New rules for Residence and non-UK Domiciled individuals
The Report Stage of the Finance Bill ended in the House of Commons on 2 July.As a result of the debate and lobbying by KPMG and others a number ofamendments were agreed to the rules governing non-domiciled individuals. Therules are still not law as this requires Royal Assent which is not expected until midto late July but there can now be no further amendments made. HMRC havepromised guidance in September. While this is helpful, the new rules came intoeffect on 6 April and in the meantime, non-domiciled individuals need to be able tocontinue to make investments in, and bring money to, the UK and so need to havean understanding of how the rules are expected to operate once the Finance Billfinally becomes law.
In addition to the legislation, our understanding of how the new rules are intendedto operate is facilitated by HMRC explanatory notes; HMRC published FrequentlyAsked Questions (FAQs) and our conversations with those at HMRC who havebeen involved in overseeing the drafting of the new rules. However, even with thisadditional assistance, there remain a number of uncertainties about how theproposed legislation will operate.
As part of a discussion hosted by KPMG on 22nd April a representative from HMRCwas asked to what extent the FAQs could be relied upon as final. She commentedthat they could not be relied upon to represent the final position, but consideredthat if the position moved on any of the issues it would be to become moregenerous (ie. in favour of the taxpayer). At present, they were not expecting anyamendments to the FAQs which would have a negative impact for taxpayers.
Contents
1) Claim for the Remittance basis 2) £30,000 annual charge 3) Amendments to the remittance basis 4) Alienation 5) Offshore mortgages 6) Mixed Funds 7) Temporary non-residence 8) Capital Gains Tax Losses 9) Deemed Gains on sales of assets by Close Companies 10) Non-UK resident trusts 11) Accrued income scheme 12) Transfer of assets abroad KPMG’s Private Client Update 4 July 2008
1) Claim for the Remittance basis
Previously, taxpayers not domiciled in the UK needed to make a claim for the remittance basis to apply to relevant foreign income. From 6 April it will be necessary to claim the remittance basis for relevant foreign income, employment income and capital gains. The claim can affect the non-UK source income, including employment income, but not the capital gains of individuals not ordinarily resident in the UK. This aspect is not considered further here and specific advice should be obtained if this is relevant.
Individuals will be able to choose from one tax year to another if they wish to be taxed on the remittance basis. The time limit is the normal one for claims which is at present 5 years and 10 months from the end of the tax year. So for the first year of 2008/09 a claim must be made by 31 January 2015. The current Finance Bill proposes to reduce this to 4 years but from a future date which has not yet been specified.
The remittance basis applies to a non-domiciled individual without a claim where unremitted income and/or gains for a tax year are less than £2,000 (this is an increase from the £1,000 announced at the time of the Pre Budget Report). A claim is also not required if an individual has no UK income or gains, has remitted no non-UK income or gains and is either under 18 in the relevant tax year or not resident for more than 6 of the proceeding 9 tax years. This is intended to help non-working spouses but it is of limited value as it cannot apply if there is any UK income such as £1 of interest on a bank account.
Those who make a claim for the remittance basis lose their entitlement to various allowances including the personal allowance and the CGT annual exempt amount.
2) £30,000 annual charge
The Finance Bill provides that there will be an annual charge to be paid by individuals claiming the benefit of the remittance basis who have been resident in the UK for at least 7 of the previous 9 UK tax years. The charge will only apply to adults and will not be payable by minor children. The charge is to be identified with unremitted offshore income or capital gains and treated as tax paid such that this overseas income/gains can be remitted to the UK with no additional charge. However, this is subject to strict ordering rules – see below.
The individual may choose the income and gains with which the £30,000 charge will be treated as identified and these will be known as “nominated” income or chargeable gains. There are strict ordering rules which apply when nominated income is brought to the UK and any other non-UK income and gains remain outside the UK. These rules operate to treat this other income/gains as having been remitted in place of the nominated income. In fact, as the legislation is drafted the rules go further than this. If even £1 of nominated income or gains are brought to the UK while leaving other non-UK income or gains unremitted, all income and gains brought to the UK will be re-characterised using strict ordering rules which work to the disadvantage of the taxpayer and would require much more onerous record keeping. This rule is particularly unfair where a tax payer wishes to remit income or gains with a credit for non-UK tax as that is treated as remitted after income or gains with no foreign tax.
