UK Tax Round Up – February 2025 – Corporate Tax

Welcome to February’s edition of the UK Tax Round Up. This
month has seen a number of interesting decisions covering the
unallowable purpose test in relation to cross border group relief
tax losses, the application of the Canada-UK double tax treaty to
the taxation of oil related payments and the application of the
statutory residence test and what constitutes “exception
circumstances, and updates from HMRC on the latest guidance on the
“capital contribution” test in the salaried members rules
and taxpayer return information provision related to carried
interest.

HMRC Announcements

Latest HMRC guidance on “capital contribution”
condition in the salaried member rules

Following wide-ranging consternation about HMRC’s unexpected
publication of revised guidance on the application of the salaried
member “target anti avoidance rule” (TAAR) to the
“capital contribution” condition in February last year,
HMRC have agreed to amend their guidance, in effect reversing those
changes. For our summary of the February 2024 rules please see our
previous UK Tax Round Up.

Under section 863A ITTOIA 2005, members of UK limited liability
partnerships (LLPs) who are treated as “salaried members”
are subject to tax on their remuneration as if they were employees.
Under the rules, all members of an LLP are salaried members unless
they “fail” one of the three tests in sections 863B, 863C
and 863D ITTOIA (so-called Conditions A, B and C). In order to fail
Condition C (the “capital contribution” test), the
relevant member’s capital contribution to the LLP for the
relevant tax year must be at least 25% or more of their expected
“disguised salary” (being the amount of their total
expected remuneration which is not “variable”). In
addition to these conditions, the salaried member rules include a
TAAR in section 863G ITTOIA which states, broadly, that no regard
is to be had to any arrangement the main purpose, or one of the
main purposes, of which is to secure that an LLP member is not a
salaried member. It is not uncommon for LLPs which rely on certain
of their members failing Condition C to have arrangements in place
under which the members will make additional capital contributions
to the LLP in anticipation of their remuneration increasing to
ensure that the contribution is equal to at least 25% of the
expected remuneration (so called “top up”
contributions).

In February 2024, HMRC updated their guidance on Condition C to
include an example to which they stated that the TAAR would apply
involving a member who had made a “genuine” capital
contribution to an LLP on becoming a member then making additional
“top up” contributions as a result of an increase in
expected remuneration and as required to ensure that the member
continued to satisfy the 25% capital contribution in Condition C.
The revised guidance stated that the additional capital
contribution would be disregarded applying the TAAR if the, or any,
main purpose of making the additional capital contribution was to
fail Condition C. This introduced a high level of uncertainty about
what sort of capital contribution arrangements HMRC considered
could be disregarded for the purpose of Condition C applying the
TAAR (and, indeed, how the TAAR was to be applied generally). The
guidance before the changes in February 2024 had stated that
“in applying the TAAR, HMRC will take into account the policy
intention underlying the legislation, which is to provide a series
of tests that collectively encapsulate what it means to be
operating in a typical partnership. A genuine and long-term
restructuring that causes an individual to fail one or more of the
conditions is not contrary to this policy aim”. This statement
had been widely interpreted to mean that a “top up”
contribution that was committed as long term capital to the LLP
that was at risk for the member would be respected for the purpose
of Condition C.

HMRC’s latest statement to the Chartered Institute of
Taxation confirms that HMRC will be reversing these changes. HMRC
maintain that the TAAR will apply if the main purpose, or one of
the main purposes, of the arrangements under Condition C is to
secure that the salaried members rules do not apply to a member,
but that in applying this test HMRC will take into account the
policy intention behind the salaried members rules and have
confirmed that an arrangement whereby a member makes a
“genuine” contribution to an LLP, which is intended to be
enduring and giving rise to real risk to the member, will not
trigger the TAAR.

HMRC have not yet released any further details or drafting
concerning the revisions to the guidance. While it is hoped that
this revised guidance will remove the uncertainty caused by the
February 2024 revisions, we wait to see whether there is any
further assistance on what is required for a contribution to be
“genuine” in a context where a main purpose of making
such contribution might be to fail Condition C.

HMRC guidance on tax return information provision for carried
interest

HMRC has published additional guidance in the Investment
Funds Manual on the information taxpayers receiving carried
interest could consider providing in or with their tax return to
reduce the likelihood of HMRC launching an enquiry. Fund managers
are being encouraged to include as much information as possible in
partnership returns to reduce the risk of HMRC requesting more
information or conducting a compliance check to verify the
taxpayer’s tax liability, with HMRC providing certain examples
of the sort of information that they would like to see.

