The UK Government has recently consulted on a revised approach to sovereign immunity from direct taxation. The consultation was brought about owing to the view that whilst the scope of sovereign immunity-based exemptions has not changed over time, the magnitude of the income exempted through sovereign immunity has increased substantially. The UK Government identifies that this has, in part, been driven by both how sovereign immune persons invest and the nature of the investments in which they invest.
The UK Government has emphasised in the consultation document the need for the UK to continue to recognise the unique status of sovereign investors and ensure the UK remains an attractive jurisdiction for inward investment whilst also implementing rules that are transparent, appropriately targeted, applied consistently and in line with the international mainstream.
The current exemptions from direct taxation on the basis of sovereign immunity are assessed by HMRC on a case-by-case basis. Accordingly, the changes proposed would be implemented through legislation in order to give effect to the design principles outlined by the UK Government.
Eligibility and Scope
The UK Government proposal would apply to federal States (including their constituent territories but not municipal authorities), heads of State and foreign governments of a State or constituent territory of that State. The UK Government has sought particular input on the approach to be taken in relation to government departments and agencies, central banks, government funds and government pension schemes, noting that some persons may be exempt under existing alternative exemptions.
The UK Government consultation also proposed to narrow the types of income and gains that would be exempt from taxation. Currently, those eligible for sovereign immunity from taxation are exempted from UK direct taxation in respect of all UK sourced income and gains. However, the UK Government proposal would limit this exemption to income and gains from investment (rather than trading) activities and, specifically, investment of a more passive nature in assets that are more commonly held as part of the undertaking of sovereign functions. The UK Government therefore considers that sovereign non-natural persons could become liable to corporation tax on sources such as: (i) profits from trades carried on through a UK permanent establishment; (ii) profits from carrying on the trade of dealing in or developing UK land for the purposes of disposing of it; (iii) profits from a UK property business; and (iv) chargeable gains arising from the disposal of assets used in or for the purposes of the UK permanent establishment’s trade or the permanent establishment itself. The effect is that the only income that would be exempt from UK tax would be UK source interest, to the extent not related to trading activities undertaken in the UK.
The position outlined by the UK Government represents a significant narrowing of the exemption from direct taxation on the basis of sovereign immunity. In addition, the consequences such as where sovereign immune investors are regarded as “qualifying investors” for the purpose of regimes such as the UK’s real estate investment trust legislation, substantial shareholding exemption and qualifying asset holding company regime will require further consideration. The UK Government has also noted that inheritance tax would be expected to be applicable unless the individual foreign sovereign passed assets to their successor (as sovereign). Transfer taxes (such as stamp duty, stamp duty reserve tax and stamp duty land tax) are expected to continue to apply.
The new rules are proposed to apply from 1 April 2024 to income recognised in accounting periods ending on or after that date for entities chargeable to corporation tax, and from 6 April 2024 to sovereign natural persons, subject in both cases to appropriate apportionment rules.