Alternative Investment Management Association Representing the global hedge fund industry
In the Spring 2008 issue of AIMA Journal, we wrote an article on the proposed changes to the UK tax rules on residence and domicile from 6 April 2008. That article was written prior to the Budget on 12 March and in fact there were significant changes between our first article and the regime coming into force. In particular, the proposed changes to the UK tax treatment of offshore trusts were almost entirely rewritten. This was partly, at least, as a result of extensive lobbying by the tax profession and non-domiciled community in response to the extremely wide reaching initial proposals which, it was agreed, would drive many non-domiciled taxpayers out of the UK.
In this article we summarise the changes that have been introduced, as well as highlight which rules remain. We then identify some practical implications of the new regime, of which non-domiciled taxpayers and their advisers, both financial and tax advisers, need to be aware.
Some things have not changed
The concepts of domicile and residence remain critical to UK taxation and are largely unchanged. The main difference in this area is in counting the number of days spent in the UK for the purpose of determining whether an individual is a UK resident under the 91 and 183 day tests. Whilst the original proposal was to include days of arrival and departure in the day count tests, the final position is that from 6 April 2008 days will now be counted if an individual is in the UK at midnight on that day. This is subject to a limited exemption where the individual is in transit through the UK. These day count tests remain only HMRC practice and a subjective approach to residence, including looking at the individual’s intention and overall lifestyle, still needs to be taken into account, particularly where an individual is seeking to lose their UK residence status. The government is under continued pressure to produce a clear statutory definition of residence based wholly on the counting of days. Whether this will be forthcoming remains to be seen.
Individuals who are UK resident but non-UK domiciled can still take advantage of the “remittance basis” of taxation. Where applicable, this means that they will not be subject to UK tax on their overseas income and gains, unless those monies are remitted to the UK.
Offshore trusts continue to be an extremely useful tax planning tool for non-domiciled individuals, but the way in which such trusts are subject to UK tax on distributions to non-domiciled beneficiaries has been significantly altered (see further below).
Changes to the remittance basis for individuals
For the tax year 2008/09 onwards, the remittance basis will only be available if a taxpayer claims it via his tax return (subject to a £2,000 de minimis). If the taxpayer claims the remittance basis in a particular tax year, he will lose his annual income tax allowance and capital gains tax exemption for that tax year. A decision will need to be taken annually as to whether or not to claim the remittance basis.
As initially proposed there will be a new annual charge of £30,000 where the remittance basis is claimed by a taxpayer who has been resident in the UK for seven or more of the last nine tax years. If the £30,000 charge applies, the taxpayer must nominate certain non-UK income/gains by reference to which the £30,000 will be paid. This decision is critical as if any of the nominated income/gains is/are brought to the UK before any other of the taxpayer’s overseas income/gains, complex remittance rules apply. This could potentially result in a significant tax bill being triggered merely by remitting just £1 of nominated income/gains. Advice should be taken as to the appropriate monies, in respect of which, to make the nomination and how to arrange the taxpayer’s overseas bank accounts accordingly.
Another consideration for the taxpayer in the first tax year in which they make a claim for the remittance basis, is whether to make an irrevocable, once and for all, election for capital losses made on non-UK assets to be allowable. This may appear to be a simple decision to which one would expect the answer to be “yes”, but the statutory ordering rules which set out the way in which elected losses will be set against gains in fact make the decision a complex one. The far reaching consequences of it need to be fully appreciated by the taxpayer.
Where taxpayers have offshore accounts containing a mixture of income and gains from different sources, there are now specific statutory ordering rules to determine the order in which monies will be treated as leaving those accounts when they are brought to the UK. This reduces the scope for bringing monies from such accounts to the UK without a tax liability. These rules are particularly relevant for taxpayers who have disposed of private equity or hedge fund investments. Offshore accounts containing only pre 6 April 2008 monies, i.e. those which were “frozen” on 5 April 2008, remain subject to the old rules with more potential planning opportunities.
As indicated in the Spring issue, a number of changes have been made to the way in which the remittance basis itself works including the removal of source ceasing rules. The definition of a “remittance” to the UK has been significantly broadened and now includes not only the bringing to the UK of overseas assets bought with overseas investment income but also where income or gains are brought to or used in the UK by or for the benefit of a “relevant person”. The new definition is potentially very onerous on the taxpayer, who may unwittingly and perhaps even unknowingly remit overseas income or gains, leading to interesting conundrums in the context of self assessment.
Changes to offshore trusts and offshore companies
Where a UK resident non-domiciled shareholder has a greater than 10 percent interest in the company (being a closely held company), from 6 April 2008 the company will be effectively transparent for both income tax (excepted in limited cases) and capital gains tax purposes, subject to the remittance basis (if claimed) for company owned non-UK assets.
This change will be of significance for those non-domiciled taxpayers who own UK property through offshore companies, perhaps for inheritance tax purposes. As and when the property is sold in the future, if the shareholder remains UK resident they will be subject to capital gains tax on any gain made, without the possibility of benefiting from Principal Private Residence Relief for one’s main home. Consideration should be given to restructuring such arrangements where this is possible without triggering a significant tax charge.
It was initially proposed that non-UK domiciled settlors of offshore trusts would be subject to tax on gains realised by the trustees on an arising/remittance basis. This was not followed through in the final form of the legislation. However, if the settlor is also a beneficiary of the trust they will be potentially subject to capital gains tax on distributions or the receipt of other benefits from the trust, as will all UK resident non-domiciled beneficiaries from 6 April 2008. The trustees of such trusts will need to take UK tax advice on the impact of the new rules and should also consider the option to make a rebasing election. The earliest time by which an election might need to be made is 31 January 2010 and it will require a market valuation of all trust and certain underlying company assets on 5 April 2008.
There are significant practical implications of the changes of which UK resident, non-domiciled taxpayers and their advisers, as well as the trustees of offshore trust need to be aware.
What were familiar rules on how offshore monies should be held in bank accounts by non-domiciled taxpayers have been affected. Advice should be taken on structuring offshore accounts, including the nomination of income and gains in respect of the £30,000 charge.
More onerous record keeping will be required. Taxpayers will need to be able to show where monies have come from, even where transfers have been made from one overseas bank account to another outside the UK.
The timing of receipt of non-UK income and realisation of overseas gains is more important than ever. Increased use of investment products to assist taxpayers with such issues, including investment wrappers and 13 month deposits, will no doubt grow in popularity.
Where non-domiciled clients make gifts to family members or offshore structures the wide extent of the remittance rules will need to be fully understood, to ensure that unanticipated UK tax liabilities do not arise for the client.
Married clients and those in civil partnerships may wish to consider transferring all non-UK assets to one spouse to avoid both taxpayers having to pay the £30,000 annual charge. However, non-tax implications of this should always be borne in mind.
Payment of UK professional fees out of offshore monies may trigger a UK tax liability. Careful consideration will need to be given to providing and invoicing advice from UK professionals, to mitigate the potential tax exposure.
Offshore structures should be reviewed and the impact of the new tax regime properly understood.
To conclude, the new regime is complex but tax planning opportunities remain. The number of potential pitfalls has, however, increased and those who act without appropriate professional advice should beware.Back to Listing