One of the examples relates to the difficulty that fund managers
can face in providing information specific to their UK tax
liability in their returns due to the information available from
the funds from which the carried interest derives which often
provide so-called K-1s relevant to US tax. While this is an issue
that HMRC are aware of, the guidance discusses the sort of
information that a fund manager should try to obtain to ensure that
they have exercised “reasonable care” in preparing their
UK tax returns. Where the fund manager does receive information
that is not tailored to UK tax, the guidance states that HMRC would
expect them “to use reasonable efforts to obtain further
information, including requesting this from their firm”.

Fund managers are also being encouraged to provide HMRC with
“tax packs” which, while not required in order to avoid a
compliance check, would provide additional useful information and
could assist in minimising any checks or enquiries by helping HMRC
determine the purpose of different sums in the fund manager’s
return. HMRC have referred to such information assisting with
determining whether sums comprising carried interest are dividends,
interest or gains, or providing the details of underlying fund
structures and details for any claims or elections by the
funds.

Funds should consider the revised guidance and whether they
could increase the information they currently provide to HMRC in
relation to carried interest in order to minimise the risk of HMRC
needing to conduct compliance checks and enquiries. The guidance
can be found here and here.

UK Case Law Developments

Unallowable purpose rule on cross border group relief tax
losses

In Lloyds Asset Leasing Limited v HMRC, the First-tier
Tribunal (FTT) considered whether Lloyds Asset Leasing Limited
(Lloyds), a UK resident company, was entitled to claim cross-border
relief in the UK under section 135 CTA 2010 for losses generated by
the Irish resident Bank of Scotland Ireland Limited (BOSI) which
was a member of the Lloyds group. The issues under consideration
were whether the qualifying loss condition in section 119 CTA 2010
and the precedence condition in section 121 were met and whether
under section 127 CTA 2010 the losses should be excluded from
relief in the UK because the main purpose, or one of the main
purposes, of the arrangement was to secure cross-border group
relief for the losses. The cross-border group relief rules were
repealed in 2021 but the decision is relevant in its consideration
of the “unallowable purpose” test in section 127, which
provided that the non-UK amount claim as group relief would not
have arisen but for arrangements the main purpose, or a main
purpose, of which was to secure that the amount might be
surrendered as group relief.

Applying the unallowable purpose test in section 127, the FTT
found on the facts that, while the conditions for cross-border
group relief for the losses in question were satisfied, one of the
main purposes of the arrangements put in place was to allow the
Irish losses to be surrendered as group relief in the UK and,
therefore, the cross-border group relief was not available in
relation to the losses.

Lloyds had acquired BOSI as part of its acquisition of the HBOS
group following the financial crisis in 2008. BOSI had a large book
of Irish real estate related loans that were standing at a
substantial loss and had accumulated tax losses. The market in
Ireland was such that it was unlikely it was going to become
profitable again. Lloyds decided to exit the Irish lending market
and considered a number of options to do that. Following tax advice
that the BOSI Irish losses could only be used in Lloyds’ UK
group if, among other things, there was no possibility that the
losses could be used in Ireland (or elsewhere other than the UK)
and the group retained no business or permanent establishment in
Ireland, it was decided in or around June 2010 that the Irish
business should be wound down through a cross border merger of BOSI
into a UK company in the Lloyds group, This had to be completed by
the end of 31 December 2010, which was an ambitious timetable.
Prior to implementing the merger into the UK company, BOSI had to
be transferred from under its Dutch parent. The cross-border merger
transaction was implemented by 31 December 2010 in the manner
planned and Lloyds claimed the Irish losses as group relief to use
against the UK profits in Lloyds. The case concerned two main
issues. First, whether the losses could benefit from cross-border
group relief under the necessary conditions in the UK. Second, if
the losses did meet the necessary conditions, should they be
excluded because the arrangements had the main purpose of attaining
a tax benefit under section 127. Lloyds argued that since the group
had commercial reasons for wanting to leave the Irish lending
market, which was not disputed, tax was not one of the main
purposes of the transaction and that after the decision to leave
Ireland had been made the group could decide how to implement the
exit in a tax efficient manner. Lloyds also claimed that the key
decision makers would have chosen to liquidate BOSI whether or not
there was the UK tax advantage.

