The age of the regime, and its many subsequent amendments, make it one of the most difficult for clients and advisers to be certain of its application. As a result there have been a large number of cases, including a flurry over the last few years, that have been making their way to the higher courts on key points such as the scope of the transferor and the application of the motive defence.
Any UK-resident taxpayer considering an offshore structure should consider the regime from the outset.
The TOAA regime found in sections 714-751 of the 2007 Income Tax Act (ITA 2007), has been in existence in some form for over 80 years and is designed to prevent UK-resident individuals from avoiding UK tax by a transfer of assets abroad. The rules are structured as a funnel: they start very wide, drawing a lot of ‘acceptable’ activity within scope, before narrowing it down through limitations and defences.
When the rules apply, the individual suffers a charge to income tax under one of three different heads, broadly intended to capture the income that has arisen outside the UK and subject it to UK tax.
It is a particular feature of disputes involving the TOAA rules that they often also involve questions regarding the interaction with other UK tax regimes, such as the settlements code or disguised remuneration. With the rising number and complexity of other anti-avoidance regimes and mobility of individuals, the flow of disputes in this area is unlikely to stem soon. HMRC regularly uses the TOAA regime as a back-up or alternative means of challenging tax structuring. Any individuals therefore considering any kind of offshore structure should always consider whether the rules may be engaged. Careful monitoring of the ongoing appeals will also be necessary.
The rules apply to ‘relevant transactions’. This means either a ‘relevant transfer’ or an ‘associated operation’.
A relevant transfer is defined in s716 of ITA 2007, and requires that there is:
There are some important points to note about this definition:
The ‘associated operations’ concept widens the scope of relevant transactions. There must always be a transfer of assets, but the transfer doesn’t have to give rise to the income — that can come from the associated operation. S179 of ITA 2007 defines associated operation as an operation of any kind by any person in relation to:
This broad definition can result in a significant tracing exercise to establish if income has arisen to a person abroad as a result of an associated operation.
Where there is a relevant transaction, there are three potential tax charges.
The first, under s720-721 ITA, applies to a UK-resident individual who, as a result of a relevant transfer and/or associated operations, has the power to enjoy income of a person abroad which would have been chargeable to UK income tax if it has been income of that UK-resident individual. The UK-resident individual has the ‘power to enjoy’ the income if one of five conditions in s723 ITA, is met, including the income increasing the value of the UK-resident’s assets or the individual being able to control the application of the income. In a 2000 case, Carvill v IRC, a shareholder who transferred shares in a UK company to a Bermudan holding company in a share for share exchange was found, as shareholder of the new Bermudan company, to have the power to enjoy the income of the person abroad, being the Bermudan company.
Any taxpayer seeking to rely on the motive defence should give the relevant case law careful scrutiny
The second charge arises under s727-728 ITA 2007 and applies where income has become the income of a person abroad as a result of a relevant transfer and/or associated operations and the UK-resident individual receives or is entitled to receive a capital sum (whether before or after the relevant transfer) and the payment of or entitlement to the sum is in any way connected to any relevant transaction. The UK-resident individual is charged income tax on the amount of income arising to the person abroad, subject to special rules for non-domiciled individuals. The target of this provision is an arrangement that might avoid the first charge to tax because the amount arising is not income, but rather capital. Capital sums are defined (apparently exhaustively) as sums paid or payable by way of loan or repayment of a loan or sums paid otherwise than as income (and not for full consideration).
The final charge, under s731-733 ITA 2007, applies to UK-resident individuals who receive a benefit that is provided out of assets that are available for that purpose as a result of a relevant transfer or an associated operation. This provision is designed to catch individuals other than the transferor of the assets and can include not only income or capital received, but also the right to use assets, e.g. live in a property. The amount of the income tax charge is capped at the amount of relevant income received by the person abroad.
There is a collection of exemptions to the regime under the broad heading of “motive” or “purpose”. Broadly, these defences can be relied on if the transactions:
However, relying on this motive test is usually much more complex than that. There are effectively three sets of rules depending on whether the relevant transactions occurred before or after 5 December 2005, or a combination of both. The precise definitions of the defences changed with effect from that date, introducing an element of objectivity which requires an assessment “that it would not be reasonable to draw the conclusion, from all the circumstances of the case” that one of the conditions has been met. Any taxpayer seeking to rely on the motive defence should give the relevant case law careful scrutiny.