It is understood from our conversations with HMRC that in order to claim the remittance basis it will only be necessary for an individual to nominate £1 of income or gains. The nomination need not be specific (it could be as simple as saying “bank interest”) but the individual must keep a record of the precise income which has been nominated in case of later enquiry. If only £1 is nominated, the legislation operates to treat the nomination as applying to sufficient income to give rise to the £30,000 charge, but the complex rules outlined above will only apply in relation to the £1 actually nominated.
The precise form of the charge is important in determining whether other countries will give credit for it, particularly the USA. HMRC published on Budget Day with BN107 a legal opinion suggesting that the charge was likely to be able to be credited against US federal income tax. It is not yet clear whether the USA will agree that the final form of the charge is creditable but the UK is aware of the issue and has amended the original Finance Bill provisions to help as far as possible.
3) Amendments to the remittance basis
In respect of relevant foreign income, it will no longer be possible to save tax by remitting income in the tax year after a source of income has ceased (e.g. a bank account has been closed). If a claim for the remittance basis is made, such income will be subject to tax when remitted. Concern was expressed in consultation that individuals would not have records in respect of sources which have been closed for some time but, the Government decided not to introduce any time limit. In theory this means that income from a source that ceased 50 years ago is now taxable if remitted after 5 April 2008.
The basis of what constitutes a remittance of relevant foreign income will be expanded beyond just cash to include assets bought abroad with the income and then brought into the UK as well as services provided in the UK. Again concern was expressed in consultation regarding some of the practical difficulties in complying with this legislation. Consequently the Finance Bill includes a number of exemptions including:
- assets owned on 11 March 2008 for so long as the same individual owns the asset, even if the asset is currently outside the UK and later imported;
- assets in the UK on 5 April 2008 for so long as the same individual owns the asset, even if the asset is later exported and then re-imported (although the existing charge that arises if such an asset is sold and the proceeds received in the UK remains);
- clothes, shoes, jewellery and watches;
- assets costing less than £1,000;
- assets brought into the UK for repair and restoration;
- assets in the UK for fewer than 276 days in total; and
works of art brought into the UK for public display in an approved establishment.
The legislation relating to claims for the remittance basis is to be amended so that it will no longer be possible to avoid a tax charge by claiming the remittance basis in a year when income arises but none is remitted and then remitting in a year where no income arises and the remittance basis is not claimed.
An amendment made at Committee Stage of the Finance Bill makes it possible to pay for UK services in some circumstances without giving rise to a remittance. To qualify the service must be performed wholly or mainly in respect of non-UK property and payment for the service must be made into a non-UK bank account of the provider. The drafting of the amendment means that this more generous treatment will only apply to certain types of remittances (there will be no relief, for example, where borrowings would be treated as remitted). It does not apply to a service provided in the UK which gives a benefit in the UK for the purposes of the legislation relating to transfer of assets abroad.
4) Alienation
The Finance Bill also provides that where income is brought to the UK by or for the benefit of a relevant person, the income will be treated as remitted to the UK. This reverses the principle established in Carter v Sharon that income could be alienated abroad and then brought to the UK by someone else without a tax charge. The definition of relevant person is very wide and includes spouses, civil partners, individuals living together as spouses or civil partners and children or grandchildren under the age of 18. The legislation will also apply to certain non-resident companies and offshore trusts. As the legislation is currently drafted an investment in the UK by the trustees of an offshore trust may lead to a remittance by the beneficiaries of that trust.
HMRC FAQs and conversations with HMRC have confirmed that if a gift had been made before 6 April 2008 and had not yet been brought to the UK, there would be no taxable remittance at the time the funds are brought to the UK unless the donor benefited from the funds.
