UK consultation on sovereign immunity from direct taxation

On 4 July 2022, the UK Government released a consultation outlining an updated approach sovereign immunity from direct taxation. The aim of the consultation is to pass legislation that will provide transparency and clarity, whilst at the same time encouraging investment in UK and ensuring different investors are treated fairly.

The consultation process closed on 12 September 2022. During this period, the Gov­ernment consulted with relevant stakeholders. The new regulations are expected to take effect for organisations subject to corporation tax on 1 April 2024 for income recognised in accounting periods ending on or after that date, and for sovereign natural persons on 6 April 2024.

Sovereign investments in UK real estate are currently free from tax related to rental income and gains. The proposed changes would eliminate this benefit but retain sovereign immunity on UK source interest income, capital gains tax and interest from passive investment, however, the Eurobond exemption would still apply.

The elimination of sovereign immunity would affect the ability of Sovereigns to reclaim the withholding tax (WHT) on property income distributions. This would potentially lead to the establishment of tax treaties to either reduce or eliminate the rate of WHT applied.

A further potential impact is to Foreign Government UK offices/branches, which could come into the scope of UK direct tax. Additional tax implications may also arise for investment managers and other agents.

The Investment Management Exception

The Investment Manager Exemption (IME) allows non-UK resident investors to appoint UK-based investment managers to manage certain investment transactions for them outside of the scope for UK tax. The Investment Transactions List (ITL) establishes the types of transactions that may qualify for the IME.

On 4 April 2022, the government announced its intention to expand the ITL used for the IME to include crypto assets, with the aim of providing certainty of tax treatment and to encourage new crypto asset investment management businesses to base them­selves in the UK.

The main purpose of the consultation is to understand (quote5):

• “The types of crypto assets which should be included within the IME”
• “Whether there is a case for extending this change to other tax regimes which also use the Investment Transactions List (ITL)”

Amendments to the qualifying asset holding companies regime

On 1 April 2022, the government introduced amendments to the qualifying asset holding companies (QAHC) regime.

The QAHC must satisfy the ownership criteria, which stipulates that the proportion of relevant interests in the firm held by non-category A investors cannot be greater than 30% for it to be eligible for inclusion in the regime. The most frequent way to meet the ownership requirement is if a qualifying fund has a large enough relevant interest. The rules are complicated when it comes to identifying the pertinent interests, measuring them, and applying them to the relatively common structures seen in practice.

Transfer pricing

From April 2023, new requirements for transfer pricing (TP) documentation for UK businesses have been proposed with the aim of standardising TP documentation in accordance with the Organisation for Economic Co-operation and Development (OECD) BEPS action plan.

Country-by-country reporting (CbCR) is already standard practice in the UK, however, the use of a standardised master file and local file is yet to be incorporated. Due to the differing approaches taken by UK businesses to reporting, it is unclear which TP docu­mentation should be kept. The regulations aim to provide more clarity on the preserva­tion of transfer pricing records. The regulations will also make reference to penalties for inaccurate record keeping.

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