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We have previously written about UK domicile before – https://htj.tax/?s=uk+domicile
Non – Doms, Bleak Horizons or New Opportunities for Wealth Management in the United Kingdom?
By Mikhail Charles and Weldon Ramirez
HTJ Tax
The United Kingdom remains attractive to non-domiciled persons, legislative traps remain however for the unwary and with recent political furores[1] in respect of the former UK Chancellor’s wife and her tax status, it may very well be that the rules may change yet again.
The non-dom regime has been in existence in form or the other since the 1700s[2] however the current ‘res/ non-dom’ remittance basis seems to be now, illogical in the writer’s view: the UK tells wealthy people to come to the UK but makes it very difficult or unattractive for them to bring their money with them once they are here. Business investment relief is still narrow in scope. We suggest that legislative encouragement is needed to help non-doms to spend their money here and to do so for longer. For example, an annual ‘lump sum’ tax regime, akin to the ‘forfait’ in Switzerland, could be the way to do this.
According to the annual wealth report (tinyurl.com/y9m3oqwn) published by property consultancy, Frank Knight, the global super-rich will continue to flock to London despite the UK’s decision to leave the EU. The report states:
‘In a European context, London is without doubt the dominant city for the wealthy … London is just more accessible for more wealthy people, it is more convenient, more connected and more open than other cities. London attracts talent from around the world, and it will continue to do so.’
There are 2 main modes in respect of being a non-dom, the non-remittance basis and the remittance basis.
The tax position of non-domiciled individuals was subject to significant change back in 2018 (with the actual rules taking retroactive effect from 2017), and many taxpayers are either still unclear as to their current position or have legacy structures in place which they may not be aware have become non-compliant.
The target of HMRC’s most recent campaign has been the remittance basis charge (RBC), which is the charge that is levied on individuals to provide them access to a more favourable tax regime. This ensures that the UK tax liability is restricted to UK source income and gains and any non-UK income and gains are remitted to the UK. Non- UK income and gains retained abroad (in an offshore bank account, for example) are then not taxable in the UK.
The total cost of the RBC varies depending on the number of years the taxpayer has been a resident of the UK. For example, those who have been resident in the UK for more than seven out of the previous nine tax years and whose non-remitted non-UK income exceeds £2,000 must pay a charge of £30,000 in any year in which they wish to access the remittance basis. Those who have been a UK resident for more than twelve years out of the previous fourteen must pay £60,000.
Because the remittance basis is claimed (and the RBC paid) on a yearly basis as per the individual’s self-assessment tax return it is unsurprising that mistakes creep in, particularly where the non-dom in question does not keep in frequent contact with their adviser. Residency is a complex matter to keep track of and assess. For example, an individual may travel in and out of the UK multiple times during a tax year and not be aware they have clocked up the time that triggers an RBC liability.
Another issue for non-doms is understanding the situs (legal location for tax purposes) of their assets. By way of example, HMRC considers the situs of cryptocurrency to be the residency location of the individual. Given the values of certain cryptocurrencies, failure to fully understand the tax implications of a change in residency status to this asset may give rise to a significant tax liability.
In our view at HTJ, we see the following as tax traps for the unwary non-dom:
- Marriage: generally, the concern here is that a charge will arise on inter-spouse transfers where one spouse is non-domiciled to the UK.[3]
- Onwards gift rules: generally, the ultimate recipient of a gift (usually from an offshore source) will have to report same to the HMRC[4], however this may be mitigated by a non-dom waiting for 3 years before making any gifts or if there is some urgency for the money then making a loan on commercial terms from the original recipient to the subsequent recipient or beneficiaries of a trust can opt to make gifts of income distributions only.[5]
- Crypto: HMRC stance on situs linked to residence, so if a non-dom is UK resident, there is no remittance basis on gains Also remittance if a UK RND invests offshore income and gains into crypto.
- Tainting trusts: [6] Broadly speaking, non-dom settlors will no longer be personally assessed on the gains or foreign income of a non-UK resident trust unless they receive a distribution or benefit from the trust. This treatment is also extended in certain circumstances to nondom settlors who have become UK deemed domiciled (i.e. have been resident in the UK in 15 out of the last 20 UK tax years) as long as certain criteria are met. These trusts are known as ‘protected trusts’. However, the ‘protected’ status of such a trust is easily lost and, once lost, cannot be reinstated. It is therefore essential that trustees take care not to inadvertently taint such a structure. If a trust is tainted, the settlor becomes subject to tax on all income and gains within the trust structure on an arising basis.[7]
- Loans: this is fraught with issues. HMRC’s guidance on the taxation of non-UK domiciled individuals who remit funds to the UK after taking out a loan overseas using unremitted income and gains as collateral has been subject to a number of changes in recent years. The most recent change of position being in 2021.[8] HMRC guidance has historically been that the amount of collateral remitted to the UK will be capped at the level of the debt. This appears to have changed between December 2020 and July 2021, although HMRC have not publicised it. HMRC’s new position is that where the whole of the loan is brought to the UK, the whole of the collateral will be remitted, even when in excess of the value of the loan. Where the loan is not fully brought to the UK, the collateral remitted will be capped at the level of the UK loan. [9]
However, we also see the following areas as opportunities for the careful non-dom:
- Clean capital: clean capital basically refers to the income or profits accrued before one becomes a tax resident in the UK under the Statutory Resident Test (SRT) and, in principle, means capital that can be remitted to the UK without paying additional UK taxes even after one becomes a UK resident. The most common clean capital may include capital accrued from foreign income and profits prior to one becoming a tax resident in the UK or gifts and monies received by way of inheritance[10].