The EU exemption, introduced in 2013 in response to infraction proceedings against the UK by the EU, applies where the transaction is a “genuine” one where subjecting the transaction to tax under the TOAA rules would constitute an unjustified and disproportionate restriction of a fundamental EU freedom. Following Brexit, this exemption remains on the UK statute book and, in relation to periods prior to 31 December 2020, it is fairly clear that taxpayers can continue to rely on its effect. The position is a lot less clear for periods after 31 December 2020 and it may be some time before we have clarity on this issue.
The TOAA rules have returned to the fore over recent years as a result of a series of cases. There are still issues arising that have not previously been decided in the courts and, in some cases, HMRC’s long-held positions are now being challenged.
One key issue – in the 2021 Fisher and 2020 Rialas cases – is that of the “quasi-transferor”: whether or not an individual who has not, personally, transferred the assets in the relevant transfer can still be subject to the tax charge arising under the power to enjoy provision and if they can, what is the extent of that group of “quasi-transferors”. In Fisher, HMRC sought to assess family shareholders in a UK resident company that had transferred its business to a Gibraltar company owned by the same individuals. HMRC argued that they had, together, procured the transfer of the business that gave rise to the income of the person abroad (the Gibraltar company), even though none of them individually had a majority shareholding. The Court of Appeal upheld the tribunal decisions regarding the father and son, who were actively involved in the business, but concluded that the mother, who was not involved in the business at all, should not be treated as a transferor. The Court of Appeal acknowledged that the legislation is not limited to imposing a charge only on transferors and that parliament “can be expected to have intended that the provision should be capable of applying to an individual who procured a transfer without himself executing it”. This part of the decision is a majority decision, with Lord Justice Phillips stridently dissenting on this issue.
In the Rialas decision, Mr Rialas had set up an offshore trust which acquired, at full market value, the shares of his business partner in the company that they jointly owned. HMRC sought to argue that Rialas was the transferor but the Upper Tribunal disagreed: the person who had transferred the shares was his business partner and Rialas had no control over his decision.
The TOAA rules should be considered for each separate relevant entity within a structure
These two decisions do not necessarily conflict with each other. In Fisher, the shareholders were making a decision together that resulted in the action of a company; whereas in Rialas the decisions were of two independent individual shareholders. The question of who constitutes the transferor has been a contentious issue since the 1940s. Rialas is being appealed to the Court of Appeal and both parties in Fisher have appealed to the Supreme Court, so there is definitely more to come in this area.
Another hot topic in these cases has been the interaction with EU law. In Fisher, there was a referral to the Court of Justice of the EU (CJEU) and the Court of Appeal concluded that the Fishers could not rely on any infringement of the freedom of establishment because Gibraltar was considered part of the UK for member state purposes. In Rialas, the Upper Tribunal declined to consider the EU fundamental freedoms “to allow better coordination of any appeal with the appeal in Fisher”. In 2021, in the Hoey case, the Upper Tribunal concluded that the taxpayer could not rely on the free movement of capital but, if that was wrong, it would have found that the application of the TOAA regime would not have been justified. While the Court of Appeal upheld the tribunal’s decision in May 2022, it expressly did not consider the point of EU law on the grounds that this was “unnecessary”.
The recent judicial attention has also clarified some other issues:
Although not forming part of its judgment in the Hoey appeal, the Court of Appeal rejected a suggestion by HMRC that the TOAA rules may take precedence over the normal employment income provisions in the 2003 Income Tax (Earnings and Pensions) Act (ITEPA).
In the past, the intricacies of the TOAA provisions were not always fully understood by advisers and trustees. One particular common mistake was the belief that a non-UK individual could set up a trust with a nominal amount and be listed as settlor in the trust deeds and a UK individual could then provide all future “elements of bounty” without the UK individual being seen as a settlor for tax purposes. The setup tended to involve shelf companies in jurisdictions which did not carry the same ownership requirements as the UK and could therefore be transferred into the trust without there effectively being a traceable transferor.
Due to the TOAA rules, this has meant that there are settlor-interested trusts with UK resident and domiciled settlors and potential historic liabilities to regularise.
The TOAA rules should be considered for each separate relevant entity within a structure. It may be that the income at trust level is taxable on the UK individual but that the motive defence is available with regards to the income realised by a company wholly owned by the trust. Therefore, the income of the company would not be taxable on the UK individual until such a time as a dividend is paid up to the trust.
A version of this article was originally published in Tax Journal.
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OUT-LAW NEWS
23 May 2022
