INTM602640 - Transfer of assets abroad: Exemptions from charge: Background

Sections 736-742A ITA 2007

The original legislation was in FA36/S18.

When the transfer of assets legislation was first introduced to prevent UK resident individuals avoiding tax by moving their assets offshore, it was recognised that individuals - including foreign visitors to the UK - might have legitimate trade or commercial purposes for having assets outside the UK. In order to provide for this, an exemption clause was included in the legislation. Difficulties have arisen over the years because of challenges as to what the particular wording means and what constitutes tax avoidance.

Tax mitigation and avoidance

Nowadays Parliament provides ways in which it is possible to reduce tax liability legitimately, for example tax free savings. We tend to refer to this as tax mitigation. The term ‘tax avoidance’ on the other hand is generally used to describe arrangements designed to circumvent the intentions of Parliament and its tax legislation.

During 1969 a case CIR v Herdman 45 TC 394 went before the courts. The appellants had transferred shares in a Northern Ireland family company to a holding company in the Republic of Ireland, for the stated reason of avoiding Irish tax. The arrangement was later used to avoid UK tax. The Courts ruled that the legislation (then in ITA52/S412 now at ITA07/S720) was defeated where the original transfer was innocent but where changed circumstances were later used to avoid UK income tax.

In addition, Cayman Islands law had been changed at the instigation of UK residents in such a way as to circumvent the transfer of assets provisions in section ITA52/S412.

Finance Act 1969

This was intended to reverse CIR v Herdman as it provided that the associated operations which must be proved innocent of the purpose of avoiding UK tax to secure exemption must include all operations which were incidental to the power to enjoy the income of the person abroad – instead of only those incidental to the acquisition of the rights by virtue of which the taxpayer has such powers.

Finance Act 1969 was later considered to be defective. FA69/S33(2) was intended to bring into consideration all associated operations. When what became ICTA88/S741 (now ITA07/S736-742) was invoked, the wording of the changes to the legislation provided that the relevant transactions were those by virtue - or in consequence of which - the individual had power to enjoy. This wording could in particular circumstances exclude associated operations which were not directly leading to the power to enjoy.

Because of this, when considering whether an exemption under ICTA88/S741 is available, HMRC will consider only the transfer and any associated operations which directly establish a power to enjoy the income of the person abroad or create a new source of income.

Finance Act 2006

This added a new section - ICTA88/S741A - deemed to come into force on 5 December 2005, which was designed to clarify the meaning of the approach of the legislation at ICTA88/S741, following concerns expressed by the Government that transactions involving the transfer of assets abroad were being increasingly used for tax avoidance purposes. It was also designed to remedy the defects in the Finance Act 1969. These provisions are now within ITA 2007, with the main avoidance purpose exemption at ITA07/S737 and S738. The old rule is at ITA07/S739.

Finance Act 2013

This introduced an additional and alternative ‘genuine transactions’ exemption test at ITA07/S742A which operates retrospectively from 2012-2013 onwards. It is aimed at ensuring the compatibility of the transfer of assets legislation with EU law.

EU law requires that any potential avoidance can be tested on a case-by-case basis, according to objective features and counteraction may not rely simply on establishing a purpose of avoiding tax. Benefitting from a more congenial tax regime within the internal market is acceptable, but in order to do so it must be shown that the relevant market freedom - usually the freedom of establishment or the free movement of capital - is in fact served. This means that the transaction contributes to ‘economic interpenetration’. These freedoms are set out in the Treaty on the Functioning of the European Union (TFEU) and the EEA Agreement (the EEA) covers Norway, Iceland and Liechtenstein in addition to the EU member states.

In terms of EU law, anti-avoidance legislation may result in a breach of one or more freedoms because there is less favourable treatment of one person who is in a position comparable to another. The legislation will nevertheless be compatible provided there are ‘compelling reasons in the public interest’ which justify it and provided the legislation does no more than is required to achieve its aims - thus there may be ‘justifications’ for the provisions which must be ‘proportionate’.

These considerations are based on general principles of EU law, and on certain cases heard by the EU and EEA courts. There are several potential public interest justifications, but the usual one which applies to direct tax is prevention of tax avoidance (or abuse), sometimes in conjunction with a balanced allocation of taxing rights. Other justifications, such as fiscal supervision and coherence of the tax system, are also possible. EU law also suggests that the tax rules must have the ‘specific object’ of excluding ‘artificial arrangements designed to circumvent domestic tax law’. Sometimes this is expressed as ‘wholly’ or ‘purely’ artificial arrangements. See INTM603140 for a discussion on this point.