- Temporary non-residence rules: The temporary non residence (TNR) anti-avoidance rules prevent a formerly UK-resident individual taxpayer from taking advantage of a short period of non-residence to realise income or gains outside the UK and, as a result, escape UK taxation on the receipt. These rules are most commonly seen in the context of capital gains tax, but they also have application to certain receipts subject to income tax. The scenarios are wide-ranging and include, for example, close company distributions, chargeable event gains and lump sum pension distributions.[11]
- Dealing properly with domicile and succession planning: while morbid in nature, the impact of one’s domicile under the ordinary rules of public international law reveal that the laws of inheritance from the non-dom’s domicile will apply unless explicitly disapplied or mitigated by succession and inheritance planning.
- Entity classification: this is very critical[12] as the use of various entities around the world varies as the colours in the rainbow. HMRC may take a dim view of the particular entity, in Anson v HMRC [2015] UKSC 44[13] the Supreme Court rejected HMRC’s long-standing position that a U.S. LLC should be considered an opaque entity for U.K. tax purposes — that is, the entity’s profits should be treated as accruing to the entity itself and not to its members.
The relevant facts in Anson v HMRC [2015] UKSC 44 were that Mr Anson was one of a number of members of a Delaware LLC. The LLC was transparent for US tax purposes, and Mr Anson was taxed at a rate of 45% on his share of the profits of the LLC as they arose. Mr Anson filed his UK income tax returns on the basis that the LLC was a partnership for UK tax purposes and so was taxed on a similar basis. Double tax credits were claimed, and no further UK tax was thought to be due.
HMRC, however, concluded that the LLC was opaque, and that Mr Anson was instead taxed in the UK on the distributions made to him by the LLC. It followed that no double tax credits were available, for the simple reason that the US tax was paid on one source of profits (the trade carried on by the LLC), whereas UK tax was paid on another (the distributions from the LLC). This resulted in an eye watering effective tax rate of 67% (a rate of 45% in the US, and of 40% in the UK on the residue).
The Court of Appeal agreed with HMRC, deciding that in order to be entitled to and therefore taxed on the profits of an entity, its members would need to have a proprietary interest in its assets. The Supreme Court disagreed. A proprietary interest in the assets held by the entity is not required. What is relevant is whether the member has an entitlement to the profits of the entity as they arise under its local law constitutive documents.
The Court found that based on Delaware’s LLC Act and the provisions of the LLC agreement in the Anson case, the LLC’s members automatically became entitled to their share of the LLC’s profits as they arose. The Court therefore concluded that because the U.K. and U.S. were taxing the same income, the taxpayer (a U.K. resident who was a member of a Delaware LLC) was entitled to a U.K. tax credit under the U.K.-U.S. tax treaty.
But this has thrown the traditional test applied by HMRC into some arrested development and what will be looked at is the substantive law of the domicile of the entity in question. Local legal advice would be essential.
A corollary of the Anson decision, is that a Delaware LLC has the potential to be a body corporate, is that other foreign law entities may merit classification as “opaque” for UK tax purposes by virtue of being a body corporate without there being any need to identify by reference to other factors whether such an entity is more akin to a partnership or a company.
- Distributions whilst non-resident: similar to point 2 above, a distribution made to a non-resident may be exempt from UK tax provided that the recipient of the funds can demonstrate the non-mingling or use of funds in the UK.
Beware the HMRC!
The tax man cometh! The Treasury has committed to increased spending across HMRC, allowing it to focus on tackling tax evasion, avoidance, and non-compliance. In particular, spending will allow HMRC to create specialist personal tax units to enquire into individual’s domicile status and target serious non-compliance by trusts, pension schemes, and non-doms, as well as a more general extension of the customer relationship model for individuals with wealth between GBP 10 million and GBP 20 million.[14]
In Embiricos v CRC [2022] STC 232, which concerned the application of partial closure notices (PCNs) where HMRC disputed a claim by a taxpayer that he was not domiciled in the UK, HMRC can now force a taxpayer to disclose overseas income and gains and demand that they pay the tax due on this prior to resolving the question of domicile status as a separate matter.
