COVID-19: UK Tax Residence Risks for Offshore Funds and Related Entities

COVID-19 related travel restrictions and self-isolation will present practical challenges for non-UK resident fund vehicles and related offshore entities with UK based directors. Care should be taken to ensure that the participation of such directors in board meetings and other strategic decision making does not inadvertently bring the entities onshore for corporation tax or VAT purposes.

Non-UK resident companies play a variety of roles in fund structures managed by UK based asset managers. They are commonly used as the fund vehicle itself, as the general partner of a limited partnership fund vehicle, and/or as intermediate or asset holding vehicles. In addition, many UK headquartered asset management groups include non-UK resident entities which provide offshore management, distribution or other services.

It is critical to the function of such entities that they do not become subject to UK corporation tax on their profits nor within the charge to UK VAT. This OnPoint provides a high-level reminder of the key issues in this area and explains why they remain of critical importance when considering how to resolve board-level logistical challenges arising out of the COVID-19 crisis.

Central Management and Control

Subject to the statutory exemption for AIFs and UCITS referred to below, as a matter of English law, a company that is incorporated outside the UK can be resident in the UK for tax purposes if its real business is carried on in the UK. If UK resident, its worldwide profits are subject to corporation tax at 19 percent.

The real business of a company is considered to be carried on where the central management and control of the company takes place. In general, central management and control will be regarded as situated where the board of directors meet. However, this will only be the case if the board does actually exercise management and control. In the absence of this, the role of a UK investment manager or adviser could be decisive.

Offshore vehicles are typically managed (or ought to be managed) in such a way that the boards of directors of the entities clearly exercise central management and control, and do so from outside the UK. Best practice requires, among other things, that all board meetings are held outside the UK, that a majority of the directors (in total and at each meeting) are non-UK resident and that no director participates from the UK (for example by telephone or video conference). Where a UK resident individual (often a representative of the UK manager) is a director of an offshore fund or related company, the director ought to leave the UK before participating in any board meeting or otherwise acting as such.

Place of Belonging

Where the corporation tax rules look to an entity’s residence, the VAT rules look to the entity’s place of belonging. Broadly, an entity belongs for VAT purposes where it has a business establishment or other fixed establishment (such as an office) or, if it has no such establishment, where it is resident. If an offshore fund or related entity inadvertently creates an establishment in the UK such that it belongs in the UK for VAT purposes, a UK service provider to such entity will be required to charge VAT if its supplies relate to that establishment. In the context of a fund vehicle, for example, this could require a UK asset manager to charge VAT in addition to management or performance fees, which would be a significant irrecoverable cost to the fund and its investors.

Statutory Exemption

A statutory exemption provides that AIFs and UCITS that are authorised or registered in a foreign state will not be treated as UK resident by reason of being centrally managed and controlled in the UK. However, this exemption is limited to the fund vehicles themselves and does not apply to other offshore companies (such as general partners or holding companies). In addition, the exemption does not prevent such fund vehicles belonging in the UK for VAT purposes.

COVID-19 and Logistical Challenges

The rapidly evolving situation and turbulent financial markets resulting from the COVID-19 crisis will mean that many offshore funds and related entities will want or need to hold board meetings or otherwise make key strategic decisions on an emergency or expedited basis. In addition, travel restrictions will mean that UK based directors may not be able to leave the UK as they ordinarily would do in order to participate in such meetings or make such decisions.

While representations are expected to be made to HMRC and some other countries like Australia and Ireland have already adopted relaxations, in the absence of any published concession it should not be assumed that the present extraordinary circumstances allow offshore entities to operate outside of the normal rules. As such, it remains the case that:

• High level strategic decisions which may amount to an exercise of central management and control should continue to be made at a board level. UK investment managers or advisers should not make decisions for offshore entities which go beyond those properly authorised or delegated to them under the applicable investment management or other agreement.
• Board meetings should continue to be held outside the UK. Where it is not possible for directors to meet in person, they should join by telephone or video conference from outside the UK.
• UK based directors should generally not participate in board meetings from the UK. In the case of an AIF or UCITS fund vehicle, UK directors may rely on the statutory exemption to participate in fund board meetings from the UK provided that care is taken to avoid the inadvertent creation of a place of belonging for VAT purposes. For example, a majority of the directors participating in each meeting should be located outside the UK (ideally from a single non-UK jurisdiction) and the majority of board meetings should have no UK participation.

In some cases, a distinction is drawn between ‘attending’ a meeting and ‘participating’ in it. While there are arguments that joining a board meeting on a non-voting, listening only basis does not amount to an exercise of central management and control, there is no reliable legislative or case law basis for such a position and such an approach should be avoided wherever possible. Possible alternative solutions might be to appoint non-UK substitute directors to replace those in the UK or to appoint additional non-UK directors, to appoint a committee of non-UK directors and delegate the required authority to them until travel restrictions ease or, if appropriate and subject to reasonable parameters, to formally delegate authority in respect of certain decisions to the UK manager.

While it is recognized that the practical limitations imposed by the UK tax rules will be particularly problematic for many offshore entities in the current environment, robust operational governance is essential to the integrity of offshore structures and should be maintained wherever possible.

Please contact a member of the Dechert tax team or your usual Dechert contact if it would be helpful to discuss the issues raised in this note.