Your Place of Effective Management
International Entrepreneurs can often get confused when they are learn that incorporating an entity in a so-called tax haven (eg Panama, Cook Islands, Liberia or a Dubai IBC) may be useless if they in turn operate this company in a high tax jurisdiction.
The issue is the definition of tax residence for corporations. There are essentially 3 models for corporate tax residence -
1. Some countries determine the residence of a corporation based on formal criteria such as place of incorporation. An example in Taiwan, as at the time of writing in early 2019, corporate residence is determined based on where the corporate entity is incorporated, regardless of the place of effective management. Please note that this is expected to change as a result of a new regulation soon to be enacted.
2. In other countries, the residence of a corporation is determined by reference factual criteria such as place of effective management or similar concepts. In Singapore and Hong Kong eg, tax rules test "management and control" to determine whether a corporation should be considered tax resident there. Conversely, rules allow for corporations to be incorporated in Singapore and Hong Kong but be considered non resident companies (and taxed at 0%) because no management and control is exercised there.
Hong Kong - https://www.mooresrowland.tax/2019/07/corporate-tax-guide-hong-kong-special.html
3. Some countries have mixed systems, where there is both a place of incorporation test and a place of effective management test. In Indonesia and the USA, either of these could lead to worldwide tax on corporate income.
Let's use the UK as a case study.
A company that is not incorporated in the UK may be treated as UK tax resident if it is centrally managed and controlled here. Much careful tax planning can be undone if this point is not well understood and continually monitored.
Over the years, the concept of 'management and control' has been examined in case law and certain key features have emerged. HM Revenue & Customs (HMRC) has also published guidance on the topic which can be found here.
How it began
The seminal case of De Beers Consolidation Mines Ltd v Howe in 1906 established the central management and control test. Lord Loreburn said: ‘A company resides….where its real business is carried on …. And the real business is carried on where the central management and control actually abides’.
The mining company, De Beers, was incorporated in South Africa and its main trading operations were in South Africa. However, the majority of its directors lived in the UK and in practice the board exercised its powers in the UK, so the company was held to be UK resident for tax purposes. This case confirmed that determining the place of management and control is primarily a question of fact.
The overbearing parent
Fifty years later in Bullock v The Unit Construction Co Ltd the tax residency of the African subsidiaries of a UK parent company was considered. Although constitutionally, the control of each subsidiary was vested in their board of directors, who were required to hold meetings outside the UK, the real control and management was exercised by the parent company's board in the UK. This case proved that it is the highest level of control of a business which counts.
Shareholders with influence
In 2006, the case of Wood v Holden examined whether a company’s management and control could be exercised by a shareholder. Mr and Mrs Wood owned shares in Greetings Cards Holdings Limited (Greetings), which they sold to a Dutch company, Eulalia Holdings BV (Eulalia). Mr Wood owned all the shares in Eulalia but had appointed a Dutch trust company to act as its sole managing director. Eulalia was a special purpose vehicle (SPV), whose only significant business decision was to sell the shareholding in Greetings. HMRC argued that the decision to sell had not been given proper consideration by the managing Dutch trust company but rather had been agreed to at the instigation of Mr and Mrs Wood, who were UK residents and that Eulalia was therefore resident in the UK at the time of the disposal. This was rejected by the Court of Appeal which held that although the managing company’s directors had been advised and influenced, they not been by-passed nor stood aside.
The dis-functional Board
The next noteworthy case was Laerstate BV v HMRC, heard in 2009. Here, the court made a distinction between a board which scrutinises and deliberates and a board which simply rubber stamps requests from the UK. Laerstate was incorporated in the Netherlands, and was resident there under Dutch law. The company had two directors during the period in dispute: Mr Bock and Mr Trapman. Mr Bock was also Laerstate’s sole shareholder. Mr Bock, a UK resident, arranged finance from a German bank for the company to acquire £150m of shares in Lonrho, a UK conglomerate. Some of the Lonrho shares were purchased by Laerstate and the company then sold an option over further Lonrho shares to Anglo American Plc. HMRC assessed Laerstate to tax on the sale of the option, arguing that the company was UK resident at the time.Evidence emerged showing that Laerstate’s board meetings were not really meetings at all since no discussions had taken place. Mr Bock told Mr Trapman to exercise the option and Mr Trapman did so without giving the matter any particular consideration. As a consequence, the court agreed with HMRC that the board did not function as such and Mr Trapman had abdicated his responsibility to a dominant director who was resident in the UK.
