How to be sure that you’re offshore

A recent decision serves a warning to those that hold UK real estate through foreign companies. Kirsten Prichard Jones offers practical advice for effective tax structuring A recent tax case has highlighted how the use of non-UK companies to hold UK real estate can be challenged by the tax authorities. Development Securities (No 9) Ltd v HMRC [2017] UKFTT 565 serves as a timely reminder of the care that must be taken by groups holding UK assets through these vehicles. Three Jersey companies ultimately owned by Development Securities were used as part of a tax structure devised by a Big Four firm, which was designed to increase the group’s tax losses. The success of the structuring depended on the companies being treated as resident in Jersey for tax purposes and HM Revenue & Customs (HMRC) was successful in its challenge to the Jersey companies’ residence, with the court finding that although the companies were established in Jersey and their directors were all based in Jersey, the companies were nevertheless resident in the UK for tax purposes. As a result, the structuring failed and did not generate the tax losses as intended. What the case means The structuring used in this case was complex and contained certain unusual elements, such as the acquisition by the Jersey companies of real estate assets from entities in the Development Securities group at an artificially high price, and the Jersey companies “migrating” to the UK and being wound up after a short period. Most groups using Jersey or other non-UK vehicles to hold their real estate assets will not do so as part of this sort of tax structuring. Overseas investors holding UK commercial real estate are not subject to UK capital gains tax, and therefore funds and joint ventures with overseas investors will typically use non-UK vehicles to hold their UK real estate assets, to ensure that their investors’ UK tax bill is no higher than it would be if they held the assets directly. HMRC generally accepts the use of non-UK vehicles to hold commercial real estate for this reason, no doubt acknowledging the importance of overseas investors to the UK economy. This tax neutrality is, however, available only where the vehicle is resident for tax purposes outside the UK. A company’s tax residence is determined not by the country in which it is incorporated, but by the place in which its “central management and control” are exercised. In practice this means the place where key decisions affecting the business of the company are taken by the board. For a real estate company these will typically be the decisions on asset acquisition, financing, major prelets, redevelopment and any disposals. For any company wishing to preserve its non-UK tax residence, it is important to be able to demonstrate that these key decisions are taken by the board outside the UK. In Development Securities, the court found that even though the companies were established in Jersey and their boards were based in Jersey, nevertheless the companies were resident for tax purposes in the UK. The unusual features of Development Securities set it apart from other groups using Jersey and other non-UK companies to hold real estate, and undoubtedly made the companies an easier target for HMRC. Nevertheless, the way in which HMRC successfully challenged the tax residence of the companies in this case contains some useful lessons for all groups and investors holding their UK real estate assets in overseas vehicles. Lessons to be learned The ability to demonstrate that a company’s key business decisions were taken outside the UK will be pivotal in any challenge. Generally, board minutes are the main record of what decisions were taken by the board, and where those decisions were taken. Often these minutes will be prepared in advance and have little detail of the discussion regarding the commercial benefits of a decision, often simply recording that “after discussion” the relevant decision was taken. Minutes that record key points made by the board during their discussion of the commercial aspects will stand up better to HMRC scrutiny. Board minutes are not the only evidence that HMRC and the courts will scrutinise in a residence challenge. Emails and even handwritten notes will be examined. A challenge by HMRC to a company’s residence may not happen for several years after the significant events have occurred, when memories may have faded and key personnel moved on, so it is all the more important to maintain comprehensive contemporaneous records. In Development Securities, reference was made, in a handwritten note of a meeting, to the parent company giving the Jersey companies an “instruction” to proceed with the transaction. This was damaging, as it suggested that the Jersey boards were merely following instructions from the UK rather than considering decisions independently. Where the role of UK-based personnel is limited to advising and making recommendations to a non-UK property vehicle, records should reflect this and shorthand expressions such as “instruction” should be avoided. Mindful of this case, purchasers of offshore vehicles holding real estate may increase their due diligence in this area, as they will be keen to ensure that the vehicle they are acquiring is able to demonstrate its non-UK residence in the event of a future challenge. Insurers providing warranty and indemnity insurance on these transactions can also be expected to focus more on this area, and may be less willing to provide cover in cases where insufficient records have been kept or there is doubt as to where key decisions have been taken. What next? Development Securities may appeal the judgment in this case, and the court’s decision could be overturned at a higher level. Whatever the eventual outcome of the case, it serves as a helpful reminder of the steps required to preserve overseas property companies’ tax status. Key points The Development Securities group has lost a recent tax case involving the use of Jersey companies to hold real estate assets Jersey (and other non-UK) companies are popular holding vehicles for real estate, as they enable overseas investors to access the market in a tax-neutral manner The beneficial tax treatment of these vehicles will be available only where the companies are appropriately managed, and the case highlights some of the practical steps that must be taken by groups to preserve this tax treatment Kirsten Prichard Jones is senior counsel in the tax group at Macfarlanes