will be of subsidiaries of United Kingdom parents with operations almost wholly abroad but which have been resident here by reason of central management and control exercised by the parent. Both parent and subsidiary must elect for postponement because the eventual charge is levied on the parent by deeming it to have disposed of some or all of the assets. Broadly speaking, a charge is imposed if the migrating company disposes of foreign assets within six years of migration or if, at any time, the parent sells the shares in the subsidiary or itself ceases to be resident in the United Kingdom. Precise details of the occasions and computations are in CG42540 onwards.
ITH413 Company residence: safeguarding collection
If a company migrated leaving nothing behind in the United Kingdom but liabilities to tax, the Revenue could obviously have difficulty in recovering the tax. Treasury consent procedures took care of this problem by making consent to migration conditional upon the appointment of an attorney and provision of a guarantee or other arrangements to cover eventual tax due.
Clearly something similar was necessary under the new regime, particularly as the exit charge could increase liabilities. FA88/S130, therefore, requires companies intending to migrate to notify the Revenue and make satisfactory arrangements before leaving the United Kingdom. The Statement of Practice SP2/90 explains what arrangements are acceptable.
Section 131 imposes penalties for non-compliance with Section 130 not only on the company, which would not be much use, but on as many people as possible, such as directors, parent company and its directors, who might be implicated in the migration and might possibly remain in the United Kingdom. On the belt and braces principle and whether or not the company has complied with Section 130, Section 132 allows the Revenue to recover the tax from other group members or controlling directors.
ITH419 Company residence: loss importation
We now come to two problems associated with the central management and control test which we have with companies which become or remain resident here. The first problem is referred to as loss importation. When an overseas subsidiary of a United Kingdom parent is making losses it is relatively easy for the parent to ensure that the central management and control of the subsidiary is in the United Kingdom even if the whole of its operations are overseas. The losses become available for group relief. The Unit Construction case gives an early example of this (chapter 3 ITH323). In those days relief was obtained by way of a deduction for subvention payments. Although the mischief is more obvious if the subsidiary only becomes resident when it starts to make losses, it can also be seen when the subsidiary is resident from the beginning. And there are also possible problems when losses are incurred not by a subsidiary but by an overseas branch of a United Kingdom resident company.
ITH420 Company residence: loss importation: the branch
The root of the problem is this. When two countries tax the same source of trading income the treaties, or unilateral relief, soften the impact of double taxation. But where there is a loss both countries may give relief for the loss. The simplest example is that of the genuine branch. In the following illustrations the company is resident in the United Kingdom and has a trading branch in country X. There is a standard Double Taxation Agreement with country X so both countries tax the profits and the United Kingdom gives credit. The tax rates are illustrative only.
ITH421 Company residence: loss importation: the branch: example
|Branch result||THE BRANCH|
|Branch result||THE BRANCH|
|United Kingdom||Country X|
|Tax @ 33%||330||330|
|Loss relief @ 33%||-330|
|(reduces Case 1)|
Both countries give loss relief and the result is fair. The relief that the United Kingdom gives in year 2 is recouped in year 3, so there is nothing essentially offensive in the idea that we give relief for losses which have also been relieved abroad. The next example is of the same situation except that the losses in country X are so large that the operation there is closed down.
ITH422 Company residence: loss importation: branch closes down: example
|THE BRANCH CLOSE DOWN|
|Branch result||THE BRANCH CLOSE DOWN|
|Branch result||THE BRANCH CLOSE DOWN|
|United Kingdom||Country X|
|Tax @ 33%||330||330|
|Year 2 as Year 1|
|(reduces Case 1)|
|Loss relief @ 33%||-3,330||NIL|
Country X may have some provision for allowing the loss in part by carry- backwards, but such a large loss is probably in the nature of things not totally relievable in country X which is taxing only the branch profit. The United Kingdom, on the other hand, will give relief either by setting against other Case I profit or by group relief. Thus we will have given relief which will never be recouped but that is arguably a consequence of asserting taxing rights on the basis of residence. The company might argue that overall the result is fair. Overall there is a loss of £8,000 (£10,000-£2,000), tax has been paid on £2,000 in country X and the United Kingdom has given relief on £10,000 so that in total only £8,000 has been relieved.
