The ongoing HMRC v Development Securities saga has garnered considerable interest amongst tax professionals since the first court decision in August 2017 as it deals with a crucial question: to what extent can a parent company or anyone else influence a company without taking over control from its directors?
On 15 December 2020, the Court of Appeal (‘CA’) overruled the Upper Tribunal (‘UT’) and reinstated the First Tier Tribunal (‘FTT’)’s decision that three Jersey-incorporated subsidiaries of a UK-resident parent company were centrally managed and controlled, and therefore tax resident, in the UK (and not in Jersey as the UT decision had concluded). The case emphasises the need for directors to ensure that they are addressing the correct questions when making decisions. It also acts as a reminder that where directors are acting in more than one capacity they should be careful to be clear which entity they are acting for when making a decision.
In this article, we summarise the background to the case and the CA’s decision, and consider some wider practical implications.
Background
Development Securities plc, a UK tax resident company, incorporated three Jersey subsidiaries for the purposes of implementing a tax planning arrangement. The arrangements involved the Jersey companies purchasing assets from other companies in the Development Securities group for significantly in excess of market value. Various conditions had to be met in order for the scheme to succeed. Notably, one of those conditions was that the Jersey subsidiaries were not UK tax resident at the time they acquired the assets. To try to ensure the subsidiaries’ non-UK residence, the directors of the Jersey companies held their board meetings in Jersey so as to meet the accepted central management and control (‘CMC’) test for tax residence.
HMRC challenged this practice, arguing that the significant director level decision as to whether to enter into the transactions was taken in the UK; all that the Jersey directors considered was whether the transaction was legal under Jersey law. HMRC argued that the purchase of assets at greater than market value provided no commercial benefit to the Jersey subsidiaries and that the Jersey directors had effectively ceded control to the parent company in agreeing to enter into the arrangements. HMRC argued that this resulted in the Jersey subsidiaries’ place of CMC being in the UK at the relevant time
The FTT ruled in favour of HMRC, concluding that the Jersey subsidiaries were in fact UK tax resident. The decision garnered significant interest at the time, as it cast doubt on the application of the long-established test for corporate residence in the very common case of a subsidiary company acting in accordance with its parent’s wishes. Following an appeal, the decision was reversed in 2019 by the UT who found that CMC was exercised in Jersey and so the Jersey subsidiaries were resident there; “the mere fact that a 100 per cent owned subsidiary carries out the purpose for which it was set up, in accordance with the intentions, desires and even instructions of its parent does not mean that central management and control vests in the parent”.
Court of Appeal decision
The CA has now overruled the UT, reinstating the FTT’s decision that the three Jersey-incorporated subsidiaries of a UK-resident parent company were centrally managed and controlled, and therefore tax resident, in the UK. In delivering its judgement, the CA confirmed that the overarching principle remains that set out by the House of Lords in De Beers Consolidated Mines Ltd v Howe [1906] AC 455, i.e. that a company resides for tax purposes where its real business is carried on, and that is where CMC actually abides. The CA agreed with the FTT that the question of where the Jersey companies were tax resident would depend on: (1) who made strategic and management decisions regarding the company’s business and (2) where those decisions were made. Both were questions of fact. Having found the UT’s reasoning to be flawed, and in the absence of any other grounds put forward by Development Securities plc for the CA to uphold the UT’s decision, the CA had no choice but to revert to the FTT decision. This was the first time the CA has considered the issue of company residence since the case of Wood v Holden [2006] 1 WLR 1393. While it highlights the fine line between (1) decisions taken by a non-UK resident board that is being influenced by a third party and (2) decisions that are being dictated by a third party, it unfortunately offers little clarity on how to distinguish the two in considering where a company is tax resident. Notably, of the three appeal judges, only one said he had no concerns with the FTT decision; another expressed significant reservations with the FTT reasoning and the third refused to comment, as he had not heard argument on it. The CA’s decision is therefore a rather unsatisfactory conclusion as it leaves questions regarding the CA’s view of the FTT’s reasoning.
Nonetheless, taxpayers can take some comfort from the fact that the CA decided the case on fairly narrow grounds, and that the outcome was influenced by several unusual elements including the uncommercial nature of the transactions. For now, the legal test for corporate tax residence has not changed, although it remains to be seen whether there will be a further appeal to the Supreme Court.
Practical Implications
The case highlights a tricky point in relation to transactions that are for the benefit of a group, but not necessarily for the company that is implementing a particular step. It also indicates that in future there may be a higher bar to establish that CMC is exercised outside the UK. Although there is no change in law (at least for now), this case shows that HMRC continue to look closely at corporate residence and are willing to take cases on this point.
As such, directors of non-UK resident companies owned by UK entities would be wise to give careful consideration to the overall pattern of decision-making. Any instructions, directions or guidance given by the owner entity should be evaluated to ensure that the level of control being exercised over the non-UK resident company does not inadvertently usurp control from its directors.
In particular:
- directors should make sure that they are properly applying their minds to the correct question (as highlighted by comments in the Development Securities case regarding directors considering whether what they were doing was legal but not considering the bigger picture of whether the company should enter into the transaction);
- where the same individuals are acting in more than one capacity (e.g. as directors of more than one related company, or as trustees of a trust and directors of companies owned by the trust), they should make clear in what capacity they are acting when making any decision and make sure that they apply their minds to the correct questions for that particular entity;
- board meetings should be genuinely held and held on a regular basis and all strategic decision-making relating to the company should take place at board meetings and not at any other time;
- careful notes of board meetings should be made, which ideally should not be prepared in advance but should be a contemporaneous note of the decision-making process, demonstrating that the directors have carefully considered the decisions being made.
How can we help?
Burges Salmon's Tax specialists have substantial experience in tax, trusts, and estate planning, including providing specialist advice on the subjects of company and trust residence. If you wish to discuss any of the matters raised in this article, please do get in touch with Emma Heelis-Adams or your usual contact within the team.
This article was written by Emma Heelis-Adams and Natalie Lim.