Grahame Jackson discusses: The UK Double Taxation Agreement

On October 15th Gibraltar 2019 and the UK entered into a double taxation agreement. This was a landmark moment for Gibraltar and was one step in the process of refreshing the overseas territories and crown dependencies for the UK. Gibraltar and UK had, of course, negotiated an agreement between UK and Spain which featured some double taxation provisions earlier in 2019, but the UK agreement is the first double taxation agreement which Gibraltar has entered into which is in the internationally recognisable form.

Where do Double Taxation Agreements come from?

Before World War One, with populations immobile, borders and customs restrictions still firmly in place in Europe and international trade occurring mostly within intercontinental empires like the British Empire or the French Empire, there was little chance of a person being taxable in one jurisdiction whilst also having income in another.

One of the methods to eliminate such problems was to have a “mother country – colony” tax system under which the “mother country” taxed persons based on their worldwide income as a result of residence, and a colonial system which taxed people solely on the basis of where they earn their income not where they are resident. This can be seen in action in the British Empire and there are still echoes of this solution in the Gibraltar taxation system, and other ex-colonial systems such as Hong Kong. Whilst the colonial empires set the boundaries of trade this system worked quite well.

However, as that system started to break down post World War One there were an increased number of instances where people subject to tax on their worldwide income were earning money in other countries.

How does this cause a problem?

John lives in UK, he’s subject to tax on his worldwide income at 40%. He crosses the channel and works in France for two months. He’s subject to French income tax on those earnings at 45%. If there are no arrangements made then he will pay a total of 85% of his income. Not very good for John!

So, countries got wise to the unfairness of this and introduced what is called “unilateral double taxation relief”. So, in John’s case, UK will allow him a credit for his French tax, and he will end up paying nothing to the UK.

But unilateral reliefs are never perfect, what happens if the tax systems don’t fit well together, what happens if France and UK have different rules about what makes you resident (they do) and John meets both tests? John clearly doesn’t want to get caught in a fight between HMRC and the French Finance Ministry.

So, in order to tackle these problems, the League of Nations (the much maligned predecessor to the United Nations) produced various standard draft treaties for jurisdictions to use in 1928, 1933, 1935 and 1946. Eventually a form of standard double taxation agreement was adopted by the successors to the League of Nations team in 1951. This went through further revisions and eventually became the responsibility of the Organisation for Economic Cooperation and Development which remains the body which issues the gold standard model convention. This was last revised in 2017 and it is this OECD Model which forms the basis of the Gibraltar – UK Agreement, with some modifications, most notably around interest and other passive income.

What sort of things do double taxation agreements do?

The model convention is designed to eliminate double taxation and eliminate chances of tax evasion and it does this by:

  • Establishing rules to “tiebreak” a situation where a person or entity is tax resident in both jurisdictions, which can arise if the rules are different in the two jurisdictions;
  • Allocating the right to tax different types of income between the jurisdiction the income comes from and the jurisdiction where the recipient is resident;
  • Establishing the rules by which any double taxation will be eliminated (in the case of the UK – Gibraltar agreement by way of a credit relief against the foreign tax and in some case a complete exemption from tax);
  • Eliminating discrimination against residents of the other jurisdiction;
  • Establishing a framework for the authorities to resolve issues between them; and
  • Ruling out access to the benefits of the treaty if the purpose of an arrangement is to avoid tax.

The Gibraltar – UK Agreement covers all these points.

A major step forward for Gibraltar

Gibraltar has walked a long road from military fortress with a minimal civilian population, whose only purpose was to feed the garrison, to the modern and highly devolved jurisdiction with a vibrant and diverse population it is today. The British colonial taxation systems were designed as a “mother country” which charged tax based on residence (the UK) and the colonies which charged tax based solely on source. In other words, the colonies were adjuncts to the UK, as a result there was no need for a double taxation agreement, as there could be no clash. The modern world is far beyond the colonial system which pre-dated World War Two. Gibraltar is a modern jurisdiction with a strong national identity and the UK-Gibraltar DTA marks the final death of the concept of the Gibraltarian tax system as an adjunct to the UK’s. It shows Gibraltar’s political and administrative development that UK and Gibraltar negotiated as equals, despite the constitutional relationships. A development in which all Gibraltarian administrations have played a part.

Economically it will encourage investment and development.  There are approximately 3000 double taxation agreements in the world. Gibraltar has now agreed two, one with its largest and most critical neighbour and one with its largest market and constitutional partner. We can only hope that these two will be the start of a concerted effort by HM Government of Gibraltar to establish a broad treaty network. Double Taxation Agreements have the potential to build new relationships for Gibraltar, not just protect the trading relationships it already has, post-Brexit we would hope that the European nations would be a focus, and with the rising technology sector in Gibraltar some unexpected countries may well be considered as relationships built around technology developments become ever more important.

The UK Agreement will help to invigorate the Gibraltar economy for years to come and the certainty it gives will facilitate investment in both directions. Gibraltar is well placed to take the opportunities it presents.

Grahame Jackson, Partner, Hassans