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Trust Residence

The tangled skein of tax residence has been given some more knots by the recent Appeal Court decision in HMRC v Smallwood.

The planning aimed to avoid CGT on a gain made by trustees by exploiting a complex interaction between UK legislation, Mauritian law and the relevant double taxation treaty. The treaty in question has since been altered so the planning is to that extent of historic interest only: but the principles have resonance well beyond the case.

There were essentially two questions before the court. The first was about "residence". When a bi-lateral tax treaty awards the right to tax a capital gain by reference to "residence" is it referring simply to actual residence as at the date of disposal; or does it mean "resident for the relevant period under domestic law?" In the Smallwood case the trust in question was undoubtedly physically resident in Mauritius at the date of disposal but was (by design) unequivocally resident in the UK for the tax year concerned. The Appeal Court's unanimous answer to the first question was (broadly) "resident for the relevant period under domestic law". This is not in principle limited its application to the UK/Mauritius treaty; nor to trusts: on the contrary it is of wide application to cross-border enterprises.

The answer to the first question meant that the trust was (for the purposes of the treaty) resident in both the UK and Mauritius. Hence the need to answer the second question - derived from the treaty's "tie-breaker" rule– namely where was the place of effective management ("POEM") located? And thus where was the trust to be treated as resident for treaty purposes? This is a question of fact, which had been determined by the Special Commissioners - a decision which could be overturned by the Appeal Court only if it was perverse (which two of the three judges said it wasn't).

As a decision on the facts the POEM element of the decision is of less wide import: but it does underline the fact that a trust (even with genuine professional non-resident trustees taking final responsibility for all decisions) can nonetheless be found to be resident in the UK if there is a sufficient degree of elbow-jogging undertaken from the UK. In the Smallwood case, it seems that the firm which had devised the scheme may have been just a little too hands-on in ensuring that everything went according to plan.

Thus the case creates just a little more unwelcome uncertainty at the margins on what exactly an enterprise has to do to free itself from the shackles of UK residence. Can a statutory residence rule be far away? Meanwhile the message is that more than ever, it is necessary to take professional advice before relying on an absence from the UK to protect against tax; but maybe then to ensure that the advisers back off and let the offshore enterprise get on with it!