The FTT recited a large amount of internal communication between
Lloyds’ personnel that showed how the decision to implement the
cross border merger of BOSI and the need to complete it by 31
December 2010 had led to a more complicated transaction than other
possible transactions and that the driver behind the specifics of
the transaction actually entered into had been to obtain the UK
group relief. The FTT emphasised that the court can consider all of
the circumstances relating to the decision taken by the taxpayer,
not just the final decision or the stated principal purposes of the
key decision makers, including all of the facts and advice received
leading to the decision in order to determine a company’s
purposes. Additionally, as per prior case law, the fact that the
taxpayer has a commercial purpose as a main purpose does not
preclude obtaining a tax advantage also being a main purpose. The
evidence also showed that Lloyds group and BOSI personnel were
aware of the risk of having tax identified as a main purpose and
specifically removed references to the importance of the potential
tax advantage in the final approval documents and emails.

The FTT found that it was clear on the facts that Lloyds had
chosen and implemented the specific method of ending BOSI’s
Irish lending business, being the “arrangement” that
allowed the Irish losses to be surrendered to Lloyds, with a main
purpose of allowing the losses to be group relieved. The group
relief was, accordingly, denied applying section 127 and it was not
relevant that the Lloyds group might have had other, commercial
reasons for planning to bring an end to BOSI’s business in
Ireland.

The decision is one of several cases in recent years which have
provided some clarity on the application of the unallowable purpose
rule, albeit the other cases have related to loan relationships,
and it serves to underline that when considering whether a company
has a main purpose, or one of its main purposes, for the
arrangement to obtain a tax benefit, the circumstances, evidence
and intentions that the court is entitled to consider are wider
than just those relating to the final decision. So, while it is
accepted that tax advice will inevitably be sought in relation to a
transaction, it is not sufficient that there is a commercial
purpose for carrying out a general course of action and it is
essential that taxpayers think carefully about just what it is that
the main purpose is focused on in the particular rules that are
relevant to the transaction in question.

No UK taxing rights over payments relating to oil licences
under UK-Canada double tax treaty

In Royal Bank of Canada v HMRC, the Supreme Court (SC)
considered the allocation of taxing rights between the UK and
Canada under the UK-Canada Tax Treaty (the Treaty) regarding
payments that were linked to oil extracted from the UK continental
shelf under licence from the UK Government and whether HMRC had the
right to claim UK corporation tax on the payments.

Previous decisions by the FTT and the Upper Tribunal (UT) held
that under Article 6 of the Treaty and section 1313 CTA 2009, the
Royal Bank of Canada (RBC) had to pay corporation tax on the
payments. The Court of Appeal (CA) disagreed and held that the UK
did not have the right to tax RBC for the relevant payments under
the Treaty and, therefore, did not consider it necessary to
determine on the application of section 1313. The SC agreed with
the CA that under the Treaty the UK did not have taxing rights in
relation to the relevant payments. However, the SC held that if the
UK had have had taxing rights under the Treaty, the relevant
payments would have fallen under the charge to UK corporation tax
under section 1313 CTA 2009.

The case related to a licence to search for and extract oil
granted by the UK government to a UK subsidiary (Sulpetro UK) of a
Canadian company (Sulpetro Canada) set up in order to comply with
the UK government’s requirement that all licences be granted to
UK resident companies, with Sulpetro Canada providing all of the
necessary financing and equipment in return for all of the oil
which Sulpetro Canada could then sell. Under the licence, Sulpetro
UK was required to make royalty payments to the UK government.
Sulpetro Canada sold all of its assets, including the entire issued
share capital of Sulpetro UK, to BP Petroleum Development Ltd (BP)
for consideration totalling £17 million. Under the share
purchase agreement, BP promised to make payments to Sulpetro Canada
in respect of the Sulpetro UK’s extracted oil (the Payments) as
consideration for the novation of the agreement under which
Sulpetro Canada had been entitled to the oil extracted by Sulpetro
UK. However, the Payments would only be made if the price of a
barrel of oil was more than US$20 and the Payments would be half
the difference between the actual market value and US$20 per
barrel.

Sulpetro Canada entered receivership and its right to receive
the Payments was assigned to RBC. The Payments were considered
income in RBC’s hands and were subject to tax in Canada. The
Payments were not made continuously due to the price of oil not
always being above $20 per barrel. HMRC sent RBC notices of
assessment which asserted that the Payments were subject to UK
corporation tax under section 1313 CTA 2009 as being “profits
from exploration or exploitation activities carried on in the UK
sector of the continental shelf or from exploration or exploration
rights”.

RBC argued that the UK did not have taxing rights over the
Payments under the Treaty because they were not “income from
immovable property” which included “rights to variable or
fixed payments as consideration for the working of, or the right to
work, mineral deposits, sources and other natural resources”
under Article 6(2) of the Treaty as the Payments were not
consideration for the “right to work” the UK’s
seabed.

