Tax treaty – residence

Introduction

The appeal relates to a tax avoidance scheme that was intended to work in the following way:

A non-resident trust which has a gain on its assets appoints Mauritian trustees for part of a tax year and realises the gains during the period that the trust is resident in Mauritius. UK resident trustees are appointed before the end of the tax year. Specific legislative provisions potentially apply because the trustees are resident in the UK for part of the year. Conversely another legislative provision, which attributes gains of non-resident settlements to beneficiaries, does not apply if the trustees are UK resident for any part of the year. The Trustees argue that the UK/Mauritius Tax Treaty prevents the United Kingdom from taxing the gains.

The Facts

In this case, the taxpayer settled property on trust for the benefit of himself and his family on 24 February 1989. The settlement gave him the power of appointing the trustees. He remained a beneficiary of the trust. The trust contained other assets, but the bulk of the assets were two shareholdings. By 2000 a Jersey company was the trustee. The shares had increased significantly in value, and it was thought to be a good idea to sell them.

A sale of those shares by the Jersey company would have led to a charge on the taxpayer (as a resident settlor having a beneficial interest under the trust). In order to avoid such a charge a plan was devised with the following elements.

1. First new trustees would be appointed to replace the Jersey company. Those trustees being offshore trustees in a country, which did not tax capital gains and which has a double taxation agreement with the UK. The shares would thereby vest in the new trustees.
2. trustees would sell them, and having done so they would be removed as trustees, and English trustees would be appointed before the end of the fiscal year.

The plan was put into operation. Mauritius was chosen as the relevant new jurisdiction.

The combined effect of the above steps should have been that the sale would attract no capital gains tax provided the trustee was resident in Mauritius. The UK/Mauritius Tax Treaty provided that where a person other than an individual was a resident of both Contracting States, then it shall be deemed to be a resident of the Contracting State in which its place of effective management was situated. The effect of the double taxation arrangement was that the trustees of the settlement would not be chargeable to tax for any gains made on the sale of the shares, because the relevant gains were taxable only in Mauritius and not in the UK. There should therefore have been no chargeable gain attributed to the taxpayer as settlor.

On 19 December 2000 a Mauritius company was appointed to be the new trustee. It sold the shareholdings in January 2001. On 2 March 2001 the new trustees ceased to be trustees and the taxpayer and his spouse became trustees (resident in the UK).

When in due course tax returns were filed, HMRC sought to charge capital gains tax on the disposal of the shares.

It was decided by the Special Commissioners that the corporate trustee was not solely resident in Mauritius for the purpose of the UK/Mauritius Tax Treaty when the gains were made on the sale of the shares held in the trust. The place of effective management of the trust was the UK. The taxpayer appealed to the High Court.

The Issue

Whether the sale of shares was subject to tax in Mauritius or the UK, or both. The key issue was the timing of the residence test in the UK/Mauritius Tax Treaty.

The Decision

Neither the taxpayer nor HMRC adopted the reasoning of the Special Commissioners.

The difference between the parties was in their respective approaches to Article 13 (dealt with double taxation in relation to capital gains). The taxpayer submitted that Article 13 allocated the right to tax as between States. HMRC said that it merely defined the permitted basis of taxation and allocated taxation as between situs-based rights and residence-based rights, i.e. it provided which gains were taxable on a situs basis, and which were taxable on a residence basis.

Taxpayer contention

The taxpayer contended that the Special Commissioners analysed the legislation incorrectly, in that one never got as far as the tie-breaker to determine residence. In the taxpayer's view, the critical time at which the snapshot should be taken was the time of the alienation, (or gain, which was the same on the facts of this case). One determined residence as at that date. Once it was determined, that was an end of that particular inquiry. No other State could come into the picture as a potential state of residence, based on subsequent events.

HMRC contention

HMRC's argument repudiated the snapshot analysis. There were two States claiming the right to tax on the basis of residence, both were entitled to do so, and Article 24 (dealt with “Elimination of double taxation”) was invoked to resolve the conflict. Since there was no Mauritius tax to deduct from the UK tax, the UK tax was recoverable in full.

The High Court found against HMRC by allowing the taxpayer's appeal.

The Judge concluded:

1. The Commissioners erred in creating a simultaneous residence for the trustees, spanning the Mauritian period.
2. The correct analysis was that there were three periods of successive residence in the relevant UK tax year – Jersey, Mauritius and then the UK.
3. Article 13(4) gave the right to tax capital gains to the State in which there was residence at the time of the disposition.
4. That state was, at that date, Mauritius.
5. Since there were no two jurisdictions vying for a claim of residence in that period, there was no tie for Article 4 to break.
6. Accordingly, Mauritius had the right to tax and the UK did not.

On the basis of the above conclusion, the place of effective management was not considered.

The judgment is available online from http://www.bailii.org/ew/cases/EWHC/Ch/2009/777.html