Congratulations are due!
As we approach the end of March, so we say a brief farewell to our Practice Manager, Jamie, who is getting married later today. We wish him and his beautiful bride, Catherine, nothing but the best. In the grand tradition of weddings, we offer something old, something new, something borrowed and something blue for our newsletter this month.
The old (and we are speaking in relative terms here) is our article on MiFID 2 and how its ‘go live’ date on 3 January 2018 went. The new is the new US GILTI regime and a discussion of how it may apply in a fund management situation.
Something borrowed is the US closing their offshore disclosure window. We say it is borrowed as it follows the UK’s announcement of a restriction to its disclosure facility in the run up to the next round of CRS exchanges due to take place later this year.
And finally, the something blue is the feeling both HMRC and taxpayers will experience after the decisions of the First and Upper Tier Tribunals in three cases we highlight this month.
- MiFID II – How was it for you?
- Gilti – Are you?
- Offshore Disclosure Facilities – Going, going, gone!
- Case round-up – Something for everyone.
- STOP PRESS – A new corporate vehicle to consider.
The ‘go live’ date
The ‘go live’ date for MiFID II was 3 January 2018 and its effect on market transparency was evident almost immediately. Three weeks after the go live date, it was reported that investors in some of the UK’s most popular funds learned the actual cost of investment – the disclosure under the MiFID II rules – was, in some cases, as high as 85% above previously disclosed fee structures… ouch.
Clearly, for investors in affected UK funds, MiFID II was working, giving them significantly better qualitative reporting about their transaction and holding costs and, no doubt, a number of rather prickly follow up conversations with investment advisers.
MiFID II objectives
Yet MiFID II’s objectives are broader than just market transparency. In a very real sense MiFID 2.0’s overarching goal is to address the short-comings of the original MiFID and to respond to lessons learned during the 2008 financial crisis. And so, in as many pages as War and Peace, it seeks to secure investor protection, provide a coherent market structure, and establish internal (primarily enhanced governance) and external controls. Quick question, but what was MiFiD for then?
In short, MiFID II represents the most substantial overhaul of EU legislation for financial markets in more than a decade and presents a major implementation challenge for firms and competent authorities across the EU.
It certainly has its critics. In 2017, Jeff Spreecher, CEO of ICE, was quoted in the Financial Times as saying it was the worst piece of legislation he had seen in his career. That’s obviously not a great start.
The US vs the EU
After the 2008 financial meltdown, Congress sought to shore up the U.S. financial regulatory system by passing the Dodd-Frank Act. As with most ‘the horse has already bolted’ legislation, it was overly broad and rather draconian.
Both Dodd-Frank and MiFID II have a lot in common. Both are aimed at protecting investors and preventing markets in financial instruments from implosion. So, for example, both typically regulate over-the-counter (OTC) derivatives like credit default swaps (CDS) by having them trade on regulated markets away from so-called ‘dark pools’ in order to neutralize the risk of market disruption.
But while the EU is undertaking the biggest overhaul in its financial markets in over a decade, the Trump administration is reeling back. Congress is currently looking to de-regulate its banking sector and financial markets by loosening some of the Dodd-Frank regulations that were widely seen as overly restrictive.
In closing, time will no doubt tell which approach (less or more regulation) better serves the financial markets and its players. We hope the EU keeps a watchful eye on the US developments and its market impact.
GILTI – Global Intangible Low-Taxed Income
The President Trump Plan
In MTN January 2018, we outlined the new Trump tax bill and highlighted the dramatic impact the provisions would have on the structure of US (and potentially global) taxation. We were recently asked to consider specific elements of the US reforms for a UK based hedge fund client. What became evident is that the reforms are likely to adversely impact all fund managers with US stakeholders.
It’s pretty obvious, given the drafting errors and some of the unintended tax consequences, that Trump’s tax plan (the Tax Cuts and Jobs Act or TCJA) was forged in the fires of typical Trumpian chaos. In particular, one unintended (or perhaps deliberate) consequence of the wholesale change in approach is the impact on UK Alternative Investment Fund Managers (UK AIFMs). AIFMs are fund managers that are in the alternative investment space, like hedge funds and private equity funds.
In our view, the Trump tax provisions could affect UK AIFMs:
- a one-off mandatory ‘repatriation tax’ or toll charge on income earned by a UK AIFM that has not yet been subject to U.S. tax and that is a U.S. Controlled Foreign Corporation (CFC); and
- from 2018, a ‘global minimum tax’ (the GILTI) might apply to a UK AIFM that is also a U.S. CFC.
