The Finance Act 2008 contained some of most significant changes to the landscape for non-UK domiciliaries resident in the UK seen for many years. The purpose of this Briefing Note is not to analyse these changes exhaustively (as this would require something more akin to a book!); rather, the Note is aimed at setting out certain key changes and addressing how these will affect non-UK domiciliaries in practice. It should also be noted that this Note does not address how the Finance Act 2008 affects offshore trusts – these issues will be discussed in a separate Note.
You will be regarded as UK resident if you spend more than 183 days here in any particular tax year. Days of arrival and departure used not to count. However, a day now counts for the purposes of the 183 day test if you are present in the UK as at midnight. That is to say that days of arrival are counted, but not days of departure (assuming departure occurs before midnight). There is an exception if one is “in transit” through the UK, although this is rather narrow.
You will also be treated as UK resident if you spend an average of 91 days or more in the UK over a rolling 4 year basis. This test is set out in guidance rather than in legislation – the guidance has not so far been updated to reflect the ‘midnight’ approach, but it is expected that such a change will be made. If you are not UK resident, it is therefore necessary to track visits to the UK with care. We would also recommend that evidence of travel (such as tickets etc) is retained
The Remittance Basis of Taxation
The £30,000 charge
Assuming you are UK resident, it is still generally necessary (subject to certain limited exceptions set out below), to make a formal claim for the remittance basis of taxation to apply if you are domiciled (or ordinarily resident) outside the UK. The significant change is that if you are over 18 and have been resident in the UK for at least seven out of the nine preceding tax years, it will now cost £30,000 for each year in which the remittance basis is claimed. The charge applies to everyone over 18 – therefore, if a husband and wife living in the UK were both domiciled outside the UK and held non-UK assets, it may be necessary to pay £60,000. Often one spouse will hold more wealth than the other – however, assets (such as bank accounts) may well be jointly owned. If £60,000 were to be paid out of taxed earnings, the gross cost would be about £100,000. It is therefore easy to see why the new regime is so unpopular!
It is not necessary to claim the remittance basis in every tax year and failure to do so does not adversely affect your domicile position (that is to say that if you are non-UK domiciled, you will remain non-UK domiciled even if you do not elect for the remittance basis in any particular year(s)).
If your foreign income and gains total under £2,000 in a particular tax year, the remittance basis will apply automatically, without the need for a claim to be made. Additionally, if you have no UK income or gains in a particular year in addition to no remittances of offshore income or gains, the remittance basis will also apply without the need for a formal claim.
It should also be noted that claiming the remittance basis will mean that you lose your personal income tax and capital gains tax annual allowances.
When the new regime was initially drafted, the £30,000 constituted a levy that was simply paid in addition to any other taxes that may be due. However, in order to optimise the position for those people who pay tax in more than one jurisdiction (and who therefore wish to try and claim a credit for the £30,000) the procedure was changed. It is now necessary to “nominate” an amount of foreign income and/or gains to be taxed. The resulting tax does not have to be as high as £30,000 (although if it is not, you will still have to pay £30,000 as you will be deemed to have nominated other sums as well). Technically speaking, if the resulting tax is over £30,000, the election for the remittance basis is not effective and you would have wasted the amount paid – however, it would be surprising if HMRC applied the rules in this manner (and hopefully this anomaly will be corrected).
Paying the £30,000 tax charge out of offshore funds will not itself trigger a remittance, so long as payment is made directly to HMRC from the offshore account in question.
Remitting nominated amounts
You would think that if you had nominated income sitting in a particular bank account and therefore paid tax on such income, a remittance out of that account could be made into the UK up to the amount nominated without any further tax charges arising. This is not the case, however. Oddly, a policy decision has been made that you are not permitted to remit nominated amounts until all other offshore funds (from all tax years) have been brought into the UK. Where nominated amounts are remitted, therefore, the new rules will actually replace (for tax purposes) what you have remitted with other offshore funds that had not so far been remitted (most likely leading to a tax charge). Worse still, the ordering of other amounts remitted into the UK (for that and potentially future tax years as well) can also be altered.
Given the above, many people will want to ensure that they do not remit any nominated amounts, as calculating what is deemed to be remitted (instead of the nominated amounts) for tax purposes will increase the compliance burden and cost.
Where funds are held in a ‘mixed’ account (meaning an account containing more than one type of item for tax purposes, for example employment income, capital and capital gains), the new rules will deem certain items to be remitted before others (according to a set of ‘ordering’ rules). Therefore, if the majority of your offshore funds are held within a single account, it may be difficult to ensure that you are not treated as remitting nominated income and gains. For this reason, some people may wish to create a separate offshore bank account generating a modest amount of income each year (that is paid directly into a separate account). It would then be possible to nominate this income (which would probably not be sufficient to generate £30,000 of tax but this would not matter as £30,000 would still be payable) and ensure that no withdrawals are ever made from this account and used in the UK.
Segregation of income and capital
The new mixed account rules also state that if funds are moved from one offshore account to another, a pro rata amount of every defined tax item will be deemed to be transferred between those accounts. Therefore, simply moving a modest amount between accounts can lead to compliance complexities.