In addition, if assets standing at a gain are disposed of for an amount below market value, such as by a transfer into trust, the Finance Bill provides that for the purpose of the remittance basis the asset will be treated as derived from any deemed chargeable gain arising on the disposal (ie based on a disposal at market value). This means that if the asset is brought to the UK (in this example by the trustees) there will be a remittance of the deemed gain, and if the asset is sold and the proceeds brought to the UK this will also be a remittance of the deemed gain. Although it had been confirmed in meetings with HMRC that this rule will only apply to disposals taking place on or after 6 April 2008, this does not appear to be reflected in the Finance Bill. However, one of FAQs and our conversations with HMRC suggest that where a gift into trust took place before 6 April 2008, in most circumstances there will not be a remittance where the trustees bring the property or anything derived from it to the UK.
5) Offshore mortgages
The special rules on debts and interest on loans are to be repealed. Instead, the more widely drafted rules in the Finance Bill treat as a remittance the repayment of the loan and the payment of interest on a loan which has been used to purchase an asset in the UK.
Transitional provisions have been introduced in the Finance Bill for existing foreign mortgages such that where an existing loan which is used to purchase residential property in the UK is secured on that property, the payment of interest out of relevant foreign income will not be treated as a remittance. The protection will last for the remaining loan period, or until 5 April 2028 if earlier, provided the terms of the loan are not varied and no further advances are made after 12 March 2008. The HMRC FAQs make clear that where any of the terms of the loan are amended, or a side letter is entered into, this would be a variation and cause the loan to cease to qualify under the grandfathering provisions. Changes that happen as a result of existing documentation, for example a move from a fixed rate to a variable rate would not change the status of the loan.
While these transitional provisions are welcomed, it appears that it will no longer be possible to use offshore employment income that is taxable on the remittance basis to make tax-free interest payments on mortgages.
One of the amendments made at the Committee Stage of the Finance Bill also allows for interest paid on re-mortgages to qualify for the relief, where similar conditions are met. An amendment made at Report Stage means that the funds obtained by re-mortgaging do not have to have been brought to the UK.
Our conversations with HMRC have confirmed the following:
a) Varying the loan, even to take out a further UK loan secured on the property, might prevent the original overseas loan from qualifying for the grandfathering provisions.
b) Where there is more than one loan secured on the property and both predate 12 March 2008 (Budget Day), the
loan used to buy the property should qualify for the grandfathering provisions, even though the other loan would
not.
Other Report Stage amendments extend the transitional relief to a case where the loan is supported by a guarantee or indemnity secured on the property even if the loan itself is not directly secured on the property.
6) Mixed Funds
The Finance Bill sets out strict rules for mixed funds. A mixed fund is an account which contains more than one kind of income and capital or income or capital of more than one tax year. If that applies:
• Where a remittance is made from a mixed fund after 5 April 2008, sums are remitted first from the income or capital of that tax year (and then if necessary of earlier tax years on a last in, first out basis) in the following order:
1) employment income (other than relevant foreign earnings, employment income relating to securities and employment income subject to a foreign tax),
2) relevant foreign earnings,
3) foreign employment income relating to securities,
4) relevant foreign income (not subject to a foreign tax),
5) foreign chargeable gains (not subject to a foreign tax),
6) employment income subject to a foreign tax,
7) relevant foreign income subject to a foreign tax,
8) foreign chargeable gains subject to a foreign tax, and
9) any other income or capital
- Where a mixed fund contains income from various sources over a period it should be treated as containing such income or capital as is just and reasonable – it is not clear how this will operate in practice. There may well be different views on what remains in a mixed fund at 6 April 2008 since these ordering rules do not apply to transfers before then.
- Where payments are made from overseas bank accounts and the funds are not remitted to the UK and there is no reasonable expectation at the end of the tax year that they will be remitted, the transfer will be treated as being a proportion of each type of income and gains within the account. This would cover situations, for example, where funds from mixed accounts are used to settle overseas expenses.
- The Government introduced a new anti-avoidance section at the Committee Stage of the Bill which is designed to frustrate arrangements which seek to make remittances from mixed funds in the most tax-efficient manner. It is not clear precisely how these provisions will operate, but the legislation provides that the amounts of income and gains of certain types should be reduced as is just and reasonable. It is possible that HMRC will argue that they result in any remittance from a mixed fund after any arrangements being treated as made in the way which maximises UK tax liability.
