31 October 2011 UK Tax Residence

Supreme Court decision in Davies and Gaines-Cooper

SUMMARY

The UK Supreme Court has handed down its judgment in Davies and Gaines-Cooper, two judicial review cases on the tax residence of individuals. The taxpayers argued that HM Revenue and Customs had said in guidance, and consistently taken the view in practice, that it would treat individuals in their circumstances as not resident in the United Kingdom. HMRC was refusing to apply that treatment, so the court should intervene and hold HMRC to its word. HMRC succeeded in convincing the court that the taxpayers had misunderstood the guidance and that there was no settled practice of the sort the taxpayers claimed.

Why it matters The guidance itself has now been extensively revised. However, the Supreme Court’s judgment and the litigation leading up to it do raise wider issues.

 The decision underscores the risks in relying on HMRC guidance and – even more so – any supposed general HMRC practice. It will be an uphill struggle for taxpayers to convince the courts that HMRC has bound itself to take any particular approach.  The judgment also offers a reminder of the current law on what a taxpayer must do to shed UK- resident status: among other things, the taxpayer must show a distinct break from his or her life in the UK (going abroad to work full-time will often qualify).  The case points up the pressing need to move to a clearer statutory definition of residence, as the government proposes to do.  Finally, the litigation has raised points on:  whether a taxpayer should apply for judicial review of the way HMRC has exercised its discretion before it begins a dispute on the law through an appeal to the Tribunal (in the circumstances, yes); and  whether the public is entitled under the Civil Procedure Rules to see the skeleton arguments HMRC provides to judges (in general, yes).

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RESIDENCE

Statute “Residence” and “ordinary residence” are key connecting factors for UK income tax, capital gains tax and sometimes inheritance tax. Nonetheless, the UK Parliament has never fully defined what it means for an individual to be “resident or ordinarily resident in the United Kingdom” for tax purposes. Even the judges have complained: “… the facility of communications, the fluid and restless character of social habits, and the pressure of taxation have made these intricate and doubtful questions of residence important and urgent in a manner undreamt of by Mr. Pitt, Mr. Addington or even Sir Robert Peel. The Legislature has, however, left the language of the Acts substantially as it was in their days …” (Viscount Sumner, commenting in 1928).1 In 1936 the Income Tax Codification Committee proposed a statutory definition. But this was never enacted.

Case law The task of defining what it is for an individual to be “resident” in the UK has fallen, by default, to the courts. Many of the cases are old, although there has been a fresh spate since 2000.2 Judges have identified several factors as relevant:

 whether an individual has accommodation available to him3 in the UK;  whether he is employed abroad;  the length, purpose and frequency of his visits to the UK; and  the extent of his ties to the UK.

The result is a test which is highly fact-sensitive and difficult to apply in practice. It causes most problems for the many peripatetic individuals who visit the UK for extended periods and/or work here but also live and work elsewhere. The test does not simply depend on counting days spent in the UK. In particular, the strict legal position is that taxpayers leaving the UK and claiming to be non-UK resident/ordinarily resident must make a “distinct break” with the pattern of their life in the UK, unless they are leaving to work abroad full-time.

Guidance In practice, however, HMRC (formerly the Inland Revenue) has played a significant role, both by adopting extra-statutory concessions and by publishing guidance. It is the guidance known as IR20 which was at issue in Davies and Gaines-Cooper4. The Inland Revenue published the first edition of IR20 in 1973 and

1 Levene v. The Commissioners of Inland Revenue 13 TC 486 at 502. 2 Most recently Grace v. Revenue and Customs Commissioners [2011] UKFTT 36 (TC). 3 Or, in a couple of cases, “her”. 4 R (on the application of Davies and James) and R (on the application of Gaines-Cooper) v. HMRC [2011] UKSC 47. -2- UK Tax Residence 31 October 2011

the one at issue in 1999. In January 2007, following the Special Commissioners’ decision in Gaines- Cooper5, HMRC issued Business Brief 1/2007, giving HMRC’s interpretation of IR20 (which HMRC claimed had always been the same). HMRC then replaced IR20 with HMRC66 in 2009.

Consultation Since 1928 “the facility of communications, the fluid and restless character of social habits, and the pressure of taxation” have increased by leaps and bounds. This, coupled with the inadequacy of HMRC’s guidance and the lack of clear law, has given rise to a general concern that the existing rules are unacceptably vague, especially for the many internationally mobile individuals whose role is so important to the UK economy. On 17 June this year HM Treasury and HMRC published a consultation document entitled “Statutory definition of tax residence: a consultation”.7 The government proposed that a new statutory definition of residence for individuals would be included in the Finance Bill 2012 and apply from 6 April 2012. The proposals were not intended to change the position of most taxpayers. The consultation closed on 9 September and received a broadly positive response.

