Double tax treaty could not prevent transfer of asset abroad provisions from applying

Mon 15 Oct 2018

In the case of Davies and others v HMRC [2018] UKFTT 0559 (TC), the First Tier Tax Tribunal (FTT) has held that the appellants were subject to tax as a result of the transfer of assets abroad rules at s720 ITA 2007 and that the UK/Mauritius double tax agreement could not be applied to prevent this.

The facts of the case

• An Isle of Man company (SAP) entered into an agreement with Wolverhampton and Dudley Breweries to purchase a property in November 2002, paying a non-refundable deposit of £125,000.
• Concerns were raised as the purchase would have constituted property development and led to SAP carrying on a trade in the UK and therefore subject to UK tax. A solution was therefore sought whereby SAP could back out of the transaction without forfeiting its deposit.
• A new Mauritian incorporated company (ABP) was therefore formed to complete the purchase in place of SAP.
• Each of the appellants took out a life policy with a wholly owned subsidiary of ABP, paying premiums of £3,000 each. The appellants’ entitlements under their life policies were linked to ABP.
• HMRC assessed the appellants on the income earned by ABP on the basis that they had the power to enjoy that income through the life policies they took out with ABP’s subsidiary.

Did the motive test apply?

The appellants argued that, whilst the transfer of asset abroad provisions potentially applied to them, they could rely on the exemption in s739 (3) or (4) ITA 2007 applicable for pre 5 December 2005 transactions. These provisions provide (respectively) that “avoiding liability to tax was not the purpose or one of the purposes for which the relevant transactions or any of them were effected”, or that “the transfer and any associated operations were genuine commercial transactions and were not designed for the purpose of avoiding liability to taxation”.

The FTT found that the appellants were concerned about SAP’s exposure to UK tax. Mauritius was chosen as the location for ABP in order to take advantage of the lower tax rates there and the ability to rely on the double tax agreement with the UK to prevent its profits being also subject to UK tax. Although the appellants would become subject to tax in the UK on their life policies in the event of a chargeable event gain, such arrangements deferred any liabilities to a later date. In the round, the FTT therefore concluded that the arrangements had been entered into for tax avoidance purposes and the motive test could not be relied upon.

Did the UK/Mauritius treaty apply?

The appellants argued that, if the income of ABP was to be attributed to them under s720 ITA 2007 (or its predecessor, s739 ICTA 1988), then it ought to be attributed along with the relief afforded by the treaty.

The Tribunal held that the only thing attributable to the appellants under s720 or s739 was the income realised by ABP. The individuals could therefore only claim any reliefs that would be available to them as UK residents as if the income had arisen to them directly. As the appellants were not resident in Mauritius, they were not entitled to take advantage of the UK/Mauritius treaty.

Why is this important?

This case is a useful reminder of the way in which the transfer of asset abroad provisions work, in particular the interaction between these provisions and double tax agreements. The exemption for post 5 December 2005 transactions is more restrictive than for transactions before that date.

Taxpayers must continue to be wary of falling foul of these rules when they use offshore structures in an attempt to divert income abroad that would otherwise be subject to UK income tax. In relation to income arising from transfers of assets before 6 April 2017, the issue could be of importance if no disclosure has yet been made.  Penalties arising in situations where the requirement to correct rules are relevant have increased to up to 200% of the tax due and cannot be below 100% of the tax due.  To discuss any area of the ‘transfer of assets abroad’ legislation or the requirement to correct rules, please get in contact with a member of the Mazars personal tax or tax investigation teams.