7) Temporary non-residence
There is a new rule to tax income remitted during a period of temporary non-residence in the year of return to the UK. It will not be possible to remit tax-free during a year of complete non-residence income arising in an earlier year of residence if the taxpayer returns within 5 years.
Similarly gains remitted to the UK while non-resident will be brought into the existing anti-avoidance rules relating to capital gains realised during a period of temporary non-residence.
8) Deemed Gains on sales of assets by Close Companies
Gains arising in non-UK resident companies that would be close if UK resident (“close companies”) will now be apportioned to non-UK domiciled participators, as well as UK domiciled participators.
The deemed gains will, however, be foreign chargeable gains, and taxable on the remittance basis if a claim is made, unless the asset sold is a UK asset.
For the purpose of deciding whether such deemed gains have been remitted to the UK, the proceeds received by the company will be treated as derived from the deemed gain. As with the sale of assets for below market value, this means that if the proceeds of the sale are brought to the UK this will result in a remittance of the gain, even if it is the company which brings the proceeds to the UK.
If the asset is sold at below market value, the asset will also be treated as deriving from the deemed gain.
9) Capital Gains Tax Losses
Non-UK domiciled individuals who are taxed on the arising basis and do not claim the remittance basis from 2008/09 will be able to use capital gains tax losses on non UK assets to set off against capital gains. Previously such losses were not allowable for non-domiciled tax payers.
Non-UK domiciled individuals who do claim the remittance basis from 2008/09 will be able to elect into a regime that allows them to get relief for their foreign losses. This election is optional but once made is irrevocable and requires them to disclose details of unremitted capital gains. The Finance Bill requires losses to be first set against remitted foreign gains of the year, then unremitted such gains and finally gains on UK assets.
10) Non-UK resident trusts
The draft legislation issued on 18 January 2008 was designed to change fundamentally the way gains in offshore trusts are taxed. Concerns were expressed in consultation that the 18 January 2008 legislation was too widely drafted. As a result of that consultation, the Finance Bill amended the original proposals significantly, such that:
- Non-domiciled settlors who are beneficiaries will not be taxed on trust gains as they arise (even for UK assets)
- Capital payments made to non-domiciled individuals before 6 April 2008 will not be subject to capital gains tax, even where they are matched with gains arising after that date provided the relevant individual is not domiciled in the UK at the time of matching.
- Capital payments made after 5 April 2008 to non-domiciled individuals will only be taxable to the extent that they are matched with gains arising after that date.
- To the extent that they are taxable, capital payments to non-domiciled beneficiaries will be taxable on a remittance basis if the beneficiary makes the claim for the remittance basis to apply in the relevant year (and pays the £30,000 charge if applicable).
- There will be complicated matching rules to determine which gains will be matched with which capital payments but, broadly, gains will be matched on a last-in, first-out basis.
- There will be a right to make a rebasing election for non-UK resident trustees – see below.
- Gains taxable in this way are subject to an increase if the payment is made more than one tax year after that in which the gain arose. The increase is from 20% to 60% of the tax to give a maximum rate of 28.8% (18% x 1.6). Such supplementary charges on gains apportioned to non-UK domiciled individuals will be based on the time at which the capital payment is made by the trustees and not the time at which the payment is remitted by the beneficiary.
1 Rebasing election
Non-UK resident trustees will have the right to make a once and for all election to calculate any capital gains tax changes for beneficiaries as if they had sold and reacquired all of their assets as at 5 April 2008. This election will also apply to any assets owned by an offshore company in which the trustees are participators.
The election will need to be made by 31 January following the tax year in which the trustees first either:
- Make a payment or provide any benefit to a UK resident beneficiary or;
- Transfer part of the trust fund (but not all) to a new settlement.
For trustees making capital payments or providing benefits to beneficiaries in 2008/09 the election will therefore need to be made by 31 January 2010.
There will be no deemed disposal of the assets; instead the trustees will need to keep a record of the 5 April 2008 value and, potentially, make two calculations when a disposal of any asset actually takes place. To the extent the gain is treated as arising before 6 April 2008 it will only be taxable when apportioned to UK domiciled beneficiaries. Where trustees have both UK and non-UK domiciled beneficiaries they must therefore keep a record of the proportion of gains which relate to pre-April 2008.