ITH423 Company residence: loss importation: the subsidiary
Next we have a similar situation but the trading operations are carried on wholly in country X by a subsidiary which is incorporated there and taxed as a resident there. If the subsidiary is managed and controlled in the United Kingdom it will also be taxed as resident here unless in a treaty case FA94/S249 applies to deem the company to be not resident in the United Kingdom. If country X allows relief for losses only by way of carry forward, then on the same results, the tax position of the subsidiary in the United Kingdom will be the same as that of the branch in examples 1 and 2, except that relief for losses will be by way of group relief.
But for a subsidiary company there are other possibilities. The subsidiary may be part of a sub-group in country X and that country may also give loss relief against group profits. It may be possible for the subsidiary to move its residence in and out of the United Kingdom so as to get the best advantage from the provisions for tax credit and loss relief. The following examples illustrate these possibilities.
ITH424 Company residence: loss importation: the subsidiary: example 3A
|SUBSIDIARY RESIDENT IN COUNTRY X :Subsidiary results||SUBSIDIARY RESIDENT IN COUNTRY X : Subsidiary results||SUBSIDIARY RESIDENT IN COUNTRY X : Subsidiary results|
The subsidiary is also resident in the United Kingdom all years. Country X gives group relief for year 2.
|United Kingdom||Country X|
|Tax @ 33%||330||330|
|Group relief @ 33%||-330||-330|
ITH425 Company residence: loss importation: the subsidiary: example 3B
The subsidiary is not United Kingdom resident in Year 1; it is United Kingdom resident Years 2 and 3. It carries back losses in country X.
|United Kingdom||Country X|
|Less Loss||Carried back 1,000|
|Group relief @ 33%||-330||NIL|
ITH426 Company residence: loss importation: the subsidiary: example 3C
The subsidiary is not United Kingdom resident Year 1; is resident Year 2; is not resident Year 3. It carries forward losses in country X.
|United Kingdom||Country X|
|Tax @ 33%||330|
|Group relief @ 33%||-330||NIL|
|Less Loss||- 1,000|
In all three examples A, B and C the United Kingdom gets no tax but gives relief on £1000 & 33%. The company makes net overall profits of £1200 but pays tax on only £200 if group relief is taken into account.
ITH427 Company residence: loss importation: the subsidiary: example 3D
If, in example 3C, the company remained resident in Year 3, we would expect the tax to be
|United Kingdom||Country X|
|Tax @ 33%||330|
|Group relief @ 33%||-330||NIL|
|Less Loss||- 1,000|
But prior to FA94/S249 the company may have turned to the treaty between the United Kingdom and country X. It would have argued that its place of effective management is in country X and that that is the country, and the only country, of which it is a resident for the purposes of the treaty (see chapter 5 ITH515). It may have a permanent establishment in the United Kingdom (the offices where the directors meet) but there is hardly any profit attributable to that. In such circumstances it is unlikely that we would be able to persuade country X that the place of effective management is in the United Kingdom or that we could tax any profit. So the result would be
|United Kingdom||Country X|
just as in example 3C.
ITH 427 Company residence: loss importation: the subsidiary: example 3D
In all the variations of example 3 the key factor is that the company is resident in the United Kingdom in the year of loss. Under the central management and control test that is reasonably straightforward to achieve. But following FA94/S249 if there is a treaty between the United Kingdom and country X containing a company residence tie-breaker, we will be able to look to the test in the tie- breaker in determining residence for United Kingdom tax purposes. If the tie-breaker is based on the location of effective management which is shown to be in country X in year 3, then it is likely that effective management in year 2 is also in country X.
