Many countries have the same model of taxation as the UK; therefore, UK residents with income in Austria, for example, could find themselves paying tax twice on that income – in the UK because of residence status and in Austria because the income arises there.
Double Tax Agreements (DTAs) sort out this problem.
The UK has around 120 bilateral DTAs with other countries and territories. The purpose of these DTAs, as set out in their preamble, is the avoidance of double taxation and the prevention of fiscal evasion. Their intention is to ensure that, as far as possible, the taxpayers of each country may trade or invest in the other country without the deterrent of unrelieved double taxation.
As a result of the complexity of cross-border taxation, DTAs can sometimes be used to exploit the terms of particular agreements and differing tax systems in each country for tax avoidance purposes. This practice is often known as “treaty shopping”.
One widely used scheme involved channelling the UK fee income of a UK resident IT contractor through a Manx partnership to a Manx interest in possession trust. The partnership paid profits to the trustees, who then made payments to the UK resident contractor in his capacity as beneficial owner of an interest in possession under the trust. Because of the DTA provisions and the legislation then in force, the income channelled to him was subject neither to UK income tax nor to Manx tax.
The UK reacted to schemes of this nature by introducing retrospective legislation which countered the tax advantages of such arrangements. The legitimacy of such a drastic response was confirmed by the Court of Appeal in July, although an appeal to the Supreme Court remains a possibility.
HMRC and HM Treasury have now apparently decided that enough is enough. A consultation document has been issued proposing anti-avoidance legislation to counter “abuse” of DTAs. This legislation is intended to take effect retrospectively.
Where certain conditions are met, the proposed legislation will apply so that the provisions of a DTA will not prevent income, profits or gains being charged to UK tax.
The conditions are that:
(a) a scheme is put in place by one or more persons
(b) the provision would not apply to the income, profits or gains in the absence of the scheme
(c) the main purpose, or one of the main purposes, of a person in putting the scheme in place is to ensure that the provision does apply to the income, profits or gains
It is hard to resist the conclusion that the UK is adopting a “scattergun” approach to this problem. The proposed anti-avoidance legislation is very widely drawn. It remains to be seen how effective it will be in practice.