HM Revenue and Customs v Smallwood & Anor

Under a double taxation agreement, residence for capital gains purposes means liability to taxation by reason of residence. It is not determined solely by the taxpayer’s physical residence when the disposal occurs. Where domestic law makes a person liable in both contracting states, the agreement’s residence tie-breaker applies even if the relevant periods of physical residence were consecutive.

For trustees treated by domestic legislation as a single and continuing body, the place of effective management is that of the trust body as a whole. The court may consider an overarching scheme of management extending beyond the decisions of the corporate trustee holding office when the assets were disposed of.

HMRC appealed against Mann J’s decision, [2009] EWHC 777 (Ch), allowing the taxpayers’ appeal from the Special Commissioners. The dispute arose from a tax-planning arrangement under which trustees resident in Mauritius sold substantial shareholdings before UK-resident trustees were appointed during the same tax year.

The taxpayers claimed relief under the UK–Mauritius double taxation agreement scheduled to the Double Taxation Relief (Taxes on Income) (Mauritius) Order 1981. The central questions were whether residence under articles 4 and 13 was determined at the date of disposal and, if the trustees were liable to taxation in both states, whether their place of effective management was Mauritius or the United Kingdom.

1. Appeal allowed by a majority. All three Lord Justices agreed that article 13(4) did not adopt a snapshot of physical residence at the date of disposal. Under article 4(1), residence meant liability to taxation by reason of residence. The domestic tax consequences of the gain therefore had to be considered retrospectively, including liability arising from residence later in the same fiscal year.

2. Where the alienator was liable to taxation in both contracting states, article 4 had to operate in its entirety. The tie-breaker in article 4(3) applied despite the relevant periods of physical residence being consecutive rather than concurrent. Article 24 was not an effective mechanism for resolving competing residence-based claims. Its function was to relieve double taxation left possible by the agreement’s earlier allocation provisions.

3. The place of effective management was the place where the real top-level management occurred and where the key management and commercial decisions were made in substance. The inquiry required consideration of all relevant facts and circumstances.

4. Hughes LJ, with whom Ward LJ agreed, held that the relevant entity was the trustees as the single and continuing body recognised by section 69(1) of the Taxation of Chargeable Gains Act 1992, rather than PMIL viewed only as the corporate trustee holding office when the shares were sold. The Special Commissioners were entitled to find that the trust’s place of effective management was in the United Kingdom. The scheme had been devised, orchestrated and controlled there; the temporary Mauritian trusteeship and subsequent return of the trust to the United Kingdom were integral parts of that management.

5. Patten LJ dissented on this issue. In his view, PMIL’s directors retained their trustee discretions and their functions had not been usurped by the UK advisers. Applying Wood v Holden [2006] EWCA Civ 26, he considered that the Special Commissioners could not properly locate PMIL’s effective management in the United Kingdom.

6. The majority restored the Special Commissioners’ conclusion. HMRC therefore succeeded and the taxpayers’ claim to double taxation relief failed.

1. Court of Appeal: By a majority, allowed HMRC’s appeal and restored the Special Commissioners’ conclusion.
2. High Court, Chancery Division: Mann J allowed the taxpayers’ appeal in [2009] EWHC 777 (Ch), holding that residence under article 13(4) was determined at the date of disposal.
3. Special Commissioners: Dismissed the taxpayers’ appeals against HMRC’s closure notices. They held that article 4(3) applied and that the trustees’ place of effective management was in the United Kingdom.