A UK company’s Jersey-incorporated subsidiaries should not be considered tax resident in the UK under the UK’s central management and control test, the Upper Tribunal ruled on 5 June, overturning a controversial First-tier tribunal decision.
The case is relevant to many structures that include companies that are not UK incorporated. It also brings a degree of clarity to the question of when a UK parent company might exercise central management and control.
Planning for UK losses
In the case, Development Securities PLC group established three Jersey subsidiaries as part of a tax planning exercise. Under the plan, the three subsidiaries acquired assets from group companies at their then book value which, at the time, was in excess of market value.
The Jersey directors then resigned and the group claimed that UK capital losses could be realised because the residence of the three companies switched to the UK upon the directors’ resignation.
In a controversial 80+ page judgment, the First-tier Tribunal concluded that the subsidiaries had always been resident in the UK; thus, the capital losses were not available to set off against chargeable gains of the group.
The tribunal reasoned that the subsidiaries’ directors had abdicated their responsibilities in executing an arrangement that was, in the court’s opinion, “uncommercial” from the subsidiaries’ perspectives, having been developed before their incorporation by the group’s tax advisors.
The Jersey directors were aware from the very beginning that they had been entrusted to carry out a specific task and that, by agreeing to serve on this basis (provided the transaction was not illegal), it could be inferred that the Jersey directors would carry their task out without question and without exercising judgment as directors, the tribunal said.
The Jersey directors were thus simply zombie directors “…administering a decision they were instructed to undertake.”
The First-tier Tribunal therefore concluded that, even though not incorporated in the UK, the Jersey subsidiaries were nevertheless always UK tax resident by virtue of their UK central management and control.
UK central management and control test
The appeal to the Upper Tribunal was hotly anticipated as this decision was considered controversial in many ways. Indeed, the case law test had been misstated in the First-tier Tribunal decision by the inclusion of an erroneous sentence that was not included in the authority quoted and the decision was amended for the “clerical mistake.”
In reversing the First-tier Tribunal, the Upper Tribunal affirmed that the location of central management and control is the true test of corporate residence, as set out in De Beers (De Beers Consolidated Mines v Howe  5 TC 198).
The Upper Tribunal included the often-quoted words of Lord Loreburn on the issue of corporate residence:
“….a company resides for the purposes of income tax where its real business is carried on. Those decisions have been acted upon ever since. I regard that as the true rule, and the real business is carried on where the central management and control actually abides.”
The Upper Tribunal then considered how this rule is applied in the case of subsidiaries and special purpose vehicles.
Special purpose vehicles
The court drew upon Park J’s judgement in the High Court in Wood v Holden (Wood and another v Holden (Inspector of Taxes) –  STC 443) to explain certain salient features which affect the determination of corporate residence for a special purpose vehicle.
The mere fact that a 100 percent owned subsidiary carries out the purpose for which it was set up, in accordance with the intentions, desires and even instructions of its parent does not mean that central management and control vests in the parent, the Upper Tribunal said.
The Upper Tribunal said that the fact that the directors had a specific task entrusted to them by their parent, after which they were to resign, did not say anything about whether UK central management and control existed.
What matters is who was exercising control of the Jersey subsidiaries and where were they exercising it from.
The facts did not show that the subsidiaries’ directors had abdicated their responsibilities and therefore had failed to exercise central management and control, the tribunal said.
The Upper Tribunal had no sympathy for the First-tier Tribunal’s primary line of argument:
“The essential error committed by the [First-tier Tribunal] was to focus on the uncommerciality of the transactions to the individual Jersey Companies without having regard to the actual duties the directors owed to those companies. These duties, as we have noted, in this case principally involved consideration of the shareholders’ interests and the [First-tier Tribunal] made no finding that the Scheme was not in the interests of the shareholder.”
Influence versus control
Crucially, the point is made that in the case of special purpose vehicles, the UK central management and control test must be approached with particular care, so as to distinguish between influence over the subsidiary and control of the subsidiary.
Where a parent company merely “influences” the subsidiary, central management, and control remains with the board of the subsidiary. It is only where the parent company “controls” the subsidiary, i.e. by taking the decisions which should properly be taken by the subsidiary’s board of directors, that central management and control could be argued to vest in the parent.
The Jersey directors were not acting as zombie directors under the control of the parent. The fact that a planning arrangement had been entered into, did not of itself indicate that the directors had abdicated their responsibility to perform their director duties.
The Upper Tribunal also observed that during board meetings of the Jersey companies, the directors were not acting “mindlessly” or going through the motions, they were not simply following instructions “come what may,” rather, they were applying their minds to the transactions.
UK tax residency
UK law on central management and control is a difficult area and the decision reached by the First-tier Tribunal had muddied the waters further.
It remains to be seen whether the case will be further appealed by the UK’s HM Revenue and Customs but the decision is a firm rebuttal of the conclusions reached by the lower tribunal.
The Upper Tribunal’s decision clarifies that a significant amount more is required than consent to a parent’s plans before central management and control can be viewed as truly residing where a parent company is tax resident.
It also reasserts the tests set out in earlier case law that the central management and control of a company is normally to be found at the location where directors’ meetings are held, provided the business of the company is considered at those meetings and the directors do not abdicate their responsibility.
By David Hughes & Helena Kanczula
For more information, please contact David Hughes.
First published in MNE Tax in June 2019.