The FTT rejected RBC’s arguments that Article 6(2) was only
concerned with taxation rights in relation to the grant of the
right to work by the person who owned the natural resources and not
the transfer of the right to the income as such an interpretation
could lead to tax avoidance. The FTT determined that RBC held
rights to variable payments as consideration for the right to work
under Article 6(2) and, therefore, the UK had taxing rights. In
addition, since RBC had the right to the (indirect) benefit of the
oil, the Payments also fell within section 1313(2)(b) CTA 2009. The
UT upheld the FTT’s decision, dismissing RBC’s appeal that
consideration should have been had to the true contractual position
of the parties with the licence always remaining within Sulpetro
UK, holding that Sulpetro Canada and then BP had been operating the
working of the rights through Sulpetro UK under the original
agreement giving Sulpetro UK its rights to exploration.

The CA disagreed, holding that Article 6(2) of the Treaty
related to rights to payments held by a person who had a continuing
interest in the land in question, and the rights held by Sulpetro
Canada in respect of the oil extracted by Sulpetro UK did not
amount to a right to work the oil, and so BP’s rights to
receive the Payments were not a right to work the oil in question.
Therefore, the Payments were not consideration for the right to
work subject to UK taxing rights under the Treaty. The CA did not
then consider whether the Payments fell within the charge to UK
corporation tax.

The issues for the SC were (i) whether the Sulpetro Canada’s
rights under the original agreement with Sulpetro UK amounted to a
right to work the oil field within the meaning of Article 6(2) of
the Treaty (ii) if yes, whether the Payments made by BP to RBC in
consideration for those rights with regard to the novation of the
agreement with Sulpetro UK from Sulpetro Canada to BP were within
the scope of Article 6(2), and (iii) if yes, whether the Payments
were subject to corporation tax under section 1313 CTA 2009.

On the first point, the SC agreed with the CA that the right to
work was granted under licence to Sulpetro UK by the UK government
and was always held by Sulpetro UK. Sulpetro Canada never held the
right to work in relation to extracting oil from the North Sea.
While Sulpetro Canada provided the necessary finance to enable
Sulpetro UK to discharge its obligations to the UK government,
Sulpetro Canada did not itself discharge those obligations and
there was no legal relationship between Sulpetro Canada and the UK
government. Sulpetro Canada’s right to oblige Sulpetro UK to
work the North Sea shelf was legally different from having a right
to work the natural resources. The SC also clarified that RBC’s
argument that the FTT and UT had assumed all income derived from
oil in the North Sea should be taxed in the UK was an incorrect
assumption to apply to the terms of the Treaty. The Treaty does not
prevent entities from “avoiding” tax or determine whether
income should be subject to tax or “tax-free”. The
purpose of the Treaty is to identify the line between Canada’s
right to tax specific profits of a Canadian resident company and
the UK’s right to tax the same profits which derive from the
exploitation of the UK’s natural resources. The main purpose of
the Treaty being to eliminate double taxation. Article 6(2) was
included to transfer certain primary taxing rights from the
jurisdiction where the company is resident to the jurisdiction
where the natural resources being exploited are located.

The SC agreed with the CA that when considering if the Payments
amounted to consideration for the right to work, as required under
Article 6(2), it was inherent in the requirement that the recipient
of the payments must be the person who can confer the right to work
on the payer. As neither Sulpetro Canada nor RBC, as respective
recipients of the Payments, had an interest in the North Sea shelf
which would enable them to confer a right to work on Sulpetro UK,
the consideration received cannot have been for the right to work
the North Sea shelf.

The case emphasises the intention of tax treaties is to provide
for the allocation of taxing rights in certain circumstances and to
assist with eliminating double taxation. A treaty does not operate
to determine if an amount should be tax free and/or that amounts
should be taxable applying a “flavour” to them.

“Exceptional circumstances” existed for purposes of
the statutory residence test

In A Taxpayer v HMRC, the CA has considered whether a
taxpayer avoided being resident in the UK in the tax year 2015/16
applying the statutory residence test (SRT) under Schedule 45 of FA
2013 by reason of only being in the UK because of “exceptional
circumstances”. The FTT had determined that the taxpayer was
not resident under the statutory residence test as she was only
present in the UK for some of the time in question because of
“exceptional circumstances”. The UT disagreed and remade
the decision of the FTT holding that the FTT had erred in law in
its approach to determining whether the circumstances in question
were or were not “exceptional” and that they were not.
The CA has held that the UT was wrong in its approach to the
FTT’s decision and has restored it.