But, let’s go back to the start. All U.S. citizens remain subject to U.S. federal tax during their lifetime. This means that even if a U.S. citizen moves to the UK, they are required to file a US tax return and pay US tax on their worldwide income annually. If they paid UK (or other) tax on that income, they can typically deduct it against their U.S. federal income tax liability. This is significant where there are U.S. individuals who are shareholders-cum-employees of a UK AIFM. Also of relevance is that the U.S. tax code includes provisions to capture income arising to CFCs and taxes such income as if it had arisen to the U.S. taxpayer directly (in defined circumstances).
Fund structures are generally designed to facilitate the frictionless transfer of investment yield back to investors. This means that it is common to see a combination of tax opaque and tax pass through entities to protect the investors particular tax profile. Fund structures with U.S. limited partners are no different. These types of fund structures would typically be outside the U.S. CFC rules given their tax transparent form (i.e. there is no need to attribute the income).
Fund managers, while clearly part of the overall arrangements, have different tax priorities. Thus, AIFMs are typically established as foreign corporations for U.S. tax purposes, and, are generally CFCs for U.S. tax purposes. The consequence of this would be that income arising in those fund management vehicles could be subject to US tax for the relevant US taxpayers (any U.S. shareholders holding more than 10% of the issued equity in a UK AIFM).
The repatriation or toll charge
The toll charge is essentially a precursor to the U.S. moving to a territorial based corporate tax system. Trump wants the likes of Apple, Google and Amazon to repatriate their untaxed foreign earnings (estimated at about $10 trillion) back to the U.S. Typically, the foreign earnings of U.S. subsidiaries are only subject to U.S. corporation tax on repatriation. The Trump toll charge forces repatriations by subjecting cash repatriations to a one-off reduced rate (c.17%).
But the toll charge tax could also apply to a U.S. CFC (including an AIFM) that has accumulated earnings and profit (E&P) at the end of 2017 that has not previously been subject to US tax (this is likely to comprise income from an active trading business – such as management fees).
Fund managers with US stakeholders should be aware of the adverse way in which the new GILTI charge is calculated and applied to fund management structures.
It seems even the current Republican Congress has a very weak sense of humour. The new global minimum tax appears to be aimed at those ‘guilty’ (apparently, the pun is intended) of not #MakingAmericaGreatAgain because they are keeping some or all of their income-producing assets outside of the U.S. For these folks, GILTI seeks to apply US federal income tax to foreign income generated on offshore assets.
In the fund management context, this is likely to have a significant downside because the majority of fund management arrangements we have seen have been specifically structured as ‘qualified foreign corporations’ (QFC) for US federal income tax purposes. This is because QFCs typically generate qualified dividend income (QDI) that is taxed at 20% for the U.S. shareholders. QFCs typically only have active income, such as management fees, rather than subpart F passive income that is caught by the CFC rules.
Moreover, AIFMs typically do not utilise a lot of property, plant and equipment or other fixed assets in their advisory work, giving them a very low tax base for the purposes of computing a GILTI charge. This is because GILTI taxes returns on tangible fixed assets that are regarded as ‘excessive’. Any income earned by an AIFM in excess of 10% of its tangible fixed assets (which are likely to be minimal) could be within GILTI.
Let’s take a very simple example. Assume we have a UK company that is a CFC for U.S. tax purposes and that is acting as a fund manager for a Cayman based hedge fund. The UK fund manager has an office in London that is fully furnished with a board room and expensive office furniture, along with computers and telephones giving it tangible fixed assets of £10. GILTI would apply to tax all income earned by the UK fund manager that is in excess of 10% of its tangible fixed assets – being £1. If it earns an annual management fee of £100 for managing the Cayman hedge fund’s investments then £99 could be within the scope of the GILTI charge.
For individuals, their share of GILTI income attributable to them will be taxed at their marginal income tax rate. For an individual in the top marginal rate it could be as high as 37% (2018 US tax year). Clearly this represents a marked increase on the 20% rate under the pre-GILTI position.