ITH429 Company residence: loss importation: branch and subsidiary
One final comment on example 3: looking back to the branch position referred to in example 2, that obviously cost the Revenue money and it was suggested that it was, arguably, not offensive. It is the inevitable consequence of asserting taxing rights over income when the primary taxing rights lie with another country. The same sort of thing can occur in the context of an overseas subsidiary becoming resident in the United Kingdom during the period of large losses leading to the closure of its business. However, that is different from the branch situation. The benefits of loss relief in the United Kingdom do not then arise as an inevitable consequence of the United Kingdom’s more general assertion of taxing rights over the entity but rather because the company, having chosen to put its profits out of range of United Kingdom tax, later endeavours to reverse the consequences of its own action. Such claims merit critical examination.
ITH430 Company residence: loss importation: effect of Section 249
As we have seen, where a company is resident in the United Kingdom under the case law test and also resident in another country with whom we do not have a treaty, or where the treaty lacks a company residence tie-breaker, the company may be able to manipulate its residence status to its advantage. Where, however, it is also resident in another country with whom we have a treaty containing a tie- breaker the effect of Section 249 is to make manipulation more difficult. It will generally be less feasible to move the location of effective management.
It might be asked why we did not legislate for all dual resident companies. But this would have come close to introducing a new statutory company residence rule. The 1994 legislation was not directed specifically at loss importation but instead at removing the anomalies attributable to the mismatch between residence under domestic law and residence under a treaty.
ITH437 Company residence: getting profits back tax free
The second problem for specific mention is loosely referred to as profit importation. It is a fundamental of our tax system that we tax a United Kingdom company under Case V if and when it receives a dividend from an overseas subsidiary. There are other tax systems where this is not so - the exemption method countries. But as a matter of policy we do not have such an approach, although, where the subsidiary is a genuine trader, we accept its right to decide whether to retain its profits or to send home dividends. It follows that we must be concerned if companies devise ways of getting profit back to this country tax free. Subsection (1)(c) and (d) of Section 765 which is considered in chapter 13, is concerned with devices of that sort and chapter 13 also looks at the problem of `upstream loans’ - from overseas subsidiaries to United Kingdom parents. Our concept of residence too may be manipulated in a way which has the effect of bringing home profit tax free.
ITH438 Companies: getting profits back tax free: inward migration
All that happens is that a non-resident subsidiary company - full of lowly taxed profit - becomes resident in the United Kingdom. The fact of becoming resident here does not involve that company or its parent in any liability to United Kingdom tax in respect of the profit, and once the subsidiary is here it is quite a simple matter to make that profit available to the parent. There are two common ways of achieving this.
- The subsidiary company declares a dividend which, since it is now resident, is intra-group.
The subsidiary makes a loan to its parent.
The parent company thus has the money in its hands and, tax apart, is in the same position as it would have been in, had the subsidiary company declared a dividend while it was non-resident. Some very large examples of this device have been seen. The tax-haven legislation may have reduced the amounts of lowly taxed profits available for importation and thus the need for legislative action. But capital gains and other profits which escape the CFC provisions may still be worth bringing in this way. International Division would like to be kept informed of cases detected in Districts. It is sometimes possible to make a challenge either by showing that the company was resident when the gains or other profits arose, or by showing that the company has not become resident in the United Kingdom. In a treaty case, following FA94/S249 it will normally be necessary for the company to show that effective management is now exercised in the United Kingdom.
ITH442 Company residence: advantage of central management/control test
The consequences of the central management and control test are not all negative for the Revenue. Once we had recognised the significance of the Unit Construction case and had set out our views in the 1983 Statement of Practice, it was possible to take a firmer line on tax-haven subsidiaries. We could argue that central management and control lay in the United Kingdom either with the parent or with any United Kingdom resident directors of the subsidiary. We have had some success in bringing into the United Kingdom tax net tax-haven profits in this way.
Since 1984 the profits of some companies can be taxed under the tax- haven (controlled foreign companies) provisions, but these provisions do not afford complete coverage. The assiduous use of a mixer company to pass dividends to the United Kingdom (see chapter 7 ITH728) can further reduce the effectiveness of the provisions. So in CFC cases, as in others, residence will remain an important issue. The residence position should always be borne in mind when an overseas subsidiary is reviewed under the CFC provisions. If arguments on residence are likely to get to Commissioners the case requires an exhaustive review of the facts. Even so, much may depend on oral evidence before Commissioners. It is, therefore, not surprising that cases tend to be settled by some compromise agreement. Nevertheless some settlements have been very substantial indeed. Important cases are usually worked by or under the supervision of International Division who like to hear of potential cases at an early stage.
