The new legislation, planned to take effect in April 2019, would bring these profits within the UK tax charge and require notification of the arrangements to HMRC and earlier payment of tax.

It is designed to tackle avoidance arrangements involving fragmentation of profit which in substance derives from a single activity, but which for tax purposes is said to arise in two or more jurisdictions and often involve offshore trusts and companies in low or nil tax territories.

HMRC says that while it has had some success in challenging such arrangements using its existing powers, the process is slow and as the tax involved can be substantial, users are benefiting from significant cash flow advantages. These would be removed under the new legislation which will target these schemes directly and require the upfront payment of tax while the enquiries are undertaken.

Three conditions

The legislation is aimed at arrangements where there are profits attributable to the professional or trading skills of an individual (A) resident in the UK, whether A is trading as an individual or a partner, or conducting business through a company. Some or all of those profits (‘alienated profits’) end up in an entity Z which results in significantly less tax being paid on them than would have been paid had they arisen to A. HMRC says an ‘entity’ for these purposes would be interpreted widely, and would include a company, partnership or trust, whether or not having legal personality.

The legislation applies where A, or a connected person, or someone acting together with A or the connected person, is able to enjoy economic benefits from the alienated profits.

HMRC says these three conditions will be met by a relatively small subset of all UK businesses, and there will be a final condition that is intended to give immediate certainty as to whether the legislation applies. This will be that it must be reasonable to conclude that some or all of Z’s profit is excessive having regard to the profit-making functions it performs with that excess being attributable instead to the connection between it and A.

The legislation will also provide for notification of use of this type of arrangement, similar to the existing DOTAS regime, and for earlier payment of any tax relating to them.

‘Significantly less tax’

The ‘significantly less tax’ test to be included in the legislation would involve a comparison with real rates of tax suffered on the alienated profits, rather than headline rates. This means that if, for example, any special rules or individual rulings apply in the other jurisdiction, they will be taken into account in the comparison.

The proposal is that the trigger should be a tax rate in the region of 80% of the UK tax that would have been paid on the same profits. HMRC will look critically at any case where those profits accrue in a low tax rate jurisdiction or any other territories where headline rates are used to mask much lower effective rates of taxation.

The final condition looks at whether the personal connection between the relevant individual and the offshore entity results in excess profits being attributed to the latter in order to minimise tax. It is proposed that this ‘excessive profits’ test will involve examining all of the facts around the arrangements. If the facts show that the sums paid to the connected entity are in reality in return for services actually carried on in the UK, and that sums paid to the offshore entity ultimately benefit members of the trader’s family, then the condition will be met.

An important element of the proposal will involve a ‘power to enjoy’ test to cover circumstances where, for example, someone does not benefit by direct payment but the money is used to pay off family loans or put in trust for grandchildren.

HMRC says the measure likely to affect around 8,000-10,000 wealthy individuals who control a small number of businesses, estimated to be in the region of 4,000-5,000, who are currently involved in tax avoidance arrangements. It is expected to increase receipts by a up to £50m a year.

The consultation on the design of the legislation closes on 8 June. 

Consultation Tax Avoidance involving Profit Fragmentation is here.

Report by Pat Sweet