2 Disclosure
The draft legislation issued in January proposed that non-UK domiciled settlors of offshore trusts would have an obligation to disclose details of the trust to HMRC. The letter of 12 February from Dave Hartnett, then acting Chairman of HMRC, announced that there will be no such obligation on either settlors or beneficiaries.
However, beneficiaries of offshore trusts may be required to supply information to HMRC where they enquire into a beneficiary’s tax return. Such an enquiry could be in respect the rebasing of gains and their calculation.
An HMRC representative was asked to comment on the level of expected disclosure which would be needed in circumstances where trustees make a rebasing election. She commented that this was still being considered but that she would expect that a form would need to be submitted to HMRC giving the names of the trustees, the settlor and any UK resident beneficiaries. It is not clear how this can be reconciled with the Hartnett letter. The requirement to provide details of beneficiaries goes beyond the requirement in the January draft legislation which has now been dropped. She was asked to comment on whether this might lead to enquiries into the tax returns of beneficiaries and confirmed that where there were UK beneficiaries who did not appear to be making full disclosure on their tax returns, they could expect an enquiry.
Offshore income gains in offshore trusts
The new remittance basis also applies to non-UK non-distributor funds (often called offshore roll-up funds). The taxation of these gains where the funds are held by overseas trusts or companies is extremely complex and the mechanism by which any gains are taxed alters depending on the year in which they are paid out. Where offshore income gains become subject to tax they will be taxed at 40%.
The Finance Bill as amended, now gives the remittance basis in respect of offshore income gains regardless of whether they are treated as paid out to non-UK domiciled beneficiaries in the year they arise and so taxed under the capital payments regime.
Where offshore income gains are treated as matched with capital payments made in the year the gain is realised or an earlier year, similar transitional provisions apply as to capital gains.
Capital payments made to non-domiciled individuals before 6 April 2008 will not be subject to tax, even where they are matched with offshore income gains arising after that date.
If a rebasing election is made, that part of any offshore income gains which accrued before 6 April 2008 will not be taxable to the extent that they are treated as accruing to a non-UK domiciled beneficiary in the year they arise.
11) Accrued income scheme
Accrued income on foreign securities is to be taxed on the remittance basis.
For the purpose of the remittance basis:
- in respect of the transferor any consideration received for the securities will be treated as derived from accrued income. If the consideration is below market value the securities will be treated as derived from the accrued income.
- in respect of the transferee the securities themselves will be treated as derived from the accrued income.
12) Transfer of assets abroad
The Finance Bill also amended the anti-avoidance rules to bring the extended remittance rules into effect for transfers of assets abroad. This is designed to catch income arising in offshore structures, particularly offshore companies, but would catch any transfer of assets to a non-resident where income arises.
Where the transferor can benefit from the income or where he receives a capital sum, the income will be within the new remittance rules, ie. if it is brought to the UK in any form by the transferor, immediate family or a connected company or trust it will be treated as remitted to the UK.
Prior to the changes the remittance rules were unclear for income in offshore structures. It is expected this change will make the definition of remittance far more wide ranging.
Benefits received by non-transferors out of assets transferred overseas will also be taxable on the remittance basis. Payments and benefits will be matched with income of the overseas company or trust and will be taxable if either the payment/benefit or the income with which it is matched is brought to the UK, either by the individual receiving the benefit or by the offshore company or trust.
As the legislation is currently drafted, overseas trustees or an offshore company might make a remittance of income on behalf of a beneficiary of the trust simply by making a payment for services (eg. investment advice in respect of UK assets) or by investing in the UK.
Conclusion
The new remittance basis as contained in the Finance Bill has become even more complex and there has not been sufficient time for it to have been fully considered. Our understanding of the new rules continues to evolve and we understand that HMRC will issue draft guidance later this year. Individuals and trustees should speak to their usual KPMG contact or one of the contacts below before taking any action which may constitute a remittance to the UK.
Contacts
For more information, contact KPMG
KPMG in the UK
|