ITH445 Company residence: nowhere companies before incorporation rule
Before looking at the consequences of the incorporation rule of residence, it is convenient to consider briefly the phenomenon of the United Kingdom registered non-resident `nowhere’ company before 1988. It was a product not so much of the central management and control test as of the absence of an incorporation rule.
A `nowhere’ company is not subject to tax on worldwide income anywhere and is unlikely to suffer tax at all. In the 1970s, foreign operators began to realise that the United Kingdom provided an ideal opportunity for such companies. Traditional tax-haven countries such as the Channel Islands and Isle of Man have provided tax shelters for companies incorporated but not having real activity there on payment of a fee. In the United Kingdom there was no fee - only the cost of setting up and keeping the company on the register. All the operators had to do was to make sure that there was nothing like management and control or trading activity or income here. There was the added advantage of the respectability of United Kingdom incorporation. Before other countries got wise to the ploy they might even have assumed the company to be taxable here. Until 1979, exchange control was something of a hindrance because these companies had to get Bank of England permission to be treated as non-resident for exchange control - they obviously did not want their money in blocked sterling. The Bank of England would have given permission but might have asked awkward questions about the background which the operators would have been reluctant to disclose, even though bank officials would not have divulged anything to the Revenue or to anybody else.
Our own attempts at getting information met with little success. Not only would this information identify the exceptional case of United Kingdom resident ownership, it could be passed on to the countries of the beneficial owners where this exchange of information is authorised by a Double Taxation Agreement. But some companies operating in low tax areas such as the Middle East used the United Kingdom for the benefit of recourse to its law and had no reason to hide anything. Representations on behalf of these companies were partly responsible for stifling the proposal for an incorporation rule in 1981. By 1988 the number of dubious companies had increased enormously, the Revenue authorities of some countries were complaining at our acquiescence and it was suspected that a number of companies were being used for criminal activities.
ITH446 Company residence: successors to the nowhere company
United Kingdom registered `nowhere’ companies active before 15 March 1988 benefited from the period of grace before becoming subject to the incorporation rule in 1993 (see chapter 3 ITH359). That year should finally have marked their demise. But in the early 1990s there were signs that, phoenix-like, some were rising from the ashes, albeit not in quite the same form. `Son of nowhere’ companies have appeared in two main guises. In one there is a United Kingdom incorporated and, therefore, resident company. But the company is alleged to carry on all its activities as trustee or nominee and only the trustee’s remuneration appears in the accounts. As with the original nowhere company, our difficulty is getting at the structure behind the company. The fact that the company is resident and, therefore, within our taxing charge gives us a stronger lead. International Division is interested to see any such cases. The other ploy to replace the nowhere company is the `nowhere’ limited partnership. There is more about this in chapter 16 on Foreign Partnerships (ITH1639).
Even after 1993 it is not quite impossible to come across a United Kingdom incorporated nowhere company although it will not be one of the type so far considered. A United Kingdom incorporated company which migrated with special Treasury consent and continues to be outside the incorporation rule may have become a nowhere company. It does not have to be managed and controlled in the same country or carry on the same business as when it migrated although it does of course have to comply with all the conditions for indefinite exception from the incorporation rule (see chapter 3 ITH359).
ITH449 Company residence: incorporation rule and Treaty Non-Residents
As mentioned in chapter 3 (ITH365), even when the case law rule was the only residence rule of the United Kingdom it was possible for a company to be a TNR. It could be centrally managed and controlled here and effectively managed elsewhere. However, central management and control and effective management are usually located in the same place so before 1988 TNRs were rare. The incorporation rule increased the scope for TNRs because a company can be incorporated in the United Kingdom and yet conduct its business wholly overseas.
From 1988 the avoidance opportunities were countered on a piecemeal basis.