However, for U.S. corporations, GILTI income is taxed at a significantly lower 10.5% effective rate This is because there’s a 50% deduction available at the 21% U.S. corporate rate, plus 80% of any foreign tax credits. So, one structuring solution for an individual U.S. shareholder liable to GILTI may be to envelop his shares in a U.S. corporation to benefit from the lower GILTI tax rate applicable to corporations.
Offshore Disclosure Facilities
This is your final call! Disclosure facilities are departing from Gate 2
The IRS announced earlier this month that its Offshore Voluntary Disclosure Program (OVDP) has served its purpose and will close on 28 September 2018. Despite the OVDP’s initial popularity (2011 saw 18,000 disclosures), uptake has declined in recent years with just 600 disclosures made to the IRS in 2017.
The OVDP is designed to entice taxpayers with undeclared offshore liabilities to make a disclosure to the IRS, in exchange for protection from criminal liabilities and the ability to agree terms to resolve their civil tax and penalty obligations. But the tax landscape has moved. The IRS heralds the success of FATCA and the Department of Justice’s Swiss Bank Program as primary drivers is ceasing voluntary disclosure.
it is said that imitation is the sincerest form of flattery. With the Liechtenstein Disclosure Facility and the three British Crown Dependency Facilities (Jersey, Guernsey and Isle of Man) all now closed, the US announcement follows the UK move to further restrict our own voluntary disclosure programmes later this year.
The UK also recently introduced ‘Requirement to Correct’ (RTC) legislation as part of its Finance (No. 2) Act 2017. The RTC compels taxpayers with undeclared offshore tax liabilities (income tax, capital gains tax and inheritance tax) to make a disclosure to HMRC prior to 30 September 2018. The leverage used is substantially increased penalties (try double) where the deadline is missed.
The 30 September 2018 was chosen to mirror the next round of CRS exchanges, where over 100 jurisdictions are expected to automatically exchange information of financial account information. Domestic provisions aside, CRS is likely to become the UK’s main weapon in tackling offshore tax non-compliance.
The more stringent penalties applied under the RTC, are:
|Standard Penalty||Equivalent to 200% of the tax liability disclosed to HMRC.||Applies where information is disclosed after 30 September 2018. But, can be reduced for: cooperation with HMRC; quality of information disclosed; or seriousness of the taxpayer’s failure to correct.|
|Asset Based Penalty||Additional 10% penalty based on the value of the asset disclosed.||Applies to serious cases where: tax undeclared exceeds £25,000 in a tax year; and the non-compliance was known but not disclosed.|
|Offshore Asset Moves Penalty||Additional 50% penalty based on the Standard Penalty.||Applies where the assets are moved to avoid a disclosure under an international automatic exchange of information agreement.|
If you think you may have undeclared tax liabilities that you would like to discuss, please get in touch.
Mrs Sabin Qureshi  UKFTT 115 (TC)
When this case popped up on the Bailii website’s Recent Decisions list, the heading “Income Tax/Corporation Tax : Penalty” was so innocuous as to make you glide over it without so much of a mouse click.
Whilst you would be correct on the subject matter, it is in fact worth a read. The facts of the case are not particularly remarkable, the appellant, Mrs Qureshi, was issued with penalty notices by HMRC for failing to file her 2014 and 2015 tax returns. Her defence was that she had never received the notices to file and had told HMRC so.
As this was a penalty case, the burden of proof rests on HMRC not the taxpayer, but where HMRC can prove they have issued the notice it falls upon the taxpayer to show, on the balance of probabilities, that they didn’t receive it. With proving a negative difficult at the best of times, unless they taxpayer can provide evidence of general problems with their post they are probably looking at the penalty being confirmed.
Here though, HMRC fell at the first hurdle; they couldn’t show that they had issued the notices to file. Counsel for HMRC produced print outs from the HMRC computer systems showing an entry for “Return Issue Date” of 12/6/14 and asked the Tribunal to conclude that a notice to file “must have been” sent on that date. Counsel went on to say that the notice “would then have been” sent to the address HMRC held on file for Mrs Qureshi’s.
The Tribunal took exception to the lack of certainty shown by HMRC’s Counsel and, using judicial language, “went ballistic” at HMRC’s assertion that the Courts should assume and conclude on the issuing of documents rather than having HMRC go to the trouble of proving they had been issued.
Forcefully reminding HMRC’s Counsel that no special rules applied, the Tribunal did set out what they would expect to see as evidence that a notice to return had been issued – a detailed explanation of how the computer process works for starters.
