UK government tackles tax avoidance involving profit fragmentation

The U.K. government has launched a public consultation on plans to tackle tax avoidance arrangements that designate earnings of U.K. residents to trusts and companies in low or no tax jurisdictions.

While Her Majesty’s Revenue and Customs said it had succeeded in challenging some of the so-called “profit fragmentation” schemes and in recovering a significant amount of tax, the required resources are considerable, and the process can take years to resolve.

“The government therefore proposes to introduce legislation to target these schemes directly and to remove any cash flow advantages for users of the arrangements,” the public consultation document states.

The schemes involve skilled individuals, for example entertainers or asset managers, whose profits from earnings are moved to an offshore company that is often owned by an offshore trust.

Typically, the taxpayer is neither settlor nor trustee of the trust and in some cases also excluded from benefiting from the trust assets. But there will often be some means by which persons with links to the taxpayer will benefit from the trust assets, HMRC said.

The new legislation, which is intended to take effect in April 2019, would bring these profits within the U.K. tax charge, require notification of the arrangements to HMRC and earlier payment of tax.

Tax advisers Mazars recommended in a client notice that doing nothing is no longer an option and those who have connections or arrangements involving offshore trusts and offshore companies should review their tax affairs.

“For many decades, HMRC has tried to get to grips with arrangements which have included offshore trusts and companies entered into by U.K. businesses to place profit out of the reach of U.K. taxation and the proposed profit fragmentation legislation is designed to address these arrangements,” Mazar’s Sajid Ghufoor said in the notice.

Because existing legislation was aimed at investment income and not designed to catch profit fragmentation, certain U.K. businesses managed to place profits outside of the U.K. tax regimes, for instance by a non-U.K. settlor creating a trust where the beneficiaries are the children of the owner of the U.K. business, he noted.

The offshore entities claim they are entitled to the payments on the basis of service agreements that allow the offshore company to offer the professional’s services to clients both in or outside of the U.K.

HMRC said, under the scenario, it is likely that the taxpayer will be paid a modest salary for these services but most of the receipts will be paid to the trust via the offshore company.

In an alternative arrangement, the offshore entity invests in a partnership through which the professional is trading and claims an entrepreneurial return on that investment before any profits are allocated to the taxpayer.

Because the offshore company is not trading in the U.K. and not a U.K. resident, it is asserted under the scheme that no taxable profits arise.

Given that the entity carries out little activity in the offshore jurisdiction compared with the activities of the individual taxpayer, HMRC said, “it is clear that the entity is either over-rewarded or designed to facilitate the avoidance of U.K. tax.”

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