THE CASES

A. GAINES-COOPER

The facts Mr Gaines-Cooper was born in the UK and remains a British citizen. A serial entrepreneur, Mr Gaines- Cooper left the UK in the mid-1970s to live overseas, principally in the Seychelles, where he was granted a residence permit in 1976. Since the 1970s he has had business interests in several countries outside the UK. Mr Gaines-Cooper retained properties in the UK, returned to the UK to visit family, and his wife and son maintained a home in the UK from 1998 until 2005 while his son attended school.

The litigation HMRC determination. HMRC issued assessments and amendments against Mr Gaines-Cooper’s self- assessments for the tax years 1992-93 to 2003-04, claiming that throughout that period his domicile, residence and ordinary residence were in the United Kingdom.

Appeals. Mr Gaines-Cooper’s case before the Special Commissioners8 was that he was not domiciled, resident or ordinarily resident in the UK for the period in question. (There was one exception: he accepted that he was resident in the UK in the tax year 1992-93. For that year only, the fact that he had a

5 Gaines-Cooper v. Commissioners for HMRC (2006) SpC 568. 6 “Guidance on Residence, Domicile and the Remittance Basis”, www.hmrc.gov.uk/cnr/hmrc6.pdf. A version of IR20 including Business Brief 1/2007 as an appendix and noting that it is no longer current is available at www.hmrc.gov.uk/pdfs/ir20.pdf. 7 See our client memorandum of 25 July: www.sullcrom.com/UK-Tax-Residence-07-25-2011. 8 The appellate body now superseded for most purposes by the First-tier Tribunal (Tax). -3- UK Tax Residence 31 October 2011

house in the UK made him resident automatically. That rule was then abolished.) The Special Commissioners found that, as a question of fact, Mr Gaines-Cooper had not demonstrated a sufficient break with the UK to shed his UK domicile, nor to establish that he was neither resident nor ordinarily resident in the UK for those periods. Mr Gaines-Cooper appealed to the High Court on the question of UK domicile. The High Court9 upheld the Special Commissioners’ finding that Mr Gaines-Cooper remained UK-domiciled. Mr Gaines-Cooper did not appeal this decision.

Application for judicial review. Between those two appeals Mr Gaines-Cooper also applied to the High Court for judicial review of HMRC’s conduct in determining his residence and ordinary residence.10 HMRC had failed, he said, to apply to him the policy set out in IR20 or (alternatively) HMRC’s settled practice. It was this that fell to be considered by the Court of Appeal, and subsequently by the Supreme Court.

B. DAVIES AND JAMES

The facts Mr Davies and Mr James are both British citizens and property developers who moved from the UK to Brussels in 2001 in order to set up a new property development business. They left the UK (and claimed that their full-time employment abroad began) before 6 April 2001. They rented apartments in Brussels and worked full-time for the Brussels business for a number of years. Mr Davies and Mr James retained their homes in the UK, and returned to the UK to attend local functions and to visit their families, who remained in the UK.

The litigation HMRC determination. HMRC issued determinations against Mr Davies and Mr James, claiming that they were resident and ordinarily resident in the UK in the tax year 2001-02, when they had made significant asset disposals for capital gains tax purposes. HMRC considered that their work did not start until after 5 April 2001: as they were not employed full-time for the whole tax year 2001-02, they could not establish non-residence in the UK for the 2001-02 tax year either as a legal matter or on the basis of the IR20 practice on full-time work abroad.

Application for judicial review. Mr Davies and Mr James followed a different path to that of Mr Gaines- Cooper and applied to the High Court for judicial review before any appeal was heard. Like Mr Gaines- Cooper, they claimed that HMRC had improperly failed to apply its guidance in IR20 or its settled practice.