A successful scheme
In June 2019, the concept of management and control received fresh scrutiny, this time in the context of a tax avoidance scheme. Although HMRC were successful at the First-tier Tribunal level, they were defeated at the Upper Tribunal and the companies in question were not taxable as UK residents. This latest decision brings some welcome clarity regarding the extent to which a parent company can influence a subsidiary without taking away control from its directors.
Development Securities v HMRC involved three Jersey-incorporated SPV companies which entered into call options with UK companies in their group to acquire certain properties and shares. The acquisitions were carried out in order to crystallise latent capital losses whilst retaining the benefit of indexation allowance. To be successful, the scheme required the Jersey-incorporated companies to be tax resident in Jersey for a specific short period. Following this, the Jersey directors resigned and the SPVs’ residency moved to the UK.
HMRC contended that the Jersey companies were resident in the UK during the critical period and denied the claims to indexation allowance.
The First-tier Tribunal had found that the only task of the Jersey directors was to approve the tax scheme which had been pre-determined by the parent company. Furthermore, the transactions were ‘uncommercial’ for the Jersey companies since (in accordance with the scheme tax planning) they paid above-market value for the assets. As such, the transactions could not be ‘in their interests’. The Tribunal concluded that by acting contrary to the interests of the Jersey companies, the Jersey directors demonstrated that they had abdicated management and control to the UK parent company.
These arguments were robustly refuted by the Upper Tribunal. First, the fact that the directors had only one task was irrelevant. SPV companies typically have a single purpose and the Tribunal held that this fact had no bearing on where management and control lay. Second, whilst conceding that that the transactions may have been ‘artificial’ or ‘commercially pointless’, as the Jersey companies were not expecting to be left out of pocket (the UK parent company funded the acquisitions) they were not in fact ‘uncommercial’ from a profit/loss perspective. Third, it was legitimate for the Jersey companies to consider the interests of their parent shareholder. Actions which were in the interests of the parent were, in this case, in the best interests of the Jersey companies.
From the evidence, the Upper Tribunal was satisfied that the Jersey directors had not abdicated their responsibilities, or ceded control. On the contrary, the facts demonstrated that they had been fully engaged in the process, asking for external tax advice and assurances as to the legality of the transactions. The Tribunal was convinced that they knew exactly what they were being asked to decide; they did so understanding their duties; and they complied with those duties.
In light of this case history, how can one best ensure that a company maintains its residency outside the UK? The answer is that it is all about proper corporate governance and following due process, even though this means a more onerous compliance regime than would be observed in relation to a UK resident company. A number of do’s and don’ts are worthy of consideration:
- simply pay lip service to the place where the board meets;
- have a majority of UK resident directors, or even an equal number of UK resident and non-resident directors;
- allow UK based board members to phone in to meetings from the UK;
- rely on the services of non-UK directors who do not have the necessary skills and experience to make informed decisions, unless they can clearly demonstrate that they put their minds to the decision-making process;
- allow a controlling shareholder or anyone else to run a company’s affairs without reference to the board. Such a person can advise, exhort and persuade – but ultimately the board must make the decisions;
- rely on board minutes prepared in advance. Pre-prepared board minutes are essential to the completion of any transaction; however, the minute of a meeting in which the decision to undertake the transaction, is a critical document and must demonstrate that the board has applied its mind;
- allow board members to involve themselves in strategic decisions in the UK without reference to the board.
Do make sure that:
- the composition of the board, and the location where board meetings are to take place, are appropriate for the business of the company. Business happens in real time and the board may have to convene at short notice;
- it is clear which decisions in relation to the company’s affairs amount to exercising ‘central management and control’. Typically, these will be strategic decisions; for example, about buying or selling an asset, or raising finance;
- it is clear to everyone involved that only the board can take strategic decisions and that its meetings will be outside the UK;
- if UK residents are to be on the board, they are prepared to travel to board meetings outside the UK;
- the board meets regularly, in keeping with the nature of the company’s business;
- the board has the information that enables it to make informed decisions on matters of strategy and policy;
- copies of the information provided to, and considered by, the board are kept;
- full minutes of board discussions and decisions are retained. Sound or video recordings of board meetings taking place can put the decision-making process beyond doubt.