Are travel restrictions increasing your tax risks?

Dana Ward Dana Ward

Travel restrictions have introduced new tax risks in the funds sector, which need careful oversight. Tax adviser Alistair Godwin outlines the issues and how to mitigate them. 

Limited travel affects offshore funds

Many offshore fund structures include overseas companies (or other corporate entities) that are non-UK resident and do not have any other UK taxable presence, such as a UK permanent establishment or place of belonging for VAT purposes.

These companies serve various purposes, for example acting as:

  • the fund vehicle itself (or feeders, blockers or parallel vehicles that form part of the fund structure)
  • a holding vehicle for investments
  • the provider of management or other services
  • the general partner of a limited partnership.

It is important to make sure these companies remain non-UK resident and without a UK taxable presence. Otherwise, there may be tax leakage from the structure that was not factored into the financial models.

Prior to COVID-19, this often involved managing the physical location of employees and directors' meetings. However, the current travel restrictions have made this more challenging.

UK residence risk

A company incorporated overseas will be resident in the UK if its place of ‘central management and control’ is in the UK. The impact of this is that if the company is UK-resident it will be subject to UK corporation tax on its worldwide taxable profits.

There is a specific carve-out from the central management and control test for alternative investment funds (AIFs) and Undertakings for Collective Investment in Transferable Securities (UCITS). However, this applies only to the fund vehicle itself and not other non-UK entities that may be within the structure. It also doesn't apply to other taxes, such as VAT.

Previously, one of the key ways to manage the UK residence risk for an overseas company was to fly out UK-based directors to the country in which the overseas company is incorporated for board meetings. This would mitigate one of the key factors pointing to central management and control being in the UK.

The travel restrictions resulting from COVID-19 make this difficult, if not impossible. There is therefore a risk that these companies may acquire UK residence and come within the UK tax net (subject to the availability of relief under an applicable double tax treaty).

HMRC has issued guidance to deal with this issue. While it is sympathetic in tone, it is not a cure-all and does not introduce any legally binding safe harbour.

Accordingly, companies should look to other practical strategies for managing residence risk. This could include:

  • holding board meetings by phone or video conference from the UK on an exceptional basis
  • changing the board composition so that the majority of the directors are personally non-UK resident
  • deferring board meetings where possible, until travel restrictions are relaxed.

Some of these strategies should be temporary in nature. For example, board meetings should be held in the appropriate non-UK jurisdiction once the travel restrictions have been lifted.

We also advise that you fully document the reasons for implementing the strategies (for example, by way of board minutes).

In general, these strategies should be considered on a case-by-case basis, taking into account regulatory considerations and the potential impact in jurisdictions outside the UK.

Permanent establishment

What if a director of an overseas company is in the UK on business but missed the last flight back home due to coronavirus travel restrictions?

The director may create a taxable permanent establishment in the UK if he or she continues working in the UK with a degree of permanence. This may create a requirement to register for – and pay – tax in the UK. The amount of any tax payable will depend on the level of profits attributable to the permanent establishment as if it were a separate enterprise.

Impact on VAT

Overseas companies often contract with UK-based entities to provide management or other services. For example, a UK-based investment adviser may provide advisory services to an overseas manager.

Where the recipient of the supply ‘belongs’ outside the UK (for example, in Jersey), the VAT place of supply rules would cause the supply to be outside the scope of UK VAT.

The test for where a company ‘belongs’ is different to the central management and control test that applies for UK corporation tax purposes. However, generally an overseas company that has its place of central management and control in the UK would also be expected to belong in the UK.

If the COVID-19 travel restrictions cause the recipient of the supply to belong in the UK, the services will be within the scope of UK VAT unless a specific exemption applies. Any VAT arising may not be recoverable in full.

Taking the above example, the practical impact is that the manager may be required to pay VAT to the UK investment adviser on the advisory fees if the manager belongs in the UK. Unless mitigation strategies are implemented (for example, registering for UK VAT) the manager may be unable to recover this VAT, representing a real cost.

Other issues arising from travel restrictions

There may be other issues caused by COVID-19-related travel restrictions, which may not always be apparent at first sight.

One example is overseas substance requirements that some jurisdictions impose on entities used in fund structures. Where directors must take key decisions concerning the overseas company from the UK, this may undermine local substance requirements.

There may also be requirements to operate UK payroll on overseas employees who unexpectedly start working in the UK. The threshold for this is very low, ie, one day spent working in the UK.

How to mitigate the tax risks

To mitigate the risks around corporate residence, permanent establishment and VAT, you should review your current tax fund structures with the following risks and considerations in mind:

  • Is there UK tax leakage and is it fully factored into your financial modelling?
  • If an overseas company becomes resident in the UK, how will this affect your forecasting and long-term business model?
  • Can you re-structure your board and defer board meetings until travel restrictions lift?
  • Are strategic tax decisions fully documented and do they reflect regulatory expectations in the UK and elsewhere?
  • Do you need to notify HMRC about chargeability to UK corporation tax and have you considered which profits will be subject to that tax?
  • Do travel restrictions affect where the company belongs for VAT purposes, and have you forecast for the additional cost? Are there are exemptions available?

Looking beyond the technical position, you should consider how changes to your tax structure may affect your broader business model. This includes key commercial drivers and your wider business strategy.

Contact our financial services tax advisory team for further information.

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