9 [2007] EWHC 2617 (Ch). 10 The appeal is a statutory process; judicial review is an administrative law process deriving from the inherent jurisdiction of the court to review the exercise by public bodies (like HMRC) of their statutory powers. Different procedures apply to the two remedies. What the appellant/applicant must prove also differs: at its very simplest, a taxpayer should win an appeal if HMRC’s decision on the law is technically wrong; he should win on judicial review if HMRC is being (sufficiently) unreasonable. -4- UK Tax Residence 31 October 2011

Appeal. They also filed an appeal with the Special Commissioners to dispute HMRC’s conclusions as a matter of law. They succeeded in convincing the Court of Appeal that the judicial review should be heard first, on the basis that a decision of the Special Commissioners against them would pre-empt the result of the judicial review. The appeal was therefore stayed until the application for judicial review could run its course.11

C. THE JUDICIAL REVIEW AT THE COURT OF APPEAL

Mr Gaines-Cooper and, separately, Mr Davies and Mr James, applied to the High Court12 for judicial review of HMRC’s failure (as they saw it) to apply IR20 or its settled practice. In both cases the High Court refused permission to apply for judicial review. The taxpayers appealed. The Court of Appeal decided to hear both appeals together.13

Legitimate expectation As far back as 1990 the Court of Appeal had established the principle that HMRC could be bound to honour statements made to the public as to how it would treat a taxpayer, if those statements gave rise to a legitimate expectation that it would fulfil them.14 Subsequent cases15 have clarified the limits to that principle. HMRC had placed some emphasis on these limitations and on the disclaimers at the beginning of IR20 in the early stages of the litigation. By the time the case reached the Court of Appeal, however, HMRC were explicitly accepting that “the taxpayer has a legitimate expectation that it will apply the guidance in IR20 to the facts of his particular case and if satisfied that the facts fall within one of the circumstances in Section 2 indicating a certain residence treatment, will treat him accordingly.”

IR20 Working abroad. Mr Davies and Mr James argued that they were non-resident on two alternate grounds. The first was that they should be treated as non-resident for the tax year 2001-02 because they had worked abroad full-time for at least one tax year. Their primary argument on this was that they left the UK before the beginning of the 2001-02 tax year and their employment abroad covered a complete tax year in 2001-02. HMRC said that they were not employed abroad until after the 2001-02 tax year had started. This question of fact was not at issue in the application for judicial review. However, Mr Davies and Mr

11 It would now be heard by the First-tier Tribunal (Tax). 12 [2008] EWHC 2608 (Admin) and [2008] EWHC 1218 (Admin) respectively. 13 [2010] EWCA Civ 83. A judicial review procedure is actually in two stages: the applicant must first apply for permission to apply for judicial review, then apply for judicial review itself. Before the High Court the taxpayers failed at the first hurdle. The Court of Appeal first granted the taxpayers permission to apply and then heard the application for judicial review itself. This is why it was the Court of Appeal which heard evidence from HMRC and the taxpayers’ witnesses. 14 In R v. Inland Revenue Commissioners, ex parte MFK Underwriting Agencies Ltd and related applications [1989] STC 873. 15 For example, R v. Inland Revenue Commissioners, ex parte Wilkinson 77 TC 78 ; Al Fayed v. Advocate General for Scotland 77 TC 273. -5- UK Tax Residence 31 October 2011

James had a fallback argument. This was that even if their full-time employment abroad began after the start of the 2001-02 tax year, they should still be treated as non-resident for the tax year 2001-02 because their full-time employment continued for a complete tax year in 2002-03. This, they said, was the effect of paragraph 2.2 of IR20 and HMRC should be held to it. The Court of Appeal disagreed: IR20 did not mean that working abroad full-time for the whole of the tax year 2002-03 was enough to establish non-residence for 2001-02 if the taxpayers had not worked abroad full-time for the whole of 2001-02.

Leaving the UK permanently, indefinitely or for a settled purpose. The second ground advanced by Mr Davies and Mr James, and the sole argument of Mr Gaines-Cooper, was that HMRC should treat them as non-resident under paragraph 2.9 of IR20. This, they said, simply required them:

 to go abroad:  for at least one whole tax year for a “settled purpose”; or  permanently; or  for at least three years (once those three years had elapsed); and  to visit the UK:  for fewer than 183 days in any tax year; and  for fewer than 91 days per tax year on average.16

The taxpayers argued that paragraph 2.9, unlike the strict legal position established by case law, did not include or suggest any requirement that they make a “distinct break” with the pattern of their life in the UK.

HMRC disagreed: paragraph 2.9 should be read with paragraphs 2.7 and 2.8 and bearing in mind the heading of that section of IR20: “Leaving the UK permanently or indefinitely”.