ITH450 Company residence: treaty migration
The first anti-TNR provision was in the 1988 package which included the incorporation rule and the exit charge. It became TCGA92/S186. It affected the company which had been resident in the United Kingdom and nowhere else for treaty purposes and remained resident but became a TNR. For example, a United Kingdom incorporated company may move its operations abroad. Section 186 imposed a charge on accumulated gains at the time it became a TNR, equivalent to the exit charge on companies which cease to be resident. It applied only to assets where the treaty prevents a charge on the gains - `prescribed assets’.
Section 186 was repealed by FA94S251 because a company effecting a treaty migration after 30 November 1993 is liable to the exit charge under TCGA92/S185 (ITH407).
ITH451 Company residence: other anti-TNR provisions
Various measures between 1989 and 1993 tackled specific avoidance using TNRs. In particular,1990 saw action against TNRs in three important areas.
- Capital Gains - Groups and company reconstructions
Safeguards in TCGA92/S171 and TCGA92/S175 ensured that the no gain no loss provisions on intra-group transfers of assets and roll-over relief for replacement of group assets did not run where the assets were transferred or the new assets were acquired by a TNR unless the treaty allows the United Kingdom to tax gains on the assets in the hands of the TNR. Similarly the Section 139 provisions for transfers of assets in company reconstructions did not run where the transferee is a TNR and the United Kingdom loses the taxing rights.
- Transfers of assets abroad
Amendments were made to ICTA88/S742 (8) to make a TNR a non-resident for the purpose of the Income Tax anti-avoidance legislation on transfer of assets abroad.
- Controlled foreign companies
Amendments were made to the Controlled Foreign Companies provisions so that a TNR was treated as resident outside the United Kingdom and could, therefore, be a CFC. The amendments also made sure that no dividends received or paid by the TNR could be included in an acceptable distribution test unless they came within the charge to Corporation Tax in the United Kingdom.
All these provisions became otiose on the introduction of FA94/S249 and were repealed by Section 251.
ITH452 Company residence: companies undergoing forced migration
Companies undergoing forced migration On FA94/S249 coming into force, existing TNR companies underwent a forced migration on 30 November 1993. FA94/S250 contains 3 measures affecting such companies.
- The exit charge (ITH407) is deferred for 6 years, or until the asset is sold if earlier. Of course the deemed disposal of assets immediately prior to migration takes place at a time when the company is a TNR and most gains will enjoy treaty protection. In general the charge will be limited to gains arising on the deemed disposal of United Kingdom land although the charge may be wider where there is no capital gains article in the relevant treaty. The provisions of Section 250(4) operate independently from any claim under TCGA92/S187 and do not accelerate a tax charge which would otherwise be deferred under Section 187.
- The requirement under FA88/S130 (ITH413) to notify the Revenue of intended migration is removed. This recognises the fact that the company would not have been able to comply with that provision.
- The degrouping charge under TCGA92/S179 in respect of assets acquired within the previous 6 years from group companies is disapplied. These special provisions do not apply to companies which undergo a forced migration in other circumstances, for example, on the entry into force of a new treaty with a company residence tie-breaker.
ITH453 Company residence: other consequences of FA94 S249
Although in cases where Section 249 applies it should be easier to challenge the more blatant cases involving manipulation of our residence rules, the main purpose of Section 249 is to align a company’s treatment under domestic law with its treatment under a Double Taxation Agreement. It also removes the anomaly that all taxing rights on profits could be eliminated under a treaty but the company nevertheless remained liable to account for ACT. Where a treaty does not contain a tie-breaker, the company remains United Kingdom resident under the treaty and it is logical that its United Kingdom residence under domestic law is also unaffected.
Furthermore, it is not intended that the new rule should be applied in marginal cases where there is no mischief unless the company itself invokes the Double Taxation Agreement. For instance, the location of effective management of the holding company for the United Kingdom subgroup of an overseas group may be unclear in a case where a company is mainly managed here but some management decisions are taken abroad. We would not regard as objectionable the fact that the company exists to allow losses to flow as group relief between members of the United Kingdom subgroup and the benefit of any doubt on the location of effective management may be given to the company.