INTM600845 - Transfer of assets abroad: The income charge: Transfers made by closely-held companies - the avoidance condition

ITA07/S720A and ITA07/S727A introduce two conditions at ITA07/S720A(2) and ITA07/S727(2) for an individual to be within the scope of ITA07/S720 and ITA07/S727 in respect of transfers made by closely-held companies.

The first condition is the involvement condition (see INTM600835) and the second condition, which is considered on this page, is the avoidance condition.

As explained in INTM600825, including transfers made by closely-held companies within the scope of the income charges would create the undesirable consequence of catching innocent participators. This is because an individual would not be able to exempt themselves from charge by claiming the motive exemption where those transactions have an avoidance purpose due to the transactional nature of how the motive exemptions work (see INTM602700).

The avoidance condition was designed to take out of the scope of the income charges those participators that either objected to the transfer or were not aware of the transfer or, if they were aware of the transfer, were not aware that the purpose was to avoid UK tax liability.

The condition is set out in ITA07/S720A(5) and ITA07/S727A(5) and has two elements which are broadly:

1. the relevant participator did not object to the transfer
2. the relevant participator was aware that the transfer took place and that the transfer had a direct or indirect consequence of avoiding tax.

Both elements need to be met for the avoidance condition to be met.

Element 1: The relevant participator did not object

The first element is that the relevant participator did not object to the making of the relevant transfer.

Again, whether someone objected is something to be determined by the facts of the case but there must be a clear objection to the transfer expressed by the individual.

If, on the facts, an individual objected to the relevant transfer, the avoidance condition cannot be met, and we do not need to consider the second element of this condition. This would also mean ITA07/S720A or ITA07/S727A would not apply.

Example 1

C Ltd is a UK resident closely-held company with 100 shares. Kevin holds 30 shares, Mandy holds 30 shares and Hayley holds 40 shares. None of the individuals are directors but all three have met the involvement condition. C Ltd has developed intellectual property and the directors suggest transferring this to D Ltd, a company resident in Malta, and sublicensing it back to C Ltd allowing royalties to accrue in D Ltd. This business decision is discussed at a shareholder meeting and a vote is cast. Kevin and Mandy vote for the transaction to go ahead and Hayley expresses her dissatisfaction and ultimately votes against the motion. As Kevin and Mandy hold the majority of the shares, a resolution is passed for the transaction to go ahead. Hayley has clearly objected.

The result of this is that:

• Hayley would not meet the first element of the avoidance condition as she has objected.
• For the avoidance condition to have been met, both elements need to be met, so Hayley does not meet this condition.
• For ITA07/S720A/S727A to apply, both the involvement AND avoidance conditions must be met meaning ITA07/S720A/S727A would not apply to Hayley.
• Hayley would therefore not meet the ToAA charging criteria at ITA07/S720/S727 in relation to this transfer.
• Kevin and Mandy did not object to the transfer so they would meet the first element, and we would go on to consider whether the second element has been met to determine the overall outcome for those individuals.

Element 2: The relevant participator had awareness of transfers and consequences

Broadly, the second element of the avoidance condition is that the individual was aware, or should have been aware, of the relevant transfer and the consequences of that transfer.

In determining whether the second element has been met, as with the exemptions (see INTM602940), a reasonableness test is introduced, and we look at all the circumstances of the case to establish whether it is reasonable to conclude that this element has been met.

The first part of this element is that the relevant participator was aware or ought reasonably to have been aware of the relevant transfer. This is to be established on the facts, and it should be relatively straightforward to determine if an individual had an awareness of the transfer. If an individual had no awareness of the transfer, then it is reasonable to conclude that they will not have known the consequence of that transfer.

Whether an individual ought to have been aware will again depend on the facts such as that individual’s role in the company, what decisions they had previously been involved in and the facts of the pattern of events before, during and after the transfer.

If an individual did have an awareness of the transfer, we then need to establish if the individual was aware that one of the direct or indirect consequences of that transfer was the avoidance of UK tax. When we look at indirect consequences of a transfer, in cases where there was no avoidance purpose to the relevant transfer but there was to an associated operation, we would also consider whether the individual was aware, or ought to have been aware, that avoidance of UK tax was the consequence of the associated operation.

For this, we are not considering the purpose of the transfer but the consequence. To determine this, we look at the effect and result of the relevant transfer and then decide on the facts if it is reasonable to conclude that the individual was aware of those consequences.

