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The UK remittance basis of taxation is almost unique and was until 2008 hugely advantageous to all those who are not domiciled in this country. Recent changes have to some extent resulted in it being available only to the very wealthy – a somewhat strange result which has made the reliefs even more controversial.
The remittance basis rules are now some of the most complex (and in one respect the most strange) in the UK tax legislation and operating it in practice can be inordinately difficult. Nevertheless with expert guidance it is possible to achieve considerable tax savings from correct operation of the rules.
It should be noted that the inheritance tax reliefs for non domiciliaries have suffered no changes under either the current Government or the previous one, despite the fact that these reliefs enable very substantial estates to escape inheritance tax liability, if appropriate professional advice is taken. To date there has been no indication that any changes as regards IHT are in prospect.
What is domicile?
Domicile is a concept of private international law which, broadly speaking, is the legal perspective on where an individual is regarded as having a “permanent home”. There are many other facets to the concept than that simple term might suggest. It is a feature of ‘common law’ legal jurisdictions such as England, the United States of America, Canada, Australia, etc. The concept is not normal in mainland European legal jurisdictions which are derived from the Napoleonic Code and Roman law.
People often think that they can end any dispute about the place of their domicile by making a simple statement in, for example, a will, saying that they are domiciled in a certain country. However, although such a statement may have some value, it will not by any means determine the matter once and for all. There have in the past been high profile cases where a wealthy individual has left the United Kingdom claiming to have become domiciled in a tax haven overseas in order to avoid UK inheritance tax, but after that person’s death it has been found that the steps taken were not enough to ensure that his or her domicile changed.
You cannot simply ask HMRC to issue a ruling concerning your domicile status. They will decline to offer any view. Accordingly the method of securing an agreement with HMRC about your domicile involves first making a transfer of some foreign assets into a trust, and then making a return of the transfer, claiming exemption on account of your non domiciled status. Even this method will not necessarily produce a verdict from HMRC and they are currently adopting a practice of non-cooperation with such claims by asking interminable questions without coming to any final verdict. Failing all else an appeal can be made to the Tax Tribunal.
Making use of the reliefs
It is vital therefore that anyone claiming not to be domiciled in the United Kingdom, but who is nevertheless resident here, should take expert advice on the matter. Similarly, those whose family roots have always been in the United Kingdom and who go abroad in order to claim the acquisition of a foreign domicile should likewise take expert advice on how to achieve this; simply buying a property overseas and making a will in a foreign country will not necessarily be enough to ensure a change of domicile.
Those who are resident in the United Kingdom, but who have foreign domicile, have always benefited from ‘the remittance basis’ of taxation in relation to income tax and capital gains tax. Very broadly, tax liability in the UK in respect of foreign income and gains arose only if the income or gains were brought into the UK. The rules were substantially redrafted in 2008, and provisions for the £30,000 annual charge on remittance basis users were introduced, with which all non-domiciliaries will no doubt be quite familiar.
An outline of the current regime for non domiciliaries follows below, although it cannot cover all the detail and this brief summary should be taken as nothing more than a layman’s guide to the topic. Some planning opportunities are also suggested.
Income tax and capital gains tax
All persons resident in the UK are liable to UK tax on sources of UK income and gains. In addition, up to the fiscal year ended 5 April 2008, non domiciliaries were, in broad terms, liable to UK taxation in respect of their foreign income and capital gains that were transmitted to the United Kingdom; this is known as the “remittance basis” of taxation. Amounts of foreign capital, being money not representing income or capital gains which have arisen since taking up residence in the United Kingdom, could be brought into the United Kingdom free of tax liability, so long as that capital had never been mixed up with other money potentially taxable if brought here. To operate the remittance basis therefore requires careful segregation of funds overseas on separate bank accounts.
After 5 April 2008
These rules were radically reformed with effect from 6 April 2008. In broad terms, non domiciliaries who have not yet been resident in the United Kingdom for 7 out of the past 9 years may claim the remittance basis of taxation but the rules concerning what constitutes a taxable remittance have been considerably tightened. Any foreign income or gains of an individual arising after 5 April 2008 will be taxable in this country if those funds are transmitted or effectively enjoyed by the non-domiciliary in the United Kingdom by any means, and the same will apply if it is a close family member, such as a spouse or partner, child or grandchild under 18 who has the effective enjoyment of the money following a gift outside the United Kingdom. Bringing money in via a trust or a company can likewise give rise to tax liability in this country.