Reading the decision, you have to wonder if HMRC Counsel’s attitude generated such a dusty response from the Tribunal. It is unlikely that the defence will be available to other taxpayers and no doubt HMRC are already drawing up a package for their Presenting Officers giving “chapter and verse” on how the relevant computer system works! It is, though, another example of HMRC being reminded that, despite the needs of the public purse and the new powers they have been granted, the rules of the Court still apply to them.
We turn now to another case where it seems HMRC tried to “wing it” rather than apply the law correctly.
HMRC v Tooth  UKUT 38 (TCC)
Given the nature of the underlying subject matter to this case (a failed avoidance scheme) you might expect the wind to be in HMRC’s sails, but they lost on several technicalities that have wider importance.
Mr Tooth ‘invested’ in a scheme to generate employment income losses that could be set against his taxable income. The main case in this area and the same promoter, was Cotter and the Supreme Court found against him.
When filing his return, perhaps unsurprisingly, it wasn’t possible for Mr Tooth to make the relevant entries in the right boxed in the return so Mr Tooth did the best he could and explained in great detail what he had done and why. HMRC said that the return was deliberately inaccurate because Mr Tooth had not put the information in the correct place and contended that this fact allowed them an extension to the usual 4 year discovery limit.
One quirk of the case was how HMRC enquired into the planning (upon such technicalities c£500,000 rests). In respect of Mr Tooth, HMRC chose a poor option. When this “oops” surfaced following the decision in Cotter, the HMRC Officer in charge of the enquiries (who admitted he didn’t understand how Self-Assessment worked – note to self always write emails on the basis that they will come to light or better yet, phone), asked for a discovery assessment to be raised to replace the original enquiry.
The first important principle from the decision was what the Upper Tier Tribunal (UTT) had to say about inaccuracy. Mr Tooth filed his Return before the decision in Cotter and, at the time he made his Self-Assessment Return, it was based upon a “bona fide albeit controversial interpretation” of the law. The UTT said, quite categorically, that such a Return is not inaccurate although they did add a rider that the person should bring their controversial interpretation to the attention of HMRC. We are not sure that this is correct – disclosure seems more to do with discovery than accuracy, but we do agree that when a genuine interpretation later turns out to be wrong it does not an inaccurate return make, or at least not at the time it is made!
The second important principle is that HMRC cannot cherry pick the entries in the Return to suit its own case. It must consider all entries that relate to the subject and consider them as a whole. Here, HMRC could not just point to Mr Tooth putting the information on the wrong part of the Return and say he had acted deliberately, they must also take into account that he had clearly explained to HMRC why he had used the wrong part of the Return. This meant he had acted deliberately – you can’t accidently make comprehensive entries on a Tax Return – but he had not acted deliberately in the way that the legislation required.
The final important principle is in respect of Discovery – this is what HMRC needs to make an assessment if they have not opened an enquiry. It is an incredibly low bar, but also an incredibly complex principle to apply. For instance, if an Officer of HMRC makes a discovery and tells a second Officer about it, that second Officer has not made a discovery. By contrast, if he reached the same conclusion without speaking to the first Officer he would have made a discovery (do you see the complexity creeping in?). Here, the relevant HMRC Officer had effectively been told of the discovery another officer had made in 2009. The only new discovery was the view that the Return was now deliberately inaccurate and this was not the sort of discovery needed to raise an assessment.
All a rather chastening reminder to HMRC as to what they can and can’t do.
Our final case though shows that taxpayers can’t always hope that a technicality will save them, and indeed may work against them.
William Tinkler  UKUT 0073 (TCC)
This case is similar to Mrs Qureshi’s above in that Mr Tinkler argued he had not received documentation from HMRC, although in his case it was a notice of enquiry rather than a notice to file.
Here it was found that Mr Tinkler had not received the notice, but his agent had. This was important because Mr Tinkler had signed a form 64-8 (the form used to tell HMRC you have someone acting for you) and the terms of the form meant that his agent was not only authorized to correspond with HMRC, but also that they were authorized to accept documents from HMRC on his behalf.
So, although Mr Tinkler didn’t get the notice but his agent had, HMRC had still opened an enquiry. As there had been an open enquiry, HMRC were able to close it and increase the amount they said was due. Whether that amount is due or not is for another hearing, but in the meantime the lesson as ever is to read very carefully whatever you are signing and understand what your signature means.