It is worth noting that the avoidance condition being met does not preclude the individual from claiming an exemption in relation to the purpose of the relevant transactions (see INTM602600). The avoidance condition considers whether the effects of the relevant transfer or associated operations involve avoidance of UK tax which would be a factual point. In terms of a claim for an exemption, purpose is subjective (see INTM602960), and a tax avoidance consequence is only one part of determining overall purpose. In addition, for commercial transactions an exemption could be due where the UK tax avoidance purpose is incidental to the commercial purpose (see INTM603020).

Example 2

Matt, Danni and Tony are business associates who wholly own S Ltd, a UK resident company. Each are also directors in the company and meet the involvement condition. Tony retires from the business and Matt and Danni continue to run the company. Tony no longer has any involvement in the company’s affairs and does not attend any shareholder meetings, but due to his extensive past involvement, the involvement condition has been met. Due to him not attending any shareholder meetings of late, he did not object to any transfers made, meaning the first element of the avoidance condition has been met.

However, it is reasonable to conclude that Tony would not be aware of any transfers made by S Ltd as directed by Matt or Danni. This would mean the second element would not be met, resulting in the avoidance condition having not been met and ITA07/S720A/S727A not applying to Tony. Depending on the circumstances of any transfer undertaken by S Ltd, it would be likely Matt and Danni would be aware of any transfers and the consequences of such transfers and so they would meet the second element of the avoidance condition. Whether s720A/s727A would apply to them would depend on whether either of them objected to any relevant transfers made by S Ltd.

Example 3a

Liz and Graham are spouses who wholly own UK resident company E Ltd; neither are directors. E Ltd is an online clothing sales business. The company directors decide that part of the manufacturing and sales would be taken offshore to a low tax jurisdiction to save tax in the UK. Liz and Graham both meet the involvement condition. The decision to move part of the business of E Ltd offshore was taken by the directors. Liz and Graham have no involvement in the day-to-day business and prefer to leave it in the hands of the directors. Depending on any other circumstances of the case, it may be reasonable to conclude that Liz and Graham were not aware of the transfer, but it is possible that they should have been aware.

Example 3b

Taking the facts from Example 3a, let’s say the directors notified the shareholders of the transfer. The directors presented the offshoring to the shareholders as being purely for commercial reasons, so both were aware of the transfer taking place and neither had reasons to object. Although both were aware of the transfer taking place, it would likely be reasonable to conclude from the circumstances that Liz and Graham were not aware that the consequence of the transfer was to avoid UK tax and so neither would meet the avoidance condition.

Finally, in respect of the avoidance condition, there is an arrangement clause set out at ITA07/S720A(8) and ITA07/S727A(8).

This means that where an individual has arranged through an agreement, understanding or series of transactions to give the appearance of the avoidance condition as having not been met, HMRC will disregard this arrangement.

The result of HMRC disregarding an arrangement is that, where the avoidance condition would have been met had it not been for said arrangement, we would treat the condition in question as having been met.

When determining if there is an arrangement in place, regard must be had for what happened before, during and after the relevant transfer and what the evidence and facts show.

Example 4

Using the facts from Example 1 above with Kevin, Mandy and Hayley. C Ltd is a UK resident closely-held company with 100 shares. Kevin holds 30 shares; Mandy holds 30 shares and Hayley holds 40 shares. None of the individuals are directors but all three have met the involvement condition. C Ltd has developed intellectual property and the directors suggest transferring this to D Ltd, a company resident in Malta, and sublicensing it back to C Ltd allowing royalties to accrue in D Ltd. This business decision is discussed at a shareholder meeting and a vote is cast. Kevin and Mandy vote for the transaction to go ahead and Hayley expresses her dissatisfaction and ultimately votes against the motion. As Kevin and Mandy hold the majority of the shares, a resolution is passed for the transaction to go ahead. In Example 1, because Hayley had objected to the motion, she did not meet the avoidance condition. However, let's say in this scenario Hayley has arranged for the appearance that she has objected to the transfer. It is uncovered in copies of advice, board meetings and emails that Hayley has been the driving force behind the transfer and had arranged the meeting to vote with the knowledge that the motion would be passed on Kevin and Mandy’s votes due to the fact the majority of the shares are held between them. We would disregard Hayley’s arrangement to appear to have objected and treat the avoidance condition as having been met and provided the other ToAA conditions are met, Hayley will fall to be charged under ToAA on any income arising to the person abroad in proportion with her qualifying interest in C Ltd.