A more damaging effect of these new rules is that in order to segregate income and capital held personally, the income must now be paid directly into the income account without first being transferred into the capital account (even for a few minutes). The best advice has always been that income should be transferred directly to an income account in this manner. However, many banks are not able to offer this service and instead income is decanted from the capital account moments after it arises. The prevailing view was generally that such an arrangement would hopefully be sufficient to achieve segregation (although this could not be guaranteed in the event of HMRC attack). It now looks as if operating accounts in this manner will definitely cause contamination.
It is easier to have a mixed account than you would think. For example, an account containing two identical tax items (such as employment income) that arose in different tax years will be treated as a mixed fund. A particular set of anti-avoidance rules apply to mixed accounts. These are aimed at preventing taxpayers from manipulating the new regime to access funds in the UK without paying the right amount of tax. However, they are widely drawn and can apply to innocent arrangements where mixed accounts are in place. Particular care is required where mixed accounts are used as collateral for loans.
Cessation of source
If an account giving rise to income was closed and a remittance of the income took place in the next (or a subsequent) tax year, it used to be possible to argue that the source of the income had ceased and, as such, the remittance did not give rise to a tax charge. Planning using the cessation of source doctrine has now been prevented. Further, a remittance after 5 April 2008 from ‘source ceased’ income can give rise to a remittance charge so accounts may need to be carefully analysed.
A further change to the remittance rules is that capital gains will now be deemed to be remitted into
the UK before clean capital. Previously capital gains were remitted on a pro rata basis to capital.
Bank accounts - practicalities
Given all of the above, we would recommend that non-domiciliaries living in the UK carefully review the bank account arrangements they have in place. They should check whether income is being paid directly into relevant income accounts and consider whether the optimal number and type of bank accounts are in place. For example, it may be beneficial to create different accounts to receive different tax items (particular where, for example, different types of income are received that are taxed at different rates).
Given that the rate of capital gains tax is now 18%, it may also make sense to ensure that capital gains are not mixed with income. If any accounts contain ‘clean capital’ that can be remitted tax-free into the UK, consideration should be given as to whether it is possible to preserve this status. This is likely
to involve having investment proceeds (where the capital account is invested) paid directly into a separate account as capital gains cannot be separated from capital. It should also be borne in mind that capital gains can be made if funds are held in non-sterling currencies.
In addition to the decision of whether or not it would be beneficial to pay the £30,000 charge in any particular tax year, it will also be necessary to address what funds would be nominated, how the tax would be funded and how to avoid any complexities regarding the remittance of nominated amounts.
Expanded deemed remittance rules
It is not always necessary for offshore funds actually to be remitted into the UK in order for a tax charge to arise. For many years, legislation has been in place to deem taxpayers to make a remittance in certain situations. Broadly speaking, many of these rules were aimed at preventing people using offshore funds (which cannot be remitted without a tax charge) to access funds in the UK without paying tax. For example, legislation was introduced to stop people borrowing against offshore funds and bringing the borrowed funds into the UK (arguing that there was no remittance of the offshore funds).
These ‘deemed remittance’ rules have been replaced with a much stricter set of provisions which catch a number of situations not previously caught under the old regime. Examples of this include:
- Paying abroad for services performed in the UK will constitute a remittance unless a particular (fairly narrow) exemption applies.
- If a gift is made to a “relevant person” (including an individual’s spouse, children and grandchildren under the age of 18 together with companies with which the individual has a “close” connection) and the recipient makes a remittance into the UK, such remittance is treated as a taxable event in the hands of the donor. Therefore, although it is possible to make gifts of offshore income and/or gains to adult children (so long as such gifts are made and perfected outside the UK) without a subsequent charge arising upon a remittance, such gifts to minors are no longer possible.
- A “conduit” rule has been introduced to prevent a gift being made to a third party which is then somehow used to benefit a “relevant person”.
- It used to be possible to borrow offshore and then service the debt out of offshore income and/or gains provided that such interest payments are made outside the UK (and no capital repayment was made out of such funds). This is no longer possible. Certain grandfathering rules do exist for loans made before 12 March 2008 – however, if the loans are varied then the new rules apply. In practice, this means that the grandfathering provisions may be of limited practical benefit given that so many mortgages are based on fixed terms that will expire within a few years and need to be renewed.
- Under the previous regime, offshore income and/or gains could be used to purchase a tangible asset outside the UK (such as a car) and such item could be brought into the UK without a tax charge arising so long as it was not sold here. Bringing the item into the UK will now constitute a remittance (although there are some exceptions for items already in the UK as at 5 April 2008).
- It was previously possible to make a gift of non-UK situate property (i.e. into a trust) without further adverse remittance consequences – the reasoning here was that although the gift generated a market value sale event for tax purposes where the proceeds of sale would be taxable if remitted into the UK, no remittance could ever arise as no sale proceeds physically existed. However, under the new rules, the latent gain within any item (for example, assets given into a trust) will be held “in stasis” within the asset in question, such that a future remittance of that item (or sale proceeds relating to the same) could generate a taxable remittance. This new provision is particularly problematic where assets standing at a gain are transferred into offshore trusts.
