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Leigh Sagar, Barrister, examines the application of permanent establishment rules to the trustee residence of offshore corporate trust service providers ('TSPs'), following changes introduced in Finance Act 2006 ('the 2006 Act') .

Leigh Sagar

Residence

Residence is important for liability to tax. For settlements, liability for tax on income and capital gains depends to a large extent on whether the trustees as a body are treated as resident or non-resident in the UK. Essentially:

if they are not resident in the UK for a tax year, they are not directly chargeable to UK income tax for that year. If they receive income from a UK source, it is to be paid to them after deduction of tax; and trustees that are not resident throughout a tax year are not chargeable to capital gains tax arising in that year, even if the gains arise in the UK.
 
Residence can be particularly serious in relation to capital gains tax. As well as causing the trust’s worldwide gains to be taxed, if the trustee then becomes non-resident, it will be deemed to have disposed of the trust assets and reacquired them at market value, giving rise to a tax on the deemed gains (section 80 of the Taxation of Chargeable Gains Act 1992).

The rules about trustee residence were changed by the Finance Act 2006 ('the 2006 Act'). For periods before 6th April 2007, there were different residence tests for each of income tax and capital gains tax. For periods after that, the test is the same for both. Section 474 of the Income Tax Act 2007 ('ITA') and section 69 of the Taxation of Chargeable Gains Act 1992 provide that the trustees are to be treated as a single person, distinct from the persons who are the trustees from time to time; a sort of corporate personality for the purposes of income and capital gains taxation. It is necessary first to look at each of the trustees to see whether or not he, she or it is resident in the UK. If there is only one trustee, such as an offshore TSP, which is not resident in the UK, the notional single person will not be resident or ordinarily resident in the UK. If there are other trustees, one or more of whom is resident in the UK, it becomes necessary to look at the residence, ordinary residence and domicile of the settlor, but it is not necessary for present purposes to examine those rules.

Generally, a trust company that was not incorporated in the UK is resident there only if its central management and control is exercised there._[1] The 2006 Act, however, added a further test for the purposes of trustee residence. Section 473(6) of ITA provides:_[2]

“If at a time a person (‘T’) who is a trustee of the settlement acts as trustee in the course of a business which T carries on in the United Kingdom through a branch, agency or permanent establishment there, then for the purposes of subsections (4) and (5)_[3] assume that T is UK resident at that time.”

Section 834(1) of the Income and Corporation Taxes Act (“the Taxes Act”) defines “branch or agency” as “any factorship, agency, receivership, branch or management.” In CIR v Brackett,_[4] B, a UK resident was employed by a Jersey property development company. If someone in the UK wanted his services, they contracted with the Jersey company and B did all the work, in the UK, using facilities available to him under arrangements that he set up himself. The Jersey company was assessed to corporation tax in the name of B, as the agent of the company. He claimed he was neither an agent nor a branch. It was held that the Jersey company was trading in the UK. Hoffmann J said:

“It is true that the conclusion of the contracts for the provision of the taxpayer’s [B’s] services and a certain amount of administration took place in Jersey, but the taxpayer was permanently resident in the United Kingdom and his activities constituted … the essential operations of the company’s trade.

“[The company] was therefore liable to be assessed to corporation tax in the name of any branch or agent in the United Kingdom if such existed. Again, I think that there was evidence before the Special Commissioners on which they were entitled to find that the taxpayer constituted such a branch or agency. He was a United Kingdom resident and the sole United Kingdom resident by whom the company carried on its trade in the United Kingdom. … I do not think that it is necessary that an agent should be a person who is empowered to enter into contractual relations on behalf of the non-resident company. Wherever the contracts are made, I find it difficult to imagine how a non-resident company which carries on a trade with any degree of continuity in the United Kingdom can do so otherwise than through a ‘branch or agency’.”

This question has been alleviated somewhat by an acknowledgment by HMRC, in an exchange of correspondence with STEP UK Technical Committee in November 2006,_[5] that, on their interpretation, “a non-resident company is within the provisions only if it has a UK permanent establishment, and that ‘branch’ or ‘agency’ relates only to a non-corporate person.”

Permanent establishment

In the correspondence between STEP and HMRC, the STEP committee described certain situations and asked for confirmation that they would not cause any trust, of which the TSP is trustee, to be UK resident:

(a) “The UK parent or UK group members have office space in the UK and typically permit visiting directors or employees of the non-resident trustee company to use their meeting rooms or other office facilities (e.g. telephones, computers or faxes). Such use is made when the director or employee concerned is in the UK on occasional visits for the purpose of meeting the settlor or beneficiaries or professional advisers. Such professional advisers may be independent practitioners or employees of the UK parent or other UK group members.