Correct operation of the “remittance basis” of taxation will therefore be all the more important in the future and this will involve taking careful advice as to how to segregate funds overseas and minimise the remittances from taxable funds. It should also be noted that, subject to some transitional provisions, use of foreign income or gains to pay interest on a foreign loan used to buy UK property now constitutes a remittance to the UK of the income or gains. Foreign income or gains used to repay the capital will, on conventional grounds, constitute a remittance.
Following the changes made to the rate of capital gains tax in the June 2010 Budget, it will be necessary to determine whether gains are for the period up to and including 22 June 2010 (taxed at 18%) or for the period on and after 23 June 2010 (taxed at 18 or 28% according to the level of income for the year).The rule here is that, for foreign gains taxed on the remittance basis, any gain is treated as arising on the date on which it is remitted to the UK. So if a gain on a foreign asset was realised on 1 December 2009, but the proceeds of the sale are not remitted to the UK until 1 September 2010, the gain is treated for UK tax purposes as arising after 23 June 2010. Many non-domiciliaries will find that any gains now remitted to the UK will be taxed at the 28% tax rate.
The annual £30,000 charge
After a non domiciliary has been resident in the United Kingdom for 7 out of the past 9 tax years, the remittance basis of taxation will not be available at all unless he or she makes a lump sum payment of £30,000 to HM Revenue and Customs (HMRC) for the year concerned. A decision on whether or not to make this payment can be taken on a year by year basis, but it will not be possible to manipulate the rules by alternating between a year of paying the charge and a year of not paying it (and thus accepting tax liability on worldwide income and gains). This is because income or gains of a year for which the £30,000 charge is paid and not remitted until a subsequent year when the remittance basis of taxation is not claimed will nevertheless be liable to tax.
Any claim for the remittance basis of taxation for any year (whether in the first seven years of becoming resident here, or thereafter with payment of the £30,000 charge) will mean that the normal income tax personal allowances will not be available, nor will the capital gains tax annual exemption be available for that year.
The £30,000 charge can be paid direct to HMRC from a foreign bank account and that will not then be regarded as a remittance of the money to the UK. This charge must be allocated to sources of foreign income or gains which have not been remitted to the UK, described as ‘nominating’ the funds concerned. The nomination gives rise to the possibility that the charge may then be allowed as a credit against any foreign tax liability on that income or gain, subject to the rules of the relevant foreign tax regime. However it remains unclear as to whether any credit will actually be available overseas. The US Internal Revenue Service has still not made any statement of its view.
Those with modest amounts of foreign income or gains (under £2,000 per annum) are not required to pay the £30,000 charge and they may continue to benefit from the remittance basis of taxation, albeit as amended in 2008.
It has been announced that subject to further consultation, the annual charge will increase to £50,000 for 2012/13 onwards for non-domiciliaries who have been UK resident for 12 years or more out of the previous 15 years.
It has been standard practice for non domiciliaries to hold their overseas assets in a non resident trust because in the past this secured exemption from capital gains tax within the trust and if any capital withdrawn from the trust was paid to a non domiciled beneficiary (even if in the United Kingdom) the gains would still remain tax free. Depending on the precise facts of the case, this rule did not necessarily apply to gains on non distributor offshore funds or hedge funds, but for other capital gains the use of the trust effectively gave the non domiciled settlor and his family exemption from UK capital gains tax whilst still allowing the trust assets to be enjoyed in the United Kingdom.
Where capital gains are realised by the trustees after 5 April 2008 and the funds concerned are then paid out of the trust and brought into the United Kingdom, there will be liability to the tax. There is, however, the facility to elect for the trust assets to be re-valued as at 5 April 2008 and it will then be possible to establish how much of any future capital gains had accrued up to that day and how much relates to the period thereafter. Only the latter proportion of the gains will be taxable on remittance to the UK for the benefit of a non domiciled beneficiary. It should be noted that this apportioning of gains is only relevant to non domiciled beneficiaries and any other beneficiaries will have full capital gains tax liability in respect of capital distribution.
It will be appreciated therefore that holding assets in an offshore trust offers all non domiciliaries a most significant shelter against UK capital gains tax liability. All gains realised by the offshore trustees, including gains on UK assets held by them are free of UK tax, and liability only arises if capital is distributed out of the trust. Even then there are methods of minimising liability and we can advise you further in this respect.
