HMRC consultation on preventing tax avoidance involving profit fragmentation,
by UK resident individuals using offshore structures
HMRC recently issued a consultation on tax avoidance involving profit fragmentation. The subject of the consultation is tackling arrangements entered into by individuals, partnerships or companies that aim to place profits proper to the UK outside the scope of UK taxation.
The consultation follows the Autumn 2017 Budget focus on UK traders and professionals who arrange for trading income to be transferred to unrelated entities. In that budget, the government announced that it would consult on proposals to prevent UK traders and professionals from avoiding tax by arranging for their UK business profits to accrue in low or no tax, or only a low rate of tax jurisdictions. These arrangements may take a number of forms, all of which involve fragmentation of profit which derives from a single activity, but which for tax purposes is said to arise in two or more jurisdictions.
The arrangements being targeted by the consultation ae those which involve offshore trusts and companies in low or nil tax jurisdictions which accrue profits attributable to the exploitation of a UK resident individual's earning capacity by arranging either for the receipts of that activity to accrue to or excessive expenses, to be paid to an overseas entity. The consultation acknowledges that such arrangements are vulnerable to challenge under existing anti-avoidance legislation (particularly the transfer of assets abroad legislation), but states that delays by promoters and users in supplying information make it difficult to apply.
It is a general principle of UK taxation that a UK resident person (individual or company) is taxable in the UK on all profits they receive from any trade or profession that they carry on, whether carried on in the UK or overseas. This applies unless one of the exemptions available for foreign profits applies. It is normally clear where profit-generating activity takes place and hence where profits should arise for tax purposes. However, HMRC is aware of arrangements which often involve offshore trusts and companies in low or nil tax territories which are designed to attribute profits in a manner which exploits a UK resident’s capacity for tax purposes to accrue in another territory. HMRC has succeeded in challenging some of these arrangements and in recovering significant amounts of tax. However, enquiries and then actions consume considerable resource and can take several years to resolve and therefore the government is proposing legislation which targets these schemes directly.
There are two proposals. The first is that UK resident individuals will be liable to tax (as an increase to trading or partnership income, or employment income, as applicable) on profits attributable to that person's professional or trading skills that "end up" in an entity where "significantly less tax" is paid (alienated profits) if both of the following conditions are met: (i) the UK resident (or certain connected persons or persons acting together with them) has "power to enjoy" the economic benefits from the alienated profits; and (ii) it is reasonable to conclude that at least some of that entity's profit is excessive (having regard to the functions it performs) and that this is attributable to its connection to the UK resident individual. This is particularly relevant to small and medium-sized enterprises exempt from transfer pricing and diverted profits tax.
The second proposal requires those who enter or have entered into such arrangements (and without, themselves, reaching a judgement as to whether the entity's profit is excessive) to notify HMRC which will review the facts. If HMRC considers the entity's profit to be excessive, it will issue a "charging notice" requiring the tax to be paid within 30 days.
Legislation is to be included in the Finance Bill 2019, to take effect from April 2019, and will apply to both new and existing arrangements.