The Court of Appeal agreed with HMRC: the correct construction of IR20 required a value judgment as to whether a taxpayer has established a distinct break with the UK and severed social and family ties. Lord Justice Moses, giving the leading judgment, said, “…any settled purpose…must be consistent with a distinct break, sufficient to cut pre-existing ties. Absence for 3 years must equally be consistent with such a break.”

16 A couple of points are worth noting on the day-count test. First, the “91-day test” is not found either in statute or case law. Second, IR20 expressly excluded days of arrival and departure from day-counting calculations (at least outside cases where the practice was being abused). However, the Special Commissioners in the case of Mr Gaines-Cooper declined to be bound by the position in IR20, and held that days of arrival and departure should be included for the purposes of day-counting. This caused a stir among taxpayers and advisers. (From 6 April 2008, a day is counted if the individual is in the UK at midnight. Days of transit spent in the UK are, however, excluded provided that the individual does not engage in substantial activities unconnected to their transit during their time in the UK.) -6- UK Tax Residence 31 October 2011

Settled practice The taxpayers failed to convince the court that HMRC had a settled practice (irrespective of the wording of IR20) of ignoring any requirement for a “distinct break” before a taxpayer could become non-resident.

Lord Justice Moses was clear that a switch by HMRC from a “laissez-faire” attitude to applying greater scrutiny was not a change in settled practice to which the taxpayer had a right to object. Lord Justice Ward agreed that the evidence given by a cross-section of tax professionals claiming a change in HMRC policy was in fact “the effect of a closer and more rigorous scrutiny…of claims”.

Disclosure of skeleton arguments: an aside Mr James Kessler QC, a barrister specialising in residence issues, asked HMRC for a copy of its skeleton argument before the Court of Appeal. HMRC refused, treating the request as one under the UK’s Freedom of Information Act. Mr Kessler applied to the Court of Appeal for a copy under the Civil Procedure Rules, on the basis that justice should be done in the open. The Court of Appeal granted the request. (Note, however, that the Civil Procedure Rules do not apply to cases before the First-tier or Upper Tribunal.)

SUPREME COURT JUDGMENT

The Supreme Court handed down its judgment on 19 October. It sided with HMRC by a 4 – 1 majority. Lord Wilson gave the leading judgment for the majority; Lord Mance dissented at length.

IR20 The test. The taxpayers needed to show that the statements they relied on in IR20 were “clear, unambiguous and devoid of relevant qualification”.17 According to Lord Wilson, the statements should be read in the context of the booklet as a whole and through the eyes of an “ordinarily sophisticated taxpayer” who might or might not be getting professional advice. In his dissenting judgment Lord Mance gave this a stronger emphasis: “The primary issue in each appeal is … how, on a fair reading, IR20 would have been reasonably understood by those to whom it was directed.” Lord Justice Moses had drawn support for his reading of IR20 from the fact that it was designed to reflect the law.18 In the Supreme Court, however, it was agreed by the parties – and accepted by the judges – that the task of the court was “not to compare [IR20] with the law but to construe it by reference to its own terms”.

The majority. Whether the majority succeeded in viewing the guidance through the eyes of the taxpayer without reference to the law is open to question.

17 This test was first set out in R v Inland Revenue Commissioners, ex parte MFK (see above). 18 This was a reference to the preface of IR20. The preface actually states that it is intended to reflect the law and practice. -7- UK Tax Residence 31 October 2011

Lord Wilson considered that there was enough in the guidance, badly drafted though it was, to alert the hypothetical taxpayer that he had to make a “distinct break” in the pattern of his life in the UK, and that various factors (implicitly including factors not mentioned in the guidance) would be relevant. There was therefore no representation that meeting the day-count criteria was enough. If he were wrong on that, Lord Wilson said, he would still conclude that IR20 was not clear enough for the taxpayer to rely on it. This conclusion rather undercuts the practical purpose of publishing IR20.

The secondary argument for Mr Davies and Mr James was that they should be treated as non-resident for the tax year 2001-02 because they had left before the beginning of that tax year and their employment abroad covered a complete tax year in 2002-03. Lord Wilson thought that this was an irrational reading of paragraph 2.2 of IR20.

Lords Hope and Clarke agreed with Lord Wilson. Lord Walker seems to have agreed with Lord Wilson’s fall-back position that the guidance was unclear. In his short speech he noted that the taxpayers (or their advisers) had not approached HMRC for their view on the position, in spite of the invitation in the guidance to do so where the position was unclear.

