On 4 July 2022, the government launched a consultation on sovereign immunity from direct UK taxation. The consultation document sets out HM Treasury’s and HMRC’s joint proposals for how sovereign persons will be treated going forward, with the reformed exemption to be codified in legislation. Under the existing regime, all UK source income and gains of sovereign immune persons, including income from commercial activities, are exempt from direct UK tax, with eligibility for the exemption assessed by HMRC on a case-by-case basis. The government’s proposals for reform would result in an exemption that is, by its own admission, more restrictive than that which currently applies, and which could potentially omit from its coverage government pension funds. Crucially, sovereign immunity would be available just for income arising from investment (rather than trading) activity, and would be further limited to investment of a passive nature. In practice, this means that the exemption – even where available – would be limited to UK source interest income (provided it does not relate to UK trading activities), including on savings and debt, and income from government securities, bonds and debentures. With these changes, the government hopes to strike an acceptable balance between encouraging UK investment and ensuring fairness amongst investors.
The consultation document highlights how the UK’s approach differs somewhat from that of other countries; in a table in the consultation document (reproduced below), amongst the 11 chosen comparators, only one other country (France) is indicated as offering immunity for income from commercial activities, including trading and property income and, as the authors of this blog understand, the “Sometimes” in the table reflects that the French exemption for this category is narrowly drawn and linked to the specific qualification and source of the income in question.
|Sovereign immunity can be available for:|
|State||Trading and property income, and income from commercial activities||Interest and dividend income|
The government has also cited other motivating factors behind its proposal, including:
- the growth of sovereign wealth fund activity, and the changing nature of sovereign wealth fund investments;
- the importance of ensuring that any exemption for sovereign investment is proportionate to sovereign investors’ structures and activities, and fair when compared to other institutional investors with similar structures and activities; and
- a change in the wider UK tax regime for non-resident investors, particularly in relation to UK real estate.
The government notes, in particular, that there has been a change in the practical impact of the UK exemption in recent years (with a substantial increase in the amount of income exempted through sovereign immunity), notwithstanding that the scope of the exemption has remained the same.
As regards eligibility for exemption under the new regime, the government proposes to include:
- sovereign states, including federal states (e.g., the US) – in relation to which all constituent territories (e.g., states) would also be eligible for immunity – but excluding municipal authorities;
- heads of state (but not their family members); and
- foreign governments.
The last of these categories will no doubt prove controversial, as the government has queried, and has particularly welcomed views on, the scope of the “foreign governments” category and the extent to which various manifestations of foreign governments should be caught. In this vein, the government has specifically raised the question of whether government pension schemes should benefit from eligibility under the new regime. This could obviously have significant consequences for any government pension schemes which are active investors in the UK debt market and which have, to date, been able to avail themselves of sovereign immune status. A shift in position may well require them to restructure their UK investments in order to access alternative exemptions from tax on UK source interest. In any case, under the new rules immunity for any eligible entity or person would only be available following approval of a formal application by HMRC.
Where foreign sovereign entities (i.e. non-natural persons) do not benefit from exemption under the new regime – essentially insofar as the relevant income and gains arising to them do not constitute UK source interest income – they would generally be treated as non-resident companies and liable to UK corporation tax as it applies under the existing rules. This effectively means that income and gains from UK immoveable property and income from UK trading activities would be brought within the UK tax net. Specifically, liabilities to UK corporation tax could be incurred in respect of:
- profits from trades carried on through a UK permanent establishment (a UK PE);
- profits from the trade of dealing in or developing UK land for the purposes of disposing of it;
- profits from any UK property business; and
- chargeable gains on disposal of assets used in, or for the purposes of, the UK PE’s trade or the UK PE itself, or other assets consisting of interests in UK land or rights to assets (including interests in Collective Investment Vehicles) that derive at least 75% of their value from UK land.
Nothing will change in relation to UK stamp duty, stamp duty reserve tax and stamp duty land tax, in respect of which there is currently no available immunity.
The government is also seeking views on the impact of the proposals on, and their interaction with, existing regimes that afford qualifying investor status to sovereign immune investors. These include the Substantial Shareholding Exemption (SSE) and the recently introduced Qualifying Asset Holding Company regime, as well as certain eligibility criteria for Real Estate Investment Trusts, Long-Term Asset Funds, Exempt Unauthorised Unit Trusts and Collective Investment Vehicles. Although the government has stated that it is not minded to change how all of these regimes operate in relation to sovereign persons – recognising that many of them are seeking to capture institutional investors with particular structures and profiles, rather than those with exempt status in relation to a particular income stream – it has also stated that allowing sovereign persons to remain as qualifying investors in some regimes could undermine the reform proposed by the consultation. Certain commentators have speculated that sovereign investors may be removed from the list of qualifying investors for the purposes of the SSE, which exempts from UK corporation tax gains arising on the disposal of a qualifying shareholding by a UK company. If this is the case, the loss of qualifying investor status could result in unwelcome tax charges on sales by UK companies owned wholly or partly by sovereign (previously qualifying) investors, to the extent this impacts satisfaction of the applicable SSE criteria by the relevant UK company. Notably, however, the government has specifically said that it does not intend to disturb the existing treatment of registered overseas pension schemes (i.e. foreign public pension funds that currently benefit from sovereign immunity which are also registered as overseas pension funds) under these other regimes.
The government consultation closes on 12 September 2022, and any new rules (insofar as they apply to non-natural persons) would apply from 1 April 2024 to income recognised in accounting periods ending on or after that date. It is proposed that transitional rules would also apply to ensure that affected persons would not be subject to tax on capital gains accrued before the effective date of the new rules.
Any entities currently benefitting from sovereign immune status in the UK should continue to “watch this space”. Please speak to your usual Weil tax contact if you have any questions regarding this consultation, or the extent to which you may be impacted by the government’s proposals.