(b) “The UK parent or UK group members provide such office accommodation on an occasional basis to enable the employees of the non-resident trustee company to meet prospective settlors or business contacts for the purpose of selling trustee services.

(c) “The non-resident trustee company has a director or other employee who is resident in the UK. This individual may also be an employee or director of UK resident group members. The group provides office accommodation in the UK to the individual concerned. His role is to market the business of the non-resident trustee company in the UK and meet with prospective settlors and other business contacts for this purpose. He also meets settlors and beneficiaries of existing trusts.

(d) “The non-resident trustee company contracts back office services such as accounting and tax compliance to UK group members on commercial terms.

(e) “The non-resident trustee company contracts with UK group members for investment advice or management on commercial terms.”

HMRC declined to give any substantive response, saying that it would depend on the facts of each case. They accepted that there needs to be some form of guidance on the matter.

The expression, “permanent establishment” is commonly used in double taxation conventions, or treaties, made between different countries. Apart from that, for income tax purposes, section 148 of the Finance Act 2003 (”FA 2003") provides that an offshore company has a permanent establishment in the UK if, and only if:_[6]

(a) “it has a fixed place of business there through which the business of the company is wholly or partly carried on, or

(b) “an agent acting on behalf of the company has and habitually exercises there authority to do business on behalf of the company.”

The definition in para (b) differs from the definition of a permanent establishment in the OECD Model Convention,_[7] where the agent must have and exercise authority to negotiate and conclude contracts on behalf of the enterprise. Under section 148, he must have and exercise authority to do business on behalf of the enterprise. I will return to this later.

Fixed place of business

The statutory provision continues that, for this purpose a “fixed place of business” includes a place of management, a branch and an office. A company is not regarded as having a permanent establishment in the UK if it carries on business there through an agent of independent status acting in the ordinary course of his business. Also, even though it maintains a fixed place of business in the UK for the purpose of carrying on its activities, or an agent carries on activities there for and on behalf of the company, there will be no permanent establishment if the activities carried on are only of a preparatory or auxiliary character; this includes displaying merchandise of, or collecting information for the company.

Defining the term as a fixed place of business through which the business of an offshore TSP is wholly or partly carried on shows that the employees of the enterprise must carry it on at premises, in the UK, that are (1) fixed and (2) have a degree of permanence.

The premises need not be used exclusively for the purposes of the enterprise; for example, they might comprise a room, within the premises of some UK business, at its disposal and used for the purposes of the business of the enterprise. The enterprise need not have any legal right to use the space and the room may be changed, so long as it remains within the offices of the UK business. The enterprise must be carrying on its business wholly or partly through the fixed place of business, even though it might not be of a productive character. It does not matter whether or not the employees working at that place have authority to conclude contracts.

The place of business must not be of a temporary nature, although it may exist for only a short time, if that is consistent with the nature of the business. It is a question of degree. Temporary interruptions of activities will not cause what is otherwise a permanent establishment to cease to exist. The permanent establishment will begin to exist as soon as the enterprise commences to carry on its business through the fixed place of business, but not while it is setting it up. The permanent establishment will cease to exist when the fixed place of business is disposed of or the activities ceased to take place there; temporary interruptions do not constitute closure.

Agent acting on behalf of the enterprise

The activities of persons known as “dependent agents” might create a permanent establishment for the enterprise. They need not be employees of the enterprise, they might be individuals or companies and they need not be residents of the UK. They must not be independent agents.

As mentioned above, under section 148 of FA 2003, only persons having the authority to conclude business can create a permanent establishment for their principal. The person will need to have sufficient authority to bind the enterprise’s participation in a business activity in the UK. They must use it “habitually”, or repeatedly, and not merely in isolated cases.

I now consider the question whether “authority to do business” means something different from “authority to negotiate and conclude contracts”, as in the OECD Model Convention. In the HMRC International Manual, §264050, it is stated that section 148 of FA 2003 “is similar to and has the same broad effect as the Model Convention definition of permanent establishment”. In §264070, however, it is stated that:

“The OECD Model Treaty definition is drawn more narrowly because it requires the agent to exercise authority to enter into contracts.”

It seems to me that the authority to do business must relate to the actual business of the enterprise. The business of a TSP is that of establishing and administering trusts. If someone is in the UK, establishing or administering trusts on behalf of the offshore TSP, there will be a permanent establishment in the UK. Merely meeting potential settlors and referring them on to the principal offshore TSP would not be enough. If the agent is in the UK meeting potential settlors and discussing with them the terms of the deed, the letter of wishes, the assets to be settled, and carrying out all other matters apart from the execution of the documents themselves, that may constititue it a permanent establishment.