- If offshore income is generated whilst you are UK resident, it is no longer possible to move out of the UK for a period (making a remittance whilst non-UK resident) unless you remain non-UK resident for at least 5 tax years.
Certain exemptions do exist from the new remittance rules. These include:
- Remitting art, collector’s items or antique in circumstances where the “public access” exemption applies.
- Personal use – clothing, footwear, jewellery and watches that derive from foreign income are exempt as long as they are for personal use. Curiously, however, this exemption only applies for income tax purposes. Therefore, purchasing the same asset out of capital gains would give rise to a tax event! It is therefore important to closely monitor what is spent outside the UK from which accounts.
The repair rule – an exemption is available in certain circumstances for items brought into the UK for repair.
- Temporary importation – so long as an item does not spend more than 275 days in total in the UK, it can be imported on a temporary basis without giving rise to a remittance charge.
- De minimis exemption – where the remitted amount would be less than £1,000 then the remittance is also regarded as exempt. It is important to note that this exemption does not include cash.
Non-Resident Companies and Section 13 TCGA 1992
A particular provision (section 13 of the TCGA 1992) can treat gains arising within closely controlled offshore companies as accruing in the hands of the participators in that company. Broadly speaking, this provision applies if a participator has over a 10% interest in the company. Section 13 previously did not apply to non-UK domiciliaries. However, under the new regime the provision applies to everyone (UK domiciled or not) who is resident or ordinarily resident in the UK.
If you are non-UK domiciled and you have paid the £30,000 charge to elect for the remittance basis in a particular tax year, the remittance basis will apply to gains made within the company in question. As the remittance basis does not apply to UK assets, however, a closely held offshore company disposing of UK assets will likely generate a tax charge for all of its participators who are resident in the UK (whether UK domiciled or not). For this reason (in addition to others), it may well be better to hold offshore companies which themselves hold UK property through offshore trusts if possible.
It is also important to note that under the new regime, if an offshore close company distributes an asset to a participator, any latent gain within the asset essentially “hides” in that asset until the asset or sale proceeds are brought into the UK.
Where offshore companies are owned by UK resident individuals, great care is also required to ensure that the company does not become UK resident by virtue of it being ‘managed and controlled’ from the UK.
Foreign Losses – Capital Gains Tax Position
It used to be the case that individuals domiciled outside the UK simply could not claim relief for foreign losses. There is now more scope for foreign losses to be utilised but the rules are very complicated.
If you never claim the remittance basis from 6 April 2008, the position is relatively straightforward in that you will be able to claim all foreign losses (putting you in the same position as if you were a UK domiciliary). You will lose this treatment, however, if you claim the remittance basis for even a single year:
As soon as the remittance basis is claimed at any point after 6 April 2008, the opportunity arises to make a one-off irrevocable election regarding foreign losses. If an election is not made, foreign losses arising in that and future years (assuming you are still domiciled outside the UK) will not be allowable. If an election is made, complex rules govern the extent to which foreign losses can be utilised. It is important to note, however, that an election may not be beneficial in every case as UK losses are generally set against foreign gains (which you may never remit) before UK based gains. Therefore, an election could increase the overall tax burden in certain circumstances.
Although the remittance basis has survived the attack on non-UK domiciliaries, the expense and complexity surrounding the new regime means that clients will have to consider their positions carefully.
A few people will be fortunate enough to be able to pay £30,000 for themselves and their spouse every year in order to preserve the remittance basis. In our view, however, the majority of clients will not wish to pay this amount every year and will need to consider strategies to minimise the number of years where the charge has to be paid (for example, by ‘clustering’ tax events into a single year). Such strategies may also involve concentrating offshore wealth in one spouse (rather than everything being held jointly) – however, the position upon divorce should be carefully considered if wealth is to be transferred between spouses.
If you are paying the £30,000, the mechanics of nominating income and/or capital gains will need to be carefully considered and a strategy should be put in place to ensure that nominated amounts will not be remitted inadvertently.
The new regime also adds considerable complexity to the management of offshore accounts. It is likely to be necessary to ensure that banks pay income directly into income accounts. Care will also need to be taken to ensure that simple transactions (such as transferring funds from one account to another) do not lead to compliance difficulties.
Further, it will be important not to fall foul of wide ranging anti-avoidance rules applying not just in the context of deemed remittances, but more generally (for example, in relation to mixed accounts). Therefore, although the £30,000 charge will not need to be paid until you file your 2008/9 tax return, we would advise you review your position sooner rather than later to ensure that you are able to navigate the new landscape in the most optimal way.
For more information please telephone or email Stuart Skeffington, Nick Acomb or your usual contact
at the firm.
This information is necessarily brief and is not intended to be an exhaustive statement of the law. It is essential that professional advice is sought before any decision is taken.
© Stevens & Bolton LLP October 2008