The taxpayer had been tax resident in the UK until just before
the commencement of the 2015/16 tax year when she relocated to
Ireland, leaving her husband in the UK who was planning to retire
shortly and join her in Ireland. She had a twin sister and a
brother who lived in the UK. Her sister had two young children.
Prior to relocating to Ireland, the taxpayer’s husband had
given her some shares which paid out a large dividend in the
2015/16 tax year. Under the SRT, the taxpayer could spend 45 days
in the UK in the tax year before she would be treated as UK tax
resident. The taxpayer agreed that she had already spent 44 days in
the UK. However, she had also visited the UK twice, in December
2015 and in February 2016, for a total of six days to look after
her twin sister and her children, and it was these days that were
the question of the case.

The taxpayer’s twin sister struggled with alcoholism and
mental illness. The taxpayer provided evidence that she felt she
had no option but to go to the UK in December and February in order
to assess the welfare of her sister and her children and that,
while she had no intention to stay at the outset, on both occasions
she found a dysfunctional family household with her sister
incapable of caring for herself or her children and she could not
leave until she had stabilised the situation and ensured her sister
was no longer a harm to herself and that the children were being
looked after.

The taxpayer relied on paragraph 22(4) in the SRT, which
provides that a day does not count for the purpose of determining
how many days a person has been in the UK if the person would not
have been present in the UK but for “exceptional circumstances
beyond their control which prevented them from leaving the UK”
and that they intended to leave as soon as the circumstances
permitted. The questions for the CA were whether the lower courts
had correctly construed the meaning of “exceptional
circumstances” and if those “prevented” the taxpayer
from leaving.

“Exceptional circumstances” are not defined in the
legislation, but certain illustrative examples are given of
national or local emergencies such as war, civil unrest or natural
disasters, and sudden or life-threatening illness or injury. The
FTT found that while the taxpayer’s sister did have alcohol and
mental health problems, this was not an “exceptional”
circumstance as there were plenty of people suffering the same.
However, in the FTT’s opinion, the presence and needs of the
minor children who were not being looked after changed this and
should be considered “exceptional circumstances” from a
moral conscience perspective. The UT agreed with HMRC that the FTT
erred in law in deciding that the requirement for exceptional
circumstances could be satisfied by a moral or conscientious
obligation, rather than a legal obligation or being physically
prevented from leaving, and that the statutory test was not
satisfied as the taxpayer was not prevented from leaving the
UK.

The CA confirmed that when considering the SRT, the ordinary
meaning should be given to the words used in it that are not
defined, particularly “prevent” and “exceptional
circumstances”. The CA agreed with the UT that
“prevent” as discussed in Financial Conduct Authority
v Arch Insurance case meant stopping something from happening
or making an intended act impossible, which is different from mere
hindrance. However, the CA confirmed that this cannot be limited to
specific categories such as a legal obligation to remain or being
physically prevented from leaving. It is the job of the courts to
distinguish between cases where there is a difference between a
taxpayer compelled or obliged to stay and prevented from leaving
and those cases where it is more convenient or preferable to stay.
When subjective reactions and moral obligations are considered, the
court should take into account whether the taxpayer’s reaction
is reasonable and in accordance with ordinary societal
expectations.

On what is to be considered to be an “exceptional
circumstance”, the CA held that the UT’s restrictive view
that illness and death were not exceptional circumstances was
incorrect. The test requires exceptional circumstances to be
considered having determined the facts and circumstances as a whole
and to determine whether, having regard to those circumstances, the
taxpayer was prevented from leaving the UK. “Exceptional”
is to be given its ordinary meaning and is a question of fact,
although it must be read as a whole phrase “exceptional
circumstances beyond the individual’s control that prevent the
individual from leaving the UK”. The purpose of the examples
of what is exceptional circumstances is to illustrate certain
circumstances that Parliament would consider as exceptional, not to
restrict exceptional circumstances to only these examples. However,
the CA did hold that given the purpose of introducing this test to
replace a more general test, it must have been part of
Parliament’s intention that the exceptional circumstances
requirement would not be met too easily and courts should have
proper consideration to whether, on the facts the circumstances
qualify or not.

Applying this reasoning, the CA upheld and reinstated the
decision of the FTT as a correct (or not unreasonable) approach to
the test in the light of the taxpayer’s circumstances and based
on its interpretation of the test. The CA stated that the FTT had
determined on sufficient evidence that the level of neglect and
consequences for the minor children were exceptional circumstances
and went further than the distress and suffering generally caused
by alcoholism, and prevented the taxpayer from leaving until the
situation for the children was stabilised. The UT had been wrong to
interfere with the FTT’s decision on the basis that the FTT had
applied the law incorrectly.

UK Tax Round Up – February 2025

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