Welcome to the June edition of the UK Tax Round Up. This month’s edition features a summary of recent HMRC guidance on QAHCs and credit funds, the publication of the new UK-Luxembourg double tax treaty and the delay in implementation by the UK of OECD-related second pillar rules on global minimum tax as well as an interesting case on whether a “white space disclosure” was a defense against negligence by a tax agent.
Evolution of case law in the United Kingdom
Disclosure of white space no defense for tax agent negligence
In Johnson and another v HMRC, the First Tier Court (FTT) considered whether a tax return had been negligently prepared despite disclosure of white space on the return.
The appellants had entered into a swap transaction with a bank in 2007 and had subsequently obtained compensation from the bank following a review by the FCA of the type of interest rate hedging product they had entered into . The first appellants received a letter from the bank which contained details of the amount of compensation payable to both appellants and included information on gross interest and the amount of tax deducted, and a statement that the balance of the payment was to be reported on the appellants’ tax returns. The exchanges related to one or more loans contracted by the appellants which were used to acquire a building in their name which they rented.
The appellants’ tax agent, Mayfield & Co, did not include the bank payment as taxable income on the appellants’ tax returns. Instead, Mayfield included a white space disclosure stating that “an offset payment of £43,218 was received during the year from the bank under interest rate hedging products which n is not considered taxable”. HMRC increased the appellants’ contributions for the 2013/2014 tax year after the standard 12-month inquiry window following lengthy correspondence between HMRC and Mayfield. The assessments were made on the basis that Mayfield, as the appellants’ agent, had been negligent in the preparation of the tax returns and that the loss of taxes arose from this negligence. Under Section 118 TMA 1970, a loss of tax is negligently caused if the taxpayer (or the taxpayer’s agent) “fails to take reasonable care to avoid causing [the loss of tax]”.
HMRC argued that the appellants’ agent was negligent in filing the returns on the grounds that there were clear guidelines published on HMRC’s website which stated that reparations payments were taxable where the taxpayer had requested a trade deduction for swap payments. Mr Green, a senior tax manager employed by Mayfield, admitted he was unsure of the tax treatment of the reparations payment when he filed the returns despite accepting that advice from HMRC was readily available and that he had, in fact, read this. Mr Green, however, stated that he believed the payment related to remuneration paid to the appellants on a personal basis and, therefore, he was of the view that it was not likely to be taxable as it was not related to a business operated by them. Mr Green argued that the inclusion of the white space disclosure meant that neither he nor Mayfield were negligent and that HMRC should have inquired into the return within the standard application window. He said the loss of tax was caused by HMRC’s failure to investigate the returns in time and not by his or Mayfield’s negligence.
In determining whether or not Mr. Green acted reasonably (or negligently), the FTT said the test to be applied was a comparison of Mr. Green’s actions with the actions of a reasonably competent tax adviser. The FTT concluded that a reasonably competent tax adviser would have considered more carefully whether the HMRC guidance applied to the appellants’ situation. HMRC has recognized that an officer who reads HMRC guidelines but then takes a different and respectable view based on merit is not negligent. However, in the circumstances of the case, the FTT found that Mr. Green had failed to establish the essential facts regarding the payment of the compensation in question and that this demonstrated a lack of due diligence which was at the origin tax loss. The FTT noted that had Mr. Green conducted a thorough analysis of the compensation payment and the Appellants’ circumstances, the Appellants’ tax returns would have included the payment as taxable income since Mr. Green would have concluded that the swaps were entered into for the purpose of the appellants’ real estate rental business and that they claimed deductions from their rental income for their swap payments. Mr Green argued that the inclusion of the disclosure contained sufficient detail to comply with HMRC Practice Notice SP 1/06, as HMRC had been provided with sufficient detail to realize during the investigation period that the self-assessment was insufficient. However, the FTT held that this argument is not a defense against negligence which is, in fact, a strict liability obligation for ratepayers (and their agents).
