Our client company is a privately-owned UK property developer that develops residential property for sale. It has identified a potential project which is much larger and more speculative than it would usually commit to or finance but which promises to be extremely profitable if successful. It has been introduced to an offshore investor who has provisionally agreed to provide the bulk of the funding on a profit-sharing basis. What are the main options and pitfalls for the client and for the investor in structuring the joint venture as far as tax is concerned?
First, a warning: the UK tax liabilities cannot be considered in isolation. It will also be necessary to consider the jurisdiction(s) in which the offshore investor operates and the vehicle through which the investment will be made. Nor should the importance of reviewing the detailed terms of any double taxation agreement which may be relevant be overlooked. Although most treaties are based on the OECD model, it is dangerous to make assumptions.
This is especially true when it comes to the permanent establishment provisions. Most but not all treaties provide that a building site or construction project will be regarded as a permanent establishment only if it lasts for more than a specified period of time, but the period varies from treaty to treaty – it is often either six or 12 months, but always check.
If, as seems to be the case, the investor is essentially providing finance for a trading transaction to be carried out by your client (or a new special purpose subsidiary of your client), the simplest option will be for the finance to be advanced on loan.
Normally, a UK resident company paying interest to a non-resident is obliged to deduct income tax at the basic rate, subject to the provisions of any relevant double tax treaty. An alternative which could be more attractive to some offshore investors may be to issue an instrument bearing a commercial rate of interest (in respect of which tax will be deducted) with a premium on redemption based on the profit of the project.
However, remember that where the consideration for a loan depends to any extent on the results of the company’s business, the tax analysis can become complicated. In principle, the return may in some circumstances be treated for tax purposes as a distribution (see CTA 2010 s 1015, s 1032 and s 1005). This would disadvantage your client (as a distribution the payment would no longer be tax deductible) and benefit the offshore investor (who would pay no UK tax on the distribution). If there is any possibility that these provisions may be relevant, it is important that the agreement with the lender should take this into account and adjust the payment to the lender accordingly.
Special purpose vehicle
Alternatively, consider a jointly-owned special purpose vehicle. Typically, your client and the offshore investor would each have a different class of share, with the share rights tailored to the commercial agreement. The joint venture company would pay tax on profits in the normal way and the profits would be distributed to each of the joint venture parties as appropriate.
The question may arise as to the method of extraction. Dividends would be simple and tax free for your client, while a capital gain on liquidation would also be tax free if the conditions for substantial shareholding exemption (SSE) are fulfilled; SSE is a little less straightforward than dividend exemption but is likely to be available. In either case, the offshore investor would pay no UK tax; however, local taxes in his home jurisdiction may lead him to prefer one extraction method over the other.
Beware of the temptation to convert income profit on the development into a capital gain by selling the shares in the joint venture company. This is likely to precipitate a charge under CTA 2010 s 815 for your client and under the income tax equivalent ITA 2007 s 752 for the offshore investor, unless it is clear that the purchaser of the shares will procure that the company will be selling the land in the ordinary course of its trade and paying tax in the normal way. The non-resident status of the offshore investor does not exempt him from s 752.
Other options
Other forms of joint venture are possible, including partnership or limited liability partnership (LLP), and these may be attractive in some circumstances. But any UK business entering into partnership (including LLP) with a non-resident should be aware that the partnership itself and any UK-resident partners will be treated as the UK representative of the non-resident and potentially liable to account to HMRC for payment of the non-resident’s UK tax liability. For that reason, the UK business will normally want to withhold distributions to the non-resident partner until all tax has been paid.
If the circumstances of the development and the offshore investor fit, it may be possible to turn things round so that the investor’s vehicle acts as the developer, avoiding all UK tax liability by taking advantage of the kind of treaty provision referred to above for a ‘short-term’ building project, with your client acting as subcontractor. But even in that case, your client should be aware of the risk that he will be treated as the UK representative of the non-resident and left to pick up the pieces should the planning go awry.
Money laundering
Finally, although not strictly a tax point, you should not overlook the possibility that, as a professional adviser involved in the transaction, you may need to consider whether you are satisfied as to the bona fides of the offshore investor and of the source of the funds involved, and to make any report under the money laundering legislation you consider appropriate.