The minority. Lord Mance gave a powerful dissenting speech. He disagreed with the reasoning of the Court of Appeal and the majority in the Supreme Court. The paragraphs in dispute did not suggest that a “distinct break” from family and social ties in the UK was necessary; in fact, some statements actually ran counter to such a requirement. Lord Mance did agree with Lord Wilson on the meaning of paragraph 2.2, however.

Settled practice The test. As a fall-back, the taxpayers argued that they had a legitimate expectation of being treated as non-resident because of HMRC’s settled practice on the point. The bar the taxpayers had to clear here was higher than the bar for their IR20 argument. They had to prove that HMRC operated a practice of treating individuals who passed the day-count tests as non-resident. They then had to show that the “practice was so unambiguous, so widespread, so well-established and so well-recognised as to carry within it a commitment” to treat them as non-resident.

The decision. Lord Wilson upheld the Court of Appeal’s view. Although there was some evidence to support the taxpayers’ contentions, there was evidence the other way. The taxpayers had failed to prove the existence of the requisite settled practice. Lord Mance declined to express a view on this point. (On his view, the taxpayers should win on IR20, so there was no need to consider the question.)

WHERE TO FROM HERE?

The Supreme Court is – as its name suggests – the final court in the UK judicial system. No appeal can be made from its decision. Mr Gaines-Cooper, however, has said that he is considering whether to take

-8- UK Tax Residence 31 October 2011

the case to the European Court of Human Rights. To succeed there Mr Gaines-Cooper would at a minimum have to persuade the European Court that the Supreme Court’s interpretation of IR20 was incorrect. In its recent judgment in Yukos, the European Court stressed that it was not its task “to take the place of the domestic courts, which are in the best position to assess the evidence before them, establish the facts and to interpret the domestic law”.19 So a victory there would be quite an achievement.

CONCLUSIONS

Relevance of the Supreme Court judgment We now know how the IR20 guidance in issue from 1999 to 2009 should be interpreted. A taxpayer who claims to have ceased to be resident in the UK cannot use it to shield himself from the case law requirement that there be a “distinct break” in the pattern of his life. (In fact, even before the decision, this was clearly the effect of HMRC’s guidance from the publication of Business Brief 1/2007.) Although this affects a number of individuals, it relates only to past tax years.

Residence and HMRC6 HMRC completely recast its guidance on residence and how to shed it in HMRC6. It is now closer to a summary of the case law. HMRC6 should, if all goes according to plan, be superseded by the statutory test from the tax year 2012-13.

Relying on HMRC’s published guidance By the time the case reached the Supreme Court it was common ground that taxpayers were entitled to rely on HMRC guidance in appropriate circumstances. The statements in the preface to IR20 – that it was not binding in law, that whether it was appropriate to apply it would depend on the facts of the case, that taxpayers should consult HMRC in difficult cases – did not mean that the guidance could never be binding where it was clear and unqualified. On the other hand, if the guidance were qualified or simply unclear, it would not bind HMRC. This in itself is not really new. The significance of the Supreme Court decision is threefold:

 the courts may construe HMRC’s guidance very differently from a large body of tax professionals;  while IR20 was designed as practical guidance to alleviate the problems of applying the concept of residence, the courts in fact interpreted it almost as if it were legislation; and  as a result, actually enforcing HMRC guidance is in practice very difficult.

Relying on HMRC practice The decision underlines the difficulty in making out a case that HMRC has departed from a general settled practice. Lord Justice Moses in the Court of Appeal contrasted the position of the taxpayers here

19 OAO Neftyanaya Kompaniya Yukos v. Russia [2011] ECHR 1342. -9- UK Tax Residence 31 October 2011

with that of the Unilever group in a previous case.20 There Unilever was arguing that HMRC had a settled practice for dealing with it. Here the question was how HMRC had dealt with other taxpayers. This caused evidential difficulties.

Lord Justice Moses also said, “There is no public law obligation of fairness which prevents the Revenue from increasing, without warning, the intensity of inquiry or scrutiny of claims to be non-resident.” Lord Wilson accepted that HMRC had intensified its scrutiny of claims to be non-UK-resident, probably because of changes in 1998 to UK income tax law. Neither he nor the other Supreme Court judges explicitly addressed the legal point made by Lord Justice Moses, but this must be because it is obviously right.

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Copyright © Sullivan & Cromwell LLP 2011

20 R v. Commissioners of Inland Revenue ex parte Mattessons Wall's Ltd 68 TC 205. -10- UK Tax Residence 31 October 2011

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