On 16 February 2011, the European Commission formally requested the UK to amend two anti-avoidance tax regimes, namely:
The Commission considers that these rules infringe two of the fundamental principles underpinning the EU’s single market. These are the freedom of establishment and the free movement of capital contained at articles 49 and 63 respectively of the Treaty on the Functioning of the European Union. The Commission states that these measures are “disproportionate, in the sense that they go beyond what is reasonably necessary in order to prevent abuse or tax avoidance”.
The UK is required to provide a satisfactory response to the Commission’s request within two months, in the absence of which, the Commission may refer the UK to the European Court of Justice (ECJ).
The basis of the Commission’s formal request
The Commission’s view is that the UK anti-avoidance rules treat the income and gains of non-UK resident companies more harshly than their UK resident equivalents. It considers that this amounts to discrimination.
The first infringement concerns the operation of the “transfer of assets abroad” rules. Where an individual (a UK resident) invests in a company by transferring assets to it, and if that company is incorporated and managed in another EU state, the investor is subject to UK tax on the income generated by the non-UK company into which assets were transferred. In contrast, if the same (UK resident) individual invested the same assets into a UK company, only the company is liable for the tax.
The second infringement relates to the attribution of gains to members of non-UK resident companies, which would be close companies if resident in the UK. Where a UK resident taxpayer (e.g. a company, individual or body of trustees) owns a large share of a company resident in another EU state (i.e. more than 10% of its equity) and the foreign company realises capital gains, the gains made by the foreign company are attributed to the UK resident taxpayer. In contrast, this rule does not apply if the company making the disposals is a UK resident company.
It is presently unclear how the UK will respond to the Commission’s formal request. If the Commission refers the case to the ECJ, then it may take years for it to be heard. The UK may of course take action before then to prevent a referral being made.
The rules in their current form are important to the UK because they operate to prevent taxpayers from sheltering income and gains by holding them through offshore structures. As such, the rules bring such income and gains within the UK tax net. The UK may seek to implement measures to address the Commission’s request, whilst simultaneously seeking to preserve its tax base, for example, it is suggested that the UK might disapply the current rules where EU companies are being used for genuine business purposes rather than for tax planning. Alternatively the UK could, for example, enact legislation to remove the existing s.13 regime in its entirety and make offshore/EU companies pay CGT.
Fladgate LLP will monitor developments closely. It will be interesting to see if any measures are announced in the forthcoming Budget.