The authority must actually be exercised and must be exercised habitually, which means that a one-off visit to the UK to see an existing client would not be enough. What is habitual will depend on the circumstances; but it needs to be done often enough and with sufficient regularity.

What about administration? If some of the TSP’s employees are in the UK and, regularly or over a prolonged period, are given administration duties in respect of trusts of which the TSP is the trustee, that would be enough to create a permanent establishment. I think that accounting and tax compliance would be sufficiently part of the business of the TSP to qualify if it is part of the administration of a trust.

Which employees would qualify? If the tasks delegated to the employees are mechanical in nature, without any discretion and, if there are any difficulties they are referred to the offshore TSP, this would not be enough. Once discretions are exercised in the UK, however, the position is different. If one of the TSP’s directors is the employee in question, he is more likely to be a permanent establishment than a clerk merely entering figures in a spreadsheet; the director is more likely to have, and exercise, authority.

If the TSP instructs investment brokers or accountants in the UK, even if they are members of its corporate group, there would be no permanent establishment if the group members are providing the services in the course of their own businesses and at what would be arms length conditions between non-affiliated persons, and are sufficiently independent of the TSP. If a group member provides such services only for the TSP, that would tend to show that there is a permanent establishment but, if the TSP is only one of a number of clients of the group member and the services provided are not significantly greater than the services provided to the other clients, the group member would not be a permanent establishment.

In order to be independent, the UK person would have to take some responsibility for the work done, so that the TSP could and would be likely to bring proceedings against it if there were any default in the work done. Control would also be a factor. If the TSP instructs the UK person as if it is an employee, that would not be independent. If the TSP instructs the UK person to carry out work and largely leaves the way it was done to the UK person, that would indicate independence.

HMRC have confirmed in a letter to STEP UK, dated 18th July 2007, that the provision of services on an arms length basis would not create a permanent establishment; they said:

“More specifically, this would include where services are carried out by a subsidiary on a fully arms length basis, such as:

• maintaining the financial or accounting records
• preparation of accounts
• preparation and submission of tax returns for any settlement by a separate entity within the organisation contracting at arms length terms.”

If the UK person is a subsidiary of the TSP, that does not, without more, constitute the UK person as a permanent establishment of the TSP.

Conclusion

Looking at the position of an offshore TSP, if it has a branch or agency in the UK and is establishing or administering trusts there, it will be deemed to be resident in the UK. If it is merely using an office to market its business or canvass for clients and all substantive transactions take place offshore, it is probably not resident in the UK. The place where trustees’ meetings are held and decisions are taken will be highly relevant. If a TSP is instructing lawyers, or accountants, or investment managers in the UK, that will not, in itself, cause it to be operating through a permanent establishment. If staff are in the UK carrying out administrative duties, that may well be.

What about a settlement under whose terms the UK resident settlor is charged with a part of its administration? I don’t think that this would be a permanent establishment but I would advise caution and a good look at all the circumstances.

What about a UK resident protector? Unless its powers are unusually extensive, it is unlikely to be a permanent establishment.

What about an employee who goes to London from time to time to discuss trust administration with the settlor or beneficiaries? Possibly not, but it would depend on the regularity of the visits and the nature of the discussions.

If there is a permanent establishment of the TSP, what is the extent of the residence of the TSP. Is the TSP UK resident for the purposes of all its settlements, or only the specific settlements that are connected with the permanent establishment? I do not think that the purpose of the legislation was to enable HMRC to tax offshore trustees that have minimal links to the UK on all their trusts, or to discourage offshore TSPs from dealing with UK persons. The TSP’s residence must relate only to settlements with the necessary UK link. This is consistent with the distinction with the TSP and its activities as trustee of each trust.

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Footnotes:

[1] For a recent decision on this, see the Court of Appeal decision in Wood v Holden [2006] STC 443, in which an outsider was involved in the decisions of a company

[2] Section 473 is a rewrite of the section REPLACE ed into section 685E of the Taxes Act by section 89 of, and Schedule 13 to, the 2006 Act..

[3] These refer to the residence of each trustee

[4] [1986] STC 521

[5] STEP members can find it at http://www.step.org/showarticle.pl?id=1791

[6] The definition in section 148 of the Finance Act 2003 is applied by section 989 of ITA. The language of the section is generic (“in a territory”)

[7] Article 5; Model Tax Convention on Income and on Capital, July 2005

The above article is taken from 'Life and Death and Taxes' (http://ladat.co.uk/) and is reproduced with the kind permission of Leigh Sagar, who retains the copyright.