Contribution to the study of "exit tax" in the UK

• Author: David Marrani
• Pages: 1-23

Page 1

Western European democracies have a strong, developed and often complex tax system organised as the way of providing the State with sufficient funds to allow its public services to function. ¹"The State needs (...) to find money necessary to cover public charges that have to fulfil by the mean of tax".²

Therefore, the charging and collection of tax happen to be linked to general interest, common good and public action. However, in recent years, we have witnessed changes in taxation use. Primarily, taxation is no longer only a concern of raising taxes for a State. Taxes have been used by States to fulfil multiple aims. An example of this can be found in eco taxation and also more precisely and discretely in the matter of capital gain taxation. Indeed, the taxation of individual or company migration through the charge on accumulated gains, the so called "exit tax", notably, has been an example of using taxes not only to provide State funds but also to provide the State with an instrument of control over individual and company behaviour. Secondly, taxation, an instrument used for funding State expenses, has developed, as a result, to another level. Attached traditionally to the sovereignty of a State, taxation has to be looked at differently nowadays, because of the integration operating in Europe through the EU. Like many other legal areas, taxation has become a matter of States within the EU, i.e. a matter of Member States and not a matter of isolated State. It may be contradictory in fact, to analyse taxation, which remains broadly a State competence and not an EU competence, with the idea that a State receives, because of its membership, the quality of Member State. Therefore, even though taxation is a matter of State sovereignty, it is also a matter of Member States sovereignty that has a trans Page 2 national character rather than an international one. In that respect, the idea that taxation may be an instrument of control over individual and company behaviour in a Member State is not similar to an instrument of control over individual and company behaviour in a State outside the union. In this scenario, the State does not have to take into consideration anything else than its own rules and policies. In the first one, the Member State is primary in its particular position of interaction with other Member States through the EU, and second, it is acting at an integrated level. The Member State, sovereign on almost every area of its fiscal policies and tax law, has to consider anyway whether or not what is done does not interfere with principles of the EU. The UK and Ireland, for example, have always been fighting to preserve their veto right over fiscal policies. In consequence, "exit tax", if it can be implemented in a State, because it is its sovereign right to do so, may contradict principles that are binding Member States. We will see in this paper that in the UK "exit tax" was designed as capital gain taxation that was used to relate both to individuals (A) and to companies (B) but recently this was modified to be only a company charge, and then how the UK legislation takes into account EU laws (C) in order to analyse if UK legislation is compliant with the EU legislation (D).

A "Return tax" rather than "exit tax" as an individual taxation matter

Capital gain tax³ in the UK was organised as post war taxation. The Special Contribution from the years 1947-1948 became in 1962 and 1965 a rather more efficient tax on long term and short-term capital gain "designed to collect 30 per cent of gains realised on assets"⁴. A series of provisions were enacted in annual Finance Acts until the Capital Gain Tax Act 1979 and, more recently, the Taxation of Chargeable Gains Act 1992⁵. Taxation under CGT of an individual or a company taxpayer migrating may create an obstacle infringing basic freedoms, equalling to Page 3 what has been called "exit tax". The impact however is different when applying to individuals or when it is applied to companies.

In the matter of individuals, capital gains tax applied only to those who were resident or ordinarily resident in the UK⁶. An individual taxpayer migrating was not supposed to pay any tax on gains made while not being resident and not ordinarily resident. Any individuals therefore could immigrate without the prospect of any sanctions when leaving or coming back to the UK. The Finance Act 1998⁷added a section 10A to the TCGA 1992⁸ which modified the mechanism. Primarily, the Finance Act 1998, rather than designing a tax that would be applied on individuals leaving the UK, introduced a charge that concerned individuals coming back to the UK after a certain period of non-residency: the act set up a tax payable on return into the UK. Indeed, subsection (3) and (4)⁹ defined that gains would be considered as accruing in the year of return. Notably, in the calculation would have excluded the disposal of assets acquired during the period of non-residency, otherwise than by means of a relevant disposal. Also, section 10A (7)¹⁰stated that it was possible for the Inland Revenue to assess the amount chargeable "at any time before the end of two years after the 31st January next following the year of return".