There are also detailed rules as regards capital gains realised in offshore trusts prior to 5 April 2008 so that with careful structuring it should be possible for these to be effectively remitted to the United Kingdom either without a tax liability or with a much reduced charge. Foreign trusts will as a result continue to be the key to significant capital gains tax savings for all non domiciliaries.
For 2010/11 trust gains have to be allocated to the period up to and including 22 June 2010 and that on and after 23 June 2010 (as mentioned above in relation to personal gains). For 2010-11 the basic approach will be that gains matched with payments received by beneficiaries before 23rd June 2010 will be liable at the single 18% rate and gains matched with payments received on or after that date will be subject to the new 18% or 28% rates, as appropriate
Gifts made overseas
In the past it was possible for a non domiciliary to make a gift of an asset overseas to a non resident trust or to a close relative and any capital gain arising in respect of the gift would not then become taxable in the UK if the proceeds were remitted to this country within the trust or by a close relative. This rule will no longer apply for gifts of income or gains which arise after 5 April 2008, if there is effective enjoyment in the UK of the gifted asset or proceeds of sale of it by the donor or his or her spouse or infant children.
In relation to income or gains which arose prior to 6 April 2008, it is still possible to avoid a UK tax liability by making a gift of the funds overseas to family member, who may then remit the money to the UK free of a tax liability so long as it is not used to benefit the person who made the gift overseas. An important point is however that the funds must not have become mixed with post 5 April 2008 income or gains before the gift is made; if they have been mixed in this way the remittance will be treated as primarily representing the most recent items of income or gains in the mixed fund. With care it can be possible to segregate the two types of funds to some degree but it is far better to keep different sources of income and gains separate at all times on different bank accounts.
As has been mentioned, unremitted foreign income or gains must be nominated for payment of the £30,000 charge. Somewhat bizarrely, the amount nominated can be as little as the taxpayer chooses. Given the doubts about credit being available overseas for the £30,000 payment, it is generally advised that an insignificant amount of income should be nominated and that income should be permanently retained on a separate bank account overseas. This is because nominated income or gains should not later be remitted to the United Kingdom; if they are remitted some quite harsh rules about foreign remittances will be brought into operation, and these rules are to be avoided at all costs.
It is vital that non-domiciliaries should take advice in relation to the substantial inheritance tax savings which can be achieved for them. Broadly, foreign assets of a non domiciled individual are excluded from liability to inheritance tax (i.e. are left out of account completely), but after 17 years of continuous residence in the United Kingdom a non domiciliary becomes “deemed domiciled” in the UK, thus losing this tax advantage; after becoming deemed domiciled, inheritance tax then applies to the person’s worldwide estate (although there are a few double tax treaties with foreign countries which override this general rule).
However, overseas assets may be transferred into a trust before the acquisition of deemed domicile, and in that event those assets will continue to qualify as excluded property whilst they remain in the trust, even if the settlor afterwards becomes deemed domiciled, and even if all the beneficiaries of the trust are domiciled in the UK. Of course if the transfer of assets into the trust takes place when the settlor is resident in the UK, it will be necessary to take into account the UK capital gains tax position and in this respect the interaction of the new remittance basis rules in relation to foreign capital gains makes this a complex area for advice.
For this reason all non domiciliaries should seek professional advice before they become ‘deemed domiciled’ in the United Kingdom. The transfer of assets into trust before that time can secure very significant capital gains tax and inheritance tax advantages. After acquiring ‘deemed domicile’ it is no longer possible to access the inheritance tax reliefs by making further transfers into trust, and in fact any such transfer will be a chargeable transfer for inheritance tax purposes, with possible 20 per cent inheritance liability arising. The capital gains tax advantages via a trust are not affected by deemed domicile issues, but the problem will be that a person who is deemed domiciled in the United Kingdom cannot put funds into trust without incurring an unacceptable inheritance tax liability.
A further proposed relief
From 2012/13 the government proposes to introduce a relief for funds remitted to the UK by a non-domiciliary for investment in a UK business. Further details will be announced later this year.
Despite the very significant changes which have been introduced in this field of UK taxation, there continue to be many opportunities for mitigating tax liability even without paying the £30,000 per annum charge. Non domiciliaries should seek advice as soon as possible in order to secure the best results for their future tax position.
FOR GENERAL INFORMATION ONLY
Please note that this Memorandum is not intended to give specific technical advice and it should not be construed as doing so. It is designed to alert clients to some of the issues. It is not intended to give exhaustive coverage of the topic.
Professional advice should always be sought before action is either taken or refrained from as a result of information contained herein.