U.K. 'Round the World' Scheme Grounded - Determining Where Central Management and Control Resides Becomes More Complicated

It was a bright and calm day when Mr. Smallwood, a U.K. resident, decided to suggest that a Jersey Trust of which he was the settlor, and in which he maintained an interest, should dispose of certain shares. Mr. Smallwood obtained advice from accountants in Bristol that if the trust sold the shares the gain would be attributed to him because of a provision in the taxing statute that would apply "if the trustees were not resident in the United Kingdom during any part of the year". The Bristol advisors then informed Mr. Smallwood that there was an off-the-peg "Round the World" tax scheme that was intended to eliminate the tax. At this point, the storm clouds began to gather.

The RTW scheme

In implementing the RTW scheme, the Jersey trustee was replaced on December 19, 2000 with a Mauritius trustee, and the Mauritius trustee was in turn replaced by Mr. and Mrs. Smallwood as trustees on March 2, 2001, prior to the April 5 tax year-end of the trust under U.K. tax law. The intention was that when the shares were sold during January of 2001 the trust's capital gain would be protected from U.K. tax by virtue of the provisions of the U.K.-Mauritius Tax Treaty. Further, as Mr. and Mrs. Smallwood, being U.K. residents, would be trustees "for part of the year" the attribution rule quoted in the preceding paragraph would not apply and no tax would be payable on the gain in the U.K.

Issues on appeal

The primary question was whether the Treaty applied to exempt the trust's gain from U.K. tax. The threshold issue was whether the matter of residence fell to be determined at the date of the disposal or more generally within the year of the disposition. Clearly the trust was, at least, resident in the U.K. from March 2 until April 5.

On July 8, 2010, the Court of Appeal held in HMRC v. Smallwood & Anor, [2010] EWCA Civ 778, that the issue of whether the taxpayer should be resident in a particular state at the time of disposal or at some other point in time is an issue for each state to decide as part of its own taxation regime. The Treaty must be assumed to have been drafted in a way that contemplates any tax treatment of capital gains based on residence or similar criteria. "Resident of a contracting state" means chargeable to tax in that state on account of residence and, for this purpose, one has to take into account the tax treatment of the gain under the domestic legislation of both contracting states regardless of the period of residence which gives...