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UK court: keep board members in the loop

A recent court decision shows that the offshore investments of UK private equity firms could be subject to the country’s higher tax rate, unless they can provide better documentation that strategic board decisions were made outside the UK.

Offshore corporate structures have been an important tool for avoiding the UK’s high capital gains taxes. However, a recent tax residency case shows that private equity firms that manage offshore investments will have to make sure that their boards of directors know what actions could endanger the company's offshore status..

HM Revenue & Customs has ruled that Dutch company Laerstate will actually be treated as a UK resident for tax purposes, because one of its two directors, Dieter Bock, was a frequent visitor to the country and exercised a number of management powers and decisions while in the country. A vehicle is considered a UK resident if its place of central management and control is in the country.

“The director that was present in the UK did a lot of great deals in regard to a company called Lonhro, but he didn’t follow the rules that the courts have now said,” said Dechert partner Adam Levin. “What he did was he said ‘I’ve got a Dutch company and made this nice profit in these shares, therefore it should be subject to Dutch tax, which was essentially zero.”

Laerstate had tried to argue that it should be considered a non-resident, as its central management and control decisions were exercised at board meetings held outside the UK. However, while evidence was produced that showed resolutions were made and meetings were held outside the country, the court ruled that Bock was the main decision-maker from within the UK.

In the court’s eyes, many of the board’s meetings did not involve strategic decisions, while the company’s other director and board members were not given sufficient information on potential deals.

“What  the UK's Revenue said was that [Bock] treated the other director as sort of a rubber stamp, he never gave him any information about the decisions that needed to be taken, and instead just effectively made all the decisions and presented him with a piece of paper to sign,” Levin said. “The tax authority said since [Bock] was making all those decisions in the UK, this is a company that is centrally managed and controlled in the UK and they’ll take their tax on all of those profits.”

This is the first time in recent memory that the UK tax authorities have won on this particular issue, which indicates that they are taking a tougher line on entities claiming to fall outside of UK tax jurisdiction. “It’s a big clarion call to ensure that the UK private equity firms have got their houses in order on these things, because if they treat the directors who are offshore as a rubber stamp they could find themselves with a massive tax bill that they didn’t anticipate,” Levin said. “They need to ensure that they’ve got their offshore boards making decisions offshore, and they have to have the paperwork to demonstrate that the boards were given sufficient information to make such decisions.”

Michael Cant, a partner at Nabarro, also outlined some other steps in a recent client update that firms should consider to avoid getting caught in the UK tax net. He said the board of directors should meet with sufficient regularity outside the UK, UK-based directors should attend in person rather than on the phone, board minutes should be sufficiently detailed to demonstrate that strategic decisions were made and key documents and board resolutions should be signed outside the UK.