Precisely, the Finance Act 1998 imposed taxation on gains accruing from sales of assets of individuals who have been UK tax resident for any part of at least four Page 4 out of the seven tax years immediately preceding the year of departure, and who became not resident and not ordinary resident for a period of less than five tax years, and owned assets before leaving the UK. This tax would be levied on all of the balance between gains and losses, which would have accrued in an intervening year¹¹ if they had been resident in the UK throughout that year but considered as accruing in the year of return. Without a doubt, the tax organised by section 10A was to act as an obstacle to leaving the country. Individuals would not have their capital movement affected when leaving the country but when coming back to the UK. Mainly this was done¹² by considering their gains abroad¹³, as if they had stayed in the UK.

The ECJ ruling in the De Lasteyrie¹⁴ case was to bring changes in UK tax law. In this case, a French national domiciled in France, M. du Saillant de Lasteyrie, decided in 1998 to move from France to Belgium. He was immediately taxed by the French revenue for awaiting capital gains on investment in shares he held from French companies. The ECJ decided that the decision of the French revenue amounted to restrictions on freedom of establishment. Indeed, applying such a tax on M. du Saillant de Lasteyrie for gains he would have had, was creating an obvious situation of discrimination between taxpayers staying in the country and taxpayers leaving the country to establish in another Member State. It was evident that M. du Saillant de Lasteyrie would not have paid (at least not right away) the French CGT if he had stayed in France instead of moving abroad. In consequence, the tax levied was creating an obstacle for M. du Saillant de Lasteryrie to move within the EU or in other words, indirectly forcing him to remain in France. The impact of the ruling was generalised within the EU. Indeed, not only French tax law was amended as a result of the ECJ ruling, but it obliged Page 5 Member States to look closely to their tax instruments. In the particular case of the UK, the ECJ ruling was considered during the Finance Bill debate¹⁵ in 2005, in particular in the specific debate on the modification of Section 10A of the TCGA 1992. This section was modified in early 2005¹⁶ to take into account the possibility of the legislation being contrary to EU law¹⁷. The Financial Secretary to the Treasury, John Healey considered the Du Saillant de Lasteyrie ruling in the discussion. He highlighted, after citing a quote of the ECJ ruling "the French authorities could, for example, provide for the taxation of taxpayers returning to France after realising their increases in value during a relatively brief stay in another Member State" where the possibility of a "return tax" was mentioned, that:

"When leaving the UK, the tax position of an individual is neither improved nor impaired as a consequence of their move from the UK. Such a tax-neutral rule means that there is no restriction on either free movement or free establishment. In other words, our temporary non-residence provision is not an exit charge, so there should be no question of its falling foul of Community law. Indeed, we take considerable care to avoid such situations arising when we frame our domestic legislation." ¹⁸

Amending section 10A was not suppose to create an "exit tax" on an individual but a "return tax" that does not appear to be discriminatory under UK law¹⁹.

Mainly, the change introduced by the Finance (No 2) Act 2005 concerns individuals going abroad to avoid capital gains tax. Under the TCGA 1992 amended in 1998, it was possible to cleverly use a double taxation agreement to avoid it. The Inland Revenue considered that a double taxation agreement could Page 6 override UK law in the case of individuals emigrating from the UK to a country covered by a double taxation agreement. With the Finance (No 2) Act 2005, those individuals can no longer rely on a double-taxation agreement between the countries they are willing to move to and the UK. Section 10A (10) of Finance Act 1998 was repealed. In that respect, individuals can no longer claim relief in accordance with any double taxation relief arrangements. Then, the Finance (No 2) Act 2005 amended section 10A (3)²⁰ by adding to...