This case highlights the importance for taxpayers and their advisers to give due consideration to the expected tax consequences of payments, any published guidance from HMRC which may be relevant to those consequences, and to ensure that any disclosure of space white is comprehensive enough to explain the intended and respectable consequences on which a taxpayer might have taken a position contrary to the relevant HMRC guidance. Also, simply referencing a question in a white space disclosure is not enough to shift the onus onto HMRC to research where the tax return and disclosure has been carelessly prepared.
Other tax developments in the UK
HMRC provides useful advice on business loan vehicles and QAHCs
On June 6, HMRC updated its guidance on the new UK tax regime for Qualifying Asset Holding Companies (QAHC), which was introduced from April 1 this year to cover companies which are used as business lending vehicles (for example, through credit funds).
One of the conditions for a company to qualify as a QAHC is that the company engages in investment activity and that any other activity (e.g. trading activity) is merely incidental to that investment activity and not not exercised to any substantial extent. Since the publication of the rules, concerns have been raised that companies with a history of making loans (either through origination or through the acquisition of existing debt) and charging fees may be considered to be carrying on a commercial activity and therefore may not qualify as QAHC.
The new guidance clarifies HMRC’s approach to whether business lending vehicles used by credit funds should be treated as carrying on an investment business and whether any other activity, such as charging fees or disposing receivables acquired, could be treated as a business activity that was not ancillary to the company’s main investment activity. The updated guidance confirms that, in the context of credit funds, origination of loans is not in itself indicative of a transaction and that, where loan originators receive standard fees in connection with their origination of loans, commission income is likely to be considered as part of the investment activity. There is a similar reference useful to companies which acquire debt with the intention of holding it until maturity, but which may then dispose of it on a speculative basis.
Although the guidance indicates that the facts and circumstances should be considered in each case, the updated guidance provides welcome clarification of HMRC’s interpretation of how the QAHC legislation should apply to loan companies. /acquisition of debt created by credit funds which should provide a high measure of reassurance for credit fund asset managers considering the use of QAHCs within their fund structures.
For more information on the updated guidelines, please read our Tax Talk blogs available here and the updated guidelines here.
UK delays implementation of minimum headline tax rate under the second pillar
The UK Treasury confirmed on June 14 that it will delay the introduction of the minimum headline corporate tax rate of 15% that will be introduced as part of the OECD’s proposals for taxation of the digital economy ( pillar two) following the lack of progress in the development of negotiations at OECD level.
In a letter from the Financial Secretary, it was confirmed that the scheme will first apply to accounting periods beginning on or after 31 December 2023 and not April 2023 as originally proposed. In the letter, the financial secretary noted that respondents had raised concerns about implementing the rules in the UK ahead of other countries, as it would put UK businesses at a competitive and administrative disadvantage. This delay will be welcomed by many, as previous responses to the consultations had pointed out that sufficient time would be needed for an orderly implementation of the new regime due to the complexity of the rules.
Draft legislation to implement the rules is still expected to be published later this year, although the actual date and terms of implementation may still depend on how the rules progress at the OECD level.
HMRC publishes new double tax treaty between the UK and Luxembourg
A new double tax treaty between the UK and Luxembourg was signed on June 7 and will replace the existing treaty once it is ratified by both countries.
While the changes are largely aimed at aligning the treaty with the OECD model (including changes made under the BEPS-related multilateral instrument), the new treaty also contains significant changes for real estate investors. companies with Luxembourg holding structures. Under the current treaty, the UK cannot tax the capital gains of a Luxembourg resident. The new treaty changes this and allows the UK to tax gains derived from a Luxembourg resident where the gain arises from the sale of shares or similar interests which derive at least 50% of their value from UK immovable property. (although UK national rules require the company derives at least 75% of its value from UK property).
In addition, under the new treaty, investors in investment funds will no longer have to file individual requests for relief from withholding tax on interest and dividends (it being specified that there is no currently no withholding tax on Luxembourg interest payments). Instead, such claims may be made directly by an authorized representative of the fund on behalf of investors. Further details of the practicalities of these arrangements are to be confirmed by the UK and Luxembourg tax authorities.