Double Taxation Relief: Anti avoidance legislation: Circumstances which can cause the legislation to take effect
The legislation only takes effect if one or more of the circumstances listed in TIOPA10/S84 to S88 apply. These are listed in statute as follows:
- The foreign tax is not properly attributable to the source from which the income or gain is derived.
- The payer of the foreign tax, taken together with all other parties to the scheme or arrangement, has not suffered the full economic cost of the foreign tax against the income or gain against which relief is claimed.
- The payer of the deemed foreign tax has not suffered the full economic cost of the foreign tax against the income or gain against which relief is claimed.
- A claim, election or other arrangement could have been made by any person:
- Under the law of any territory; or
- Under any arrangements made in relation to any other territory,
which would have reduced the amount of credit for foreign tax. Alternatively, a claim, election or arrangement was made that had the effect of increasing the amount of credit for foreign tax.
- The foreign tax credit given as a result of the scheme or arrangement reduces the amount of tax payable to an amount less than would have been payable if the transactions making up the scheme had never taken place.
- A source of income subject to foreign tax has been acquired wholly or partly as consideration for a tax-deductible payment.
Further detail on the circumstances is set out below:
The foreign tax is not properly attributable to the source from which the income or gain is derived.
For example, a derivative contract such as a swap might be used to “strip” profit from a transaction, leaving a foreign tax payment without the matching income. Other income might then be attributed to the foreign tax, also through the operation of the derivative.
The person who claims a relief for the foreign tax has not suffered the full economic cost of the foreign tax against the income or gain against which relief is claimed.
This will be the case if a person claims relief for double taxation by way of credit for foreign tax which is payable and either:
- that person, any connected person, or any other person who is party to a scheme or arrangement to which the legislation applies benefits from a reduction in tax directly or indirectly in consequence of the payment of foreign tax by the first person; or
- the payment of foreign tax does not increase the aggregate amount of tax paid by that person together with any connected person or other party to the scheme.
A recent example within the first bullet is where a scheme participant received taxable interest attributed to a UK resident person by reason of their participation in a partnership. The interest was paid by another scheme participant who obtained a matching tax deduction. Hence there is no net payment of foreign tax by the scheme participants viewed together.
Another known example within the second bullet is where a UK resident person receives income that does not suffer foreign tax, but also pays foreign tax attributable to other income belonging to another person. The UK person participates in the taxed income through a hybrid entity, but returns the benefit of the income to its original owner through a manufactured payment.
The person who claims a relief for deemed foreign tax has not suffered the full economic cost of the foreign tax against the income or gain against which relief is claimed.
Introduced in Finance Act 2010, this rule has effect from 21 October 2009, the date on which the proposal was set out in a written Ministerial Statement. The rule means that the legislation can apply to deemed overseas tax deducted from manufactured overseas dividends (MODs) in the same way that it applies to overseas tax deducted from real dividends. The circumstance may also apply in other situations where the UK Tax Acts treat an amount that is not overseas tax as if it were overseas tax and has effect in relation to amounts deemed to be foreign tax paid or payable on or after 21 October 2009.
The circumstance will apply where foreign tax is treated as paid or payable by a person and either condition A or condition B is met.
Condition A is met where it could reasonably be expected that, under the scheme or arrangement, no real foreign tax is paid by persons involved in the scheme or arrangement. Certain provisions in Tax Acts which deem foreign tax to have been paid look to the rate of tax that would have been suffered if the claimant had received the real overseas dividend or interest. As a result, there may not have been any tax withheld on the real overseas dividend or interest but the Tax Acts could still deem a UK person to have suffered foreign tax. HMRC sees this situation as analogous to schemes which have been notified to us. Under those schemes, a person claims a credit for deemed foreign tax where real foreign tax has been paid but there is also a relief arising to another person party to the scheme which means that the overall foreign tax is zero.
The fact that there would be no real foreign tax must have been in the contemplation of the claimant, in other words, part of the scheme or arrangement. If the recipient of a MOD cannot reasonably be expected to know whether or not tax will be paid in respect of a dividend, then Condition A will not apply.
One of the main functions of the foreign equities market is to enable holders to receive income in such a way that they can realise a greater proportion of the value of gross dividends inherent in shares than they would if they received the dividend. This legislation will not stop market participants taking advantage of pricing arbitrage opportunities in the market, for the following reasons:
* Condition A may not apply as there may not be a scheme or arrangement to which the person receiving the real dividend is a party. * Even if there is a scheme or arrangement, where the effect of the arbitrage opportunity is to increase the pre-tax profits of the person claiming the deemed foreign tax credit, a main purpose of the scheme should not be to cause an amount of foreign tax to be taken into account.
In such a case, HMRC would not therefore serve a notice under TIOPA10/S81(2) (formerly ICTA88/S804ZA).
Condition B is met only where it could reasonably be expected that, under the scheme or arrangement, real foreign tax would be paid by persons involved in the scheme or arrangement but another person party to the scheme claims a relief for that foreign tax which results in the foreign tax total increasing by less than the amount of deemed foreign tax.
A bank borrows £1,500 to buy German shares. The cost of funds is 5% pa (including overheads). The German shares pay a gross dividend of £100 but subject to a 15% withholding tax. The bank’s ‘mini-Case I computation’ in accordance with TIOPA 2010/S44 (formerly ICTA88/S798A) would be as follows:
The credit for foreign tax paid would be limited under section 44 to the UK tax on the net profit from the transaction. Consequently, the net value to the bank of the real dividend would be £92, being the net dividend plus the allowable credit (100 - 15 + 7). However, if a market participant valued the dividend at £2 higher then the bank might decide to repo the share to the market counterparty and receive a MOD instead. The bank’s income statement would then be:
|Profit on repo||2|
The bank has increased its PBT by £2 by transferring the shares and receiving a MOD. The reason why the market counterparty valued the dividend higher might be because it could receive the dividend gross or because it is entitled to reclaim any tax withheld on the real dividend. However, HMRC would consider that the market counterparty should not be considered party to or concerned in a scheme or arrangement. Even if there was a scheme or arrangement, a main purpose should not be to cause an amount of foreign tax to be taken into account.
HMRC will consider issuing a notice where taxpayers have sought to receive MODs rather than real dividends in order to avoid the application of TIOPA10/S81 onwards. We generally see this avoidance in highly structured transactions where there is little or no commercial purpose and the benefit is mainly through the tax line in the form of a tax credit.
A step was taken or could have been taken by any person:
- Under the law of any territory; or
- Under any arrangements made in relation to any territory,
and the effect of that action or failure to act is to increase the amount of credit for foreign tax.
The steps include claims, elections or other arrangements.
The foreign tax credit reduces the amount of tax payable to an amount less than would have been payable if the transactions making up the scheme had never taken place.
This covers “dividend buying” or similar arrangements, if the tax credit relief is not denied by legislation that imposes a net basis of credit relief. It ensures that foreign tax credit arising from a scheme or arrangement is limited to tax due on the profit arising from the scheme or arrangement, in order to prevent it reducing tax due on profits that arise outside of the scheme or arrangement.
A dividend buying transaction might consist of the purchase of a shareholding just before the dividend date and its resale shortly afterwards. Little or no profit arises, but a tax credit for withheld tax reduces the tax bill to less than it would have been without the whole transaction.
A source of income subject to foreign tax has been acquired wholly or partly as consideration for a tax-deductible payment.
For example, a tax-deductible payment of 100 gives rise to income of 100 on which foreign tax of 30 is paid. There is no increase in taxable profit from the transaction, but credit for foreign tax is obtained. This example may also trigger TIOPA10/S87.