Conclusion
It is clear that enforcement action is part of the government’s plans to tackle the deficit. The pandemic has shone a light on existing issues for taxpayers and it has also created new ones. At a time when many taxpayers are trying to get back on their feet, HMRC’s emboldened approach to disputes could create further financial setbacks and cashflow issues. Tax advisers will play a crucial role in ensuring their clients do not come unstuck with the stricter approach HMRC is expected to take in 2022 and beyond. Clear communication is key, and advisers should be in frequent correspondence with their clients to enable them to assess and mitigate any risks before it is too late.
[1] Shadow Chancellor Rachel Reeves has announced that the Labour Party will ‘abolish non-dom status, which top Tories have benefitted from while raising taxes on working people’. The announcement follows the recent controversy over the tax status of Akshata Murty, the chancellor’s wife.
The Labour Party’s press release states that a Labour government would:
∙ ‘Abolish non-dom status, and introduce a modern scheme for people who are genuinely living in the UK for short periods to allow us to continue to attract top international talent. This would put an end to the broken 200-year-old system that lets people dodge millions in tax, and bring our rules into line with those of system similar to other major economies like France, Germany and Canada.
Writing in Tax Journal, former Treasury minister David Gauke observed: ‘The concern has always been that abolition will cost more revenue than it will raise. By definition, non-doms have looser ties to the UK than most of us and have choices as to where to live. Typically, they already pay a lot of tax directly to the UK exchequer, so the risk is that the entirety of this revenue is lost if they cease to be resident here.’
‘I put these points as questions not assertions because the nature of this debate is that there is much uncertainty as to the answers,’ Gauke wrote. ‘The Treasury or HMRC (or anyone else) cannot predict with much confidence what the behavioural response will be to a change of policy. The sky has not fallen in so far, some will argue, but an ill-judged reform could still provoke a fiscally and economically damaging behavioural response.’
[2] E.g., In 1799 the major market for overseas products was in fact the UK so, in general, profits achieved on overseas products could only be realised once those products were either delivered to the UK in kind or were financially traded through a bill of exchange and the proceeds brought into the UK.To accommodate this, the then PM concluded that foreign income and profits should be taxed only when they had been brought into the UK; hence the remittance basis was born. The original concept of the remittance basis was therefore one of timing.
[3] < https://www.taxinsider.co.uk/married-to-a-non-uk-domiciled-spouse-inheritance-tax-implications-ta > Accessed 20 July 2022
[4] < https://www.charter-tax.com/wp-content/uploads/2020/04/Helpsheet-Closely-Related-Beneficiaries-and-Onward-Gifts.pdf > Accessed 20 July 2022
[5] < https://www.taxjournal.com/articles/-offshore-trusts-onward-gifts > Accessed 20 July 2022
[6] Sample Tainted Clause in Trust Deed: “The Trustees shall have no power to accept any deemed domiciled addition and are prevented from doing so … where the trustees purport to accept a deemed domicile addition then
- To the extent that the deemed domiciled addition comprises the transfer of assets or other property by a settlor to the trustees or so as to otherwise be under the trustees’ control, the trustees shall hold the asset or property, any income or gain arising thereon upon bare trust for the settlor;
- To the extent that a deemed domiciled addition comprises the transfer of assets to or under the control of the trustees by the trustees of an additions trust, the trustees hereby declare that they shall hold the asset or property, any income or gain upon trust for the trustees of the additions trust in their capacity as trustees of the addition trust;
- To the extent that a deemed domiciled addition would provide an addition to the value of the Trust Fund otherwise than as above such addition shall not form part of the trust fund but shall be treated as a full or partial repayment of any loan owed to the trustees by the settlor or as a loan to the trustees by the settlor.”
[7] < https://www.blickrothenberg.com/app/uploads/2019/11/Protecting-tainted-trusts.pdf |> Accessed 20 July 2022
[8] < https://www.rossmartin.co.uk/overseas-residence/1441-changes-to-remittance-basis-concession-on-loans-from-overseas > Accessed 20 July 2022
[9] < https://assets-eu-01.kc-usercontent.com/220a4c02-94bf-019b-9bac-51cdc7bf0d99/98270e75-593d-4263-aefa-c7c46922610d/211221-CIOT-technical-news-treatment-of-loans-secured-on-foreign-income-or-gains-by-remittance-basis.pdf > Accessed 20 July 2022
[10] < https://www.spencer-west.com/articles/tax-planning-for-individuals-relocating-to-the-uk Accessed 20 July 2022
[11] < https://www.bdo.co.uk/en-gb/insights/tax/tax-support-for-professionals/temporary-non-residence-the-anti-avoidance-rules > < https://www.bdo.co.uk/getmedia/9a110ced-e759-47f8-ad63-21e68d91956e/Tax-Journal-Temporary-non-residence-the-anti-avoidance-rules.pdf.aspx> Accessed 20 July 2022
[12] < https://www.sullivanlaw.com/assets/htmldocuments/B1898496.pdf > Accessed 20 July 2022
[13] < https://www.taxjournal.com/articles/anson-entity-classification-revisited-08072015-0 > Accessed 20 July 2022
[14] < https://taxsummaries.pwc.com/united-kingdom/individual/significant-developments > Accessed 20 July 2022
