Proposed Reforms to Sovereign Immunity from Direct Tax in the UK – Government Consultation | Dechert LLP

On July 4, 2022, the government released a consultation paper calling for engagement on proposed reforms to clarify who is entitled to benefit from sovereign immunity and also to restrict the availability of sovereign immunity from direct taxation UK as it applies to sovereign entities and investors. : Sovereign immunity from direct taxation: consultation on policy design.

In summary, if the reform proposals are passed, sovereign immunity will only apply to passive interest or dividend income,1 which is a major change from the current policy. In particular, income and gains from a UK property sovereign entity (including the sale of shares in UK property rich companies) and income from UK business activities will for the first time be subject to UK tax.

Current position

Sovereign immunity is the principle of international law that a sovereign state should not seek to impose its law on another sovereign state. In the UK, sovereign immunity has been implemented in a tax context by granting foreign sovereigns (including extensions of the state such as funds or corporations) exemption from liability to tax direct, regardless of the activity undertaken by the sovereign entity (whether the activities are related to their sovereign functions or of a more commercial nature).

Proposed reforms

The UK’s position is different from the way sovereign immunity works internationally, where most countries generally limit tax exemptions to certain public investments. The main factor behind the proposed reforms to the UK’s sovereign immunity rules is that changes to other tax rules in recent years (mainly the broadening of the scope of tax UK to non-residents on UK property) have increased the impact of sovereign immunity on UK tax revenue. . The government also wants to bring the UK into line with the international mainstream when it comes to the treatment of sovereign immunity.

In summary, the consultation proposes the following:

1. Codification of the principles and conditions underlying the right to sovereign immunity in legislation to provide greater clarity and certainty. At present, the principle of sovereign immunity in UK tax law is a creation of HMRC case law and practice.

2. Limitations on the type of income that enjoys sovereign direct tax immunity to income that:

a. stems from investment as opposed to commercial activity;

b. arises with respect to investments that are more passive in nature and are more commonly held in the exercise of sovereign functions; Where

vs. arises in relation to investments where the direct tax exemption strikes an appropriate balance between support for investment in the UK and fairness between the different players in the UK market.

Accordingly, income and gains to a sovereign entity from UK property (and from the sale of shares in UK property-rich companies) and income from UK business activities would be included in the scope of UK tax application. However, similar to the introduction of the original rules for taxing non-resident capital gains, transitional rules will likely be introduced to ensure that capital gains tax only accrues once the new rules entered into force, i.e. the assets will be recalculated on the date of entry into force. of the legislative change (with an option for any gain to be recalculated on the original acquisition cost to the extent that the rebased value leads to an unfair result).

3. Sovereign Immunity Investors are currently treated as eligible institutional investors benefiting from favorable tax treatment for the purposes of various tax provisions of UK tax law. These concepts were introduced to encourage the use of UK structures by large institutional investors (such as sovereign wealth funds). The concept is used in Real Estate Investment Trust (REIT) legislation, the Substantial Holding Exemption (SSE) in the UK, the new Qualifying Asset Holding Company (QAHC) regime, the fund regime Long Term Assets (LTAF), the Exempt Unauthorized Unitary Trust and the UK CIV rules for wealthy non-residents capital gains tax. At present, the government recognizes that the operation of these regimes alongside a reformed sovereign immunity regime will need to be considered, but has noted that allowing sovereign persons to remain eligible investors under the regimes existing tax legislation could undermine the intended tax collection motive behind the proposed reform.

4. Sovereign immunity will only be available after approval of a formal application made to HMRC, and status will be retained unless there is a change in circumstances.

5. Existing reporting requirements in tax laws will apply to sovereign persons with the obligation to file income and corporate tax returns to the extent that they fall within the scope of the tax British. In addition, the non-resident owners regime will apply to sovereign persons. Alongside this change, legislation will be enacted to ensure that a state is not immune from the jurisdiction of UK courts in respect of proceedings relating to its liability for direct taxes.

Expected timeline and next steps

Please note that the consultation ends on September 12, 2022, with a view to publication by HMRC/HM Treasury of a summary of the responses in due course. Subject to any changes in government policy or priorities, the current intention is that any new legislation enacting these policies will come into effect from April 1, 2024.

Interested parties are invited to take this opportunity to provide their views.


1) The UK does not currently tax non-residents on UK source dividend income.

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