Alternative Investment Management Association
In his pre-Budget Report (PBR) of 9 October 2007, the UK Chancellor proposed sweeping changes to the taxation of foreign domiciliaries living in the UK. In addition, the residence rules would be tweaked to make it harder for certain taxpayers to claim non-residence status. Since the PBR, a consultation document has been issued in December 2007, asking for responses by 28 February 2008. Draft legislation was finally published on 18 January and is expected to be included in the 2008 Finance Bill and take effect from 6 April 2008. The draft legislation is extremely complex and it is not helpful that HM Revenue & Customs (HMRC) warn that it is “work in progress” and “not in its final form”.
This indeed turned out to be the case and as of the date of writing (20 February 2008), there have been two further formal documents published in which HMRC confirm their intention on a number of points, which will necessitate amendments to the legislation. The first was a letter from HMRC of 12 February 2008 (the Letter) and the second a statement on 15 February from the Society of Trust and Estate Practitioners (the STEP Statement). Whilst these are welcomed, until revised draft legislation is seen, much remains uncertain.
Individuals and trustees of offshore trusts may be able to take action before 5 April 2008 to minimise the impact of these changes, though they will need to act swiftly given the short window of opportunity.
Annual £30,000 Charge
Under the new rules, from 6 April 2008 there will be an annual flat rate tax charge of £30,000 (in addition to tax due on income and gains remitted to the UK) on non-UK domiciled individuals who have been resident in the UK for at least seven out of the last nine tax years and who wish to continue benefiting from the remittance basis of taxation. (The remittance basis means that offshore investment and employment income and offshore capital gains are only subject to UK tax if and when brought into the UK). Alternatively, a non-UK domiciled individual will pay UK tax on their worldwide income and gains whether or not they are remitted to the UK.
The first year in which the £30,000 may become payable is the eighth tax year of residence in the UK and years before 2008/09 will be counted. The charge will therefore apply to certain individuals in 2008/09. Individuals will be able to opt in and out of this system on an annual basis and so will be able to assess the level of their offshore income and gains each year in order to calculate whether it is worth paying the £30,000. As personal allowances will not be available to those taxpayers who claim the remittance basis (see below), £30,000 equates to about £80,500 of income taxable at 40 percent.
The £30,000 is described as an annual tax charge. Careful consideration will need to be given to the wording of specific double tax treaties to determine whether it will be eligible for double tax relief. In the Letter HMRC state that they will continue to discuss with the US authorities how the change can become creditable against US tax.
HMRC are consulting on whether people who have been resident in the UK for longer than ten years should pay more tax. A number of options are being considered, including the possibility of increasing the charge for such individuals who wish to claim the remittance basis, perhaps to £50,000. Another possibility is to set a maximum length of time for which the remittance basis can be claimed, after which all UK residents would be taxed on their worldwide income and gains on an arising basis. One suggestion here is an alignment with the Inheritance Tax 17 out of 20 year rule.
Change to Residence Day Count Practice
The residence rules will also be amended from 6 April 2008 to include days of arrival and departure in the “day count” tests for residence purposes, ending the practice of entering the UK on a Tuesday and leaving on a Friday but only counting two days for the purposes of the 183 and 91 day tests. The residence test will, however, remain subjective and there will still not be a clear statutory definition of residence based wholly on the counting of days; an individual’s intention and overall lifestyle will still need to be taken into account.
Loss of Personal Allowances
Subject to a £1,000 de minimis limit, individuals will not be able to claim both the remittance basis of taxation and any of the personal income tax allowances or the capital gains tax annual exemption. This will apply even to those who have not been in the UK for at least seven years and so are not yet eligible to pay the £30,000 additional tax charge.
Changes to Remittance Basis
Following consultation, it is proposed that there will be a number of changes to the remittance basis itself. These include:
• The removal of the source ceasing rules which currently allow the tax free remittance of income from, for example, bank accounts which have been closed in a previous tax year.
• Extending the definition of a remittance to include the bringing to the UK of assets purchased with non-UK investment income (with an exception for art works for public display) as well as the payment outside the UK for services provided in the UK. The remittance need not benefit the individual directly. Where income or gains are brought to the UK by or for the benefit of a connected person (which itself is widely defined), there will be a remittance by the individual. This will catch gifts to close family members, trusts and companies.
• There are new rules for temporary periods of non-residence (less than five full tax years) whereby remittance of foreign investment income during the period of absence will be taxable in the year of return. This mirrors the existing rules for gains.
Offshore Trusts and Offshore Companies
The way in which income and gains of offshore structures (offshore trusts and companies) will be subject to UK tax is also to be significantly altered from 6 April 2008. The extended remittance rules will apply to catch income arising in offshore structures, particularly offshore companies. In addition and most significantly, there will be major changes to the capital gains tax rules. Currently only UK domiciled individuals are taxed on disposals made by offshore trusts and closely-held companies and on capital distributions from offshore trusts. From 6 April 2008, non-UK domiciled individuals will be brought within the rules but with the benefit of the remittance basis for non-UK assets.
Thus, where a non-UK domiciled settler (or close family) can benefit from an offshore trust, gains realised by trustees will, from 6 April 2008, be taxed on the settler (with the benefit of the remittance basis for non-UK gains if the remittance basis is claimed). Non-domiciled beneficiaries receiving capital distributions will be subject to capital gains tax if these distributions can be matched to gains arising in the trust. (In the STEP Statement we are told that HMRC intend the remittance basis will apply to these rules, although the extent of this is not clear). The Letter states that there will be no retrospection in the tax treatment of trusts and the changes will not apply to gains accrued or realised before the changes come into effect. It is unclear how this will be achieved or exactly what gains will be exempt.
In addition, non-domiciled shareholders holding a greater than 10 percent interest in closely held offshore companies will be taxed when the company realises a gain (with the benefit of the remittance basis if claimed).
What does this mean in practice?
There is a window of opportunity to act before the proposed changes take effect on 6 April 2008. Therefore before this date:
• Offshore trusts and companies should be reviewed to consider whether they still offer sufficient of the benefits for which they were originally set up. It should be noted that structures may still provide inheritance tax benefits even if other tax benefits are lost.
• Both individuals and offshore structures should consider re-basing assets.
• Income accrued but not yet remitted to the UK should be identified, together with assets bought overseas that might in the future be brought into the UK.
• Any planned gifts out of offshore income/gains should be brought forward to the current tax year.
• Non-UK domiciled individuals who spend time in the UK should consider the impact of the new residence rules. Previously the 183 day and 91 day tests could be counted without reference to days spent commuting. It will now be much harder for an individual to work in London during the week but spend the weekend elsewhere without being UK tax resident. Employers of globally mobile employees should also consider the impact of the new residence rules before 6 April 2008.
• Non-UK domiciled individuals should consider how long they have been resident in the UK in order to establish when the £30,000 charge will become relevant to them. For the very wealthy non-domiciled individual the £30,000 additional tax may seem a price worth paying for continuing to enjoy the benefits of the remittance basis. The increased administrative and compliance costs of reporting worldwide income and gains may also be relevant. More worrying for these very wealthy individuals will be the proposed detailed changes to the remittance basis and the extension of anti-avoidance rules.
The proposed changes are far-reaching and it will take some time to become accustomed to the more restrictive regime. Nevertheless, by taking some actions before 6 April, individuals can improve their position for the future.