The doctrine of sovereign immunity is the international law principle that one sovereign State should not seek to apply its law to another sovereign State. In the UK, the application of that principle to the courts is governed by the State Immunity Act 1978, but its application in a tax context is based on a combination of case law and common practice. That means the extent to which a particular entity is a sovereign person, and to which particular income is exempt from UK direct tax is determined by HMRC on a case-by-case basis, having regard to the particular circumstances and activity of the government or other entity in question.
HMT is now consulting not only on codifying that process to make it more consistent and transparent, but also taking the opportunity to narrow the scope of the exemption to target investment (rather than trading) income. This appears to be driven by two factors: firstly, a desire to align with other jurisdictions, and secondly the opportunity to tap into the rapidly growing and diversifying activity of sovereign wealth funds in the UK market.
The consultation seeks views on the following key proposals:
Under the proposal, foreign Sovereign States will continue to be eligible for immunity, as will federal States; however, each constituent territory of a federated State will also be eligible for immunity on an individual basis, without the need for a case-by-case review. Eligibility will not extend to municipal authorities below the federal level.
The Government proposes that the exemption be available to Heads of States (but not others in their household) and the government possessing sovereignty jointly with the Head of State. However, it is seeking input on how "government" should be defined. In particular, the consultation invites views on whether government pension schemes - which may already be eligible for other exemptions - should be included, and how wholly-owned, state-controlled entities should be treated.
The Government also proposes amending legislation to ensure that it continues to exempt from all direct taxes international organisations such as NATO and the UN, in line with its treaty obligations.
Scope of immunity
As mentioned above, the proposal seeks to restrict the applicability of sovereign immunity to income from passive investment activity (including interest on savings or debt, and income from government securities, bonds and debentures). Since the UK does not tax non-residents on UK-source dividend income, the consultation proposes that the exemption be formulated as an exemption for foreign Sovereign States in respect of UK-source interest income.
The proposal expressly excludes immunity from inheritance tax (other than on the transfer of UK property by a Head of State to their successor, or otherwise where the property remains state property) and stamp taxes.
The scope of existing sovereign immunity to court proceedings will also need to be amended to ensure HMRC has recourse to the UK courts to enforce any tax liabilities to which sovereign persons are liable.
Treatment of non-eligible income
The Government proposes that foreign sovereign persons (other than natural persons) should be treated as non-resident companies for the purposes of UK tax on their non-exempt income.
Sovereign natural persons would be subject to income tax and capital gains tax in the usual way, including on profits arising from a trade carried out in the UK.
As a result, sovereign persons would also be subject to the same self-assessment reporting requirements as other UK taxpayers.
Commencement and transition
The Government proposes that the new rules should apply to income recognised in accounting periods ending on or after 1 April 2024 (with apportionment for straddle periods) for foreign sovereign non-natural persons, and from 6 April 2024 for sovereign natural persons.
The consultation acknowledges that capital gains in particular may have accrued over a long time period prior to the proposed changes. Accordingly, the consultation suggests that transitional rules could be introduced to enable sovereign persons to rebase the cost of assets to market value on the date that the new rules come into force. It notes that there may be a need to introduce a mechanism to mitigate against any unfair results of such rebasing (for example, where rebasing creates or increases a chargeable gain).
Interaction with other UK tax regimes
Sovereign immune investors constitute "qualifying investors" for a number of UK tax regimes, including for the purposes of:
- determining genuine diversity of ownership for Real Estate Investment Trusts, Qualifying Asset Holding Companies, Long-Term Asset Funds and Exempt Unauthorised Unit Trusts;
- qualifying for the third additional exemption from corporation tax on gains on share disposals under the Substantial Shareholding Exemption regime; and
- applying the specific regime for non-resident capital gains tax purposes for UK property-rich Collective Investment Vehicles and their investors.
The consultation document acknowledges the need to balance the policy aims of these regimes with the intended narrowing of sovereign immunity. The document appears to suggest that where the reference to sovereign immune investors is a means of identifying genuine investors this may be preserved, but that may not be the case where the reference functions as a gateway for further tax exemption. However, at this stage the consultation does not put forward a developed proposal.
The Government expects the proposal to have a positive impact on the Exchequer, and for the majority of additional revenue raised to come from sovereign wealth funds, particularly those invested in UK real estate. However, a full assessment of the economic impact of the proposal is yet to be published; this will rely to a significant extent on analysis of how many sovereign wealth funds currently benefit from immunity, whether existing sovereign investment is or might be eligible for other tax reliefs, and whether the proposals might impact on the investment decisions of sovereign immune entities.
The consultation is now open for responses, and will run until 12 September.