The spotlight turns on offshore management

UK investment property is often held through an offshore vehicle which must be non-resident for tax purposes. However HM Revenue and Customs (HMRC) is cracking down on the legitimacy of tax-exemption, Nick Burt explains

In recent years there has been a proliferation of offshore holding structures for UK investment property, such as unit trusts and companies. This followed the introduction of Stamp Duty Land Tax (SDLT) at the end of 2003, and more specifically the application of those rules to partnerships in mid-2004. As a basic principle these structures allow for UK property to be bought and sold within a corporate wrapper, without incurring either an SDLT or stamp duty charge.

A number of other tax advantages may arise (such as exemption from capital gains tax) depending on the precise nature of the structure and the investor mix. It is critical to all of these arrangements that the vehicle used is non-resident, and therefore that it is properly managed and controlled outside the UK. Where UK investors have used these structures, particular care needs to be taken to ensure that a vehicle’s residency remains offshore.

The residency test
The starting point is that the residency of a vehicle will typically be determined by where its central management and control takes place. The concept of ‘central management and control’ has arisen from case law rather than legislation, and is generally considered to be where the key strategic decisions affecting the vehicle are taken, rather than day-to-day operational management.

In the case of a company, this will usually be where the board of directors meet. However, this is a rebuttable presumption which is ultimately dependant upon the facts. For example, it is possible that decisions could actually be made by a strong managing director outside of the board meetings, or that the board merely rubber stamps decisions taken by someone other than a director. Where the person actually making the decisions is based in the UK, problems can arise. Therefore, HMRC are looking closely at entities that purport to be non-resident, yet have strong links with the UK.

HMRC suffered a setback before the Court of Appeal in 2006 in the case of Wood v Holden. Having won in the first instance, they failed to demonstrate that offshore directors had not taken independent decisions. This case concerned a sophisticated tax planning structure which required all companies involved to be non-resident. HMRC contended that one of those companies had effectively been controlled and managed from the UK by Mr Wood and accordingly, was UK resident for tax purposes. In dismissing HMRCs arguments, the Court clarified a number of important principles, emphasising the distinction between exercising management and control and influencing those who do. A UK-based outsider can advise directors, but must not dictate the decisions to be made. 

The Court held that all decisions were made, and documents executed, by the directors and found no evidence that the board had been bypassed or usurped. Therefore, the only tenable conclusion was that the company was non-resident. This win may have provided taxpayers and some advisers with false confidence. Had HMRC carried out a more detailed investigation as to the facts and been able to show precisely where and by whom decisions were taken, they may have won.

HMRC seems to have learned this lesson. Following their loss in Wood v Holden HMRC have been more rigorous in their investigations, and this has resulted in their recent success before the First Tier Tax Tribunal.

The case of Laerstate BV v HMRC demonstrated that despite previous setbacks, it was possible for HMRC to show that the central management and control functions of a company’s board could be usurped.

The matter revolved around the struggle between Dieter Bock and Tiny Rowland over Lonrho plc during the 1990s. Laerstate, a company resident in the Netherlands, acquired a substantial shareholding in Lonrho in December 1992. For most of the period in question the company had two directors - Mr Bock and Mr Trapman. Mr Bock was the sole shareholder of Laerstate and resigned as director prior to the sale of the shares in Lonrho to Anglo in 1996. HMRC determined that, in practice, Mr Bock exercised control of the company from the UK and it was therefore UK resident for tax purposes. Accordingly, HMRC sought to tax Laerstate’s gain on its disposal of its shareholding in Lonrho.
To determine the location of the company’s central management and control, the Tribunal looked at the period before, during and after Mr Bock was a director. They realised that it was Mr Bock who for the most part made decisions which were simply implemented by Mr Trapman in the Netherlands. Furthermore, HMRC were able to demonstrate that Mr Bock’s decisions were primarily taken in the UK.

HMRCs investigations were incredibly thorough. They investigated the minutiae of actions taken, including matching travel details to the board meetings directors claimed to have attended. There was evidence that some resolutions were passed and documents executed outside the UK. Yet the Tribunal found that the company’s actual “course of business and trading” and the key decisions in “policy, strategic and management matters” were made by Mr Bock in the UK. Mr Trapman was simply a mouthpiece for the company, having no input in the top level management. Accordingly, the Tribunal determined that the company was UK resident for tax purposes.

Practical advice
The consequences of not having strict and robust procedures in place for the management of offshore structures can be severe. Laerstate serves as a reminder that a company’s activities as a whole are more important than specific instances of purported management.  Diligence is therefore required where an offshore vehicle has strong links to the UK.

To minimise the risk of a successful challenge, the following steps should be taken:

- A majority of directors should be non-resident;
- Board meetings should take place outside the UK, preferably in the same jurisdiction as the vehicle so that         residence can be positively identified;
- Board meetings should be held often enough to allow the board to exercise central management and control;
- All directors should be capable of making their own decisions, which will require them to have experience
    in the relevant market;
- All directors should be given the relevant documents in sufficient time to allow them to fully consider the issues;
- All important decisions should be discussed at board meetings rather than merely ratified;
- Written resolutions and corporate representatives should be avoided unless absolutely necessary, and all UK             - Board minutes should detail the information provided to directors and the issues deliberated, as opposed to
    simply being ‘off the shelf’;
- All advisers dealing with the offshore vehicle should treat the non-resident vehicle as the client, rather than look to
    a UK resident for instructions; and
- Documentation such as tickets, receipts and diaries, which can prove that directors were not in the UK at the         relevant times, should be retained as evidence.

It is important these steps are followed throughout the life of the offshore vehicle. Whilst their importance will be obvious at the time of set-up, good intentions will fade over time, and it is possible that lapses in ‘best practice’ will begin to occur. By not allowing this to happen, companies can protect themselves from facing taxation on their UK holdings.