Piers Master and Lyndsey West consider the implications of the UK Finance Bill 2012 on non-domiciliaries and highlight the favourable conditions provided for those wishing to invest in the UK.
The UK Finance Bill 2012 contains several draft provisions relevant to the taxation of non-domiciliaries. There is one major piece of good news in the form of a new relief from the remittance rules for non-domicilaries making certain kinds of investments into the UK. There are also some minor but nevertheless welcome simplifications of the tax rules affecting UK resident, non-domiciled individuals. And finally there is one piece of negative news, namely, an increase in the annual remittance charge for non-domiciliaries who have been UK resident in at least 12 out of the previous 14 tax years. Assuming that these provisions are enacted in this year’s Finance Bill they will take effect from 6 April 2012.
These changes reflect the Government’s policy, set out in its June 2011 consultation document entitled ’Reform of the taxation of non-domiciled individuals’, to promote inward investment in business, to simplify the current remittance basis rules and, by increasing the annual charge for some non-domicilaries, to ensure a greater tax contribution from this group. The draft Finance Bill reflects the results of the Government’s consultation, as set out in the ‘Summary of responses to consultation’ published in December 2011. The Government has moreover committed itself not to make any further changes to the taxation of non-UK domiciliaries during the life of this Parliament (that is until the next general election due in May 2015).
This article begins by looking at what is potentially the most important change, that is, the new investment relief, before going on to examine the other, more modest, developments. The article also considers what the likely effects will be for non-domiciliaries.
The New Investment Relief
The new investment relief applies if the UK resident non-domiciliary, or a ‘relevant person’ in relation to the non-domiciliary, makes investments on or after 6 April 2012 in one or more UK private trading companies (‘target companies’). A relevant person includes, broadly speaking, a family member of the non-domiciliary in question or a company or the trustees of a trust in which the non-domiciliary or such family member has an interest or of which he/she is a beneficiary. The effect of the relief, which must be claimed by the non-domiciliary in question, is that non-UK income and/or gains used to make the investment are treated as not remitted to the UK (if they otherwise would be) provided the investment meets certain requirements. The investment must be made within 45 days of the remittable funds coming into the UK, it must be a qualifying investment and there must be no benefit from the target company to the non-domiciliary or to a relevant person. There is no minimum investment duration.
A qualifying investment must be by way of shares issued to the investor by the target company or by way of loan to such company. The target must be a private limited company (not a listed company, nor a limited liability partnership), which is an ‘eligible trading company’ or an ‘eligible stakeholder company’. The former is a company which carries on one or more commercial trades with a view to profit or which is preparing to do so within the two years following the investment. Moreover, carrying on such commercial trade must be all or substantially all that it does or is reasonably expecting to do once it begins trading (according to the Government response to the June consultation no more than 20 per cent of the company’s activities - normally based on turnover - can be non-qualifying). A trade for this purpose can include developing or letting commercial or residential property. In the original proposal it was intended that residential property would be excluded from the relief but this is now allowed, subject to the general anti-avoidance rule that prevents the non-domiciliary (or any relevant person in relation to such non-domiciliary) from receiving a benefit on non-commercial terms from the investee company. An eligible stakeholder company is one whose sole aim is investing into eligible trading companies and which actually holds such investments or plans to do so within the following two years.
If income or gains have been brought into the UK under the relief (so that there is no initial remittance) they will be treated as remitted subsequently if a ‘potentially chargeable event’ occurs after the investment has been made and if appropriate steps are not taken within the ‘grace period’ of 45 days after the potentially chargeable event.
A potentially chargeable event can take a number of forms, including if the target company ceases to be an eligible trading company or eligible stakeholder company, which would happen for example if its shares were listed. There will also be a potentially chargeable event if the non-domiciliary or a relevant person who made the investment sells all or part of his holding in the target company or if he or a relevant person receives value (other than income in the ordinary course of business) from the target company or from a company connected with the target company. Other situations where a potentially chargeable event occurs include where the target company fails to start trading (or investing in trading companies) within two years of the non-domiciliaries’ investment or where a relevant person having made an investment ceases to be a relevant person. As mentioned above, anti-avoidance rules will prevent the non-domiciliary or a relevant person from receiving benefits directly or indirectly from their investments.
If a potentially chargeable event occurs it will not result in a retrospective taxable remittance if mitigation steps are taken within 45 days. The original proposal envisaged a charge if mitigation steps were not taken within 14 days; the relaxation of this time limit is to be welcomed. Where the potentially chargeable event is constituted by sale of the qualifying investment then the required mitigating step is for the proceeds to be taken offshore or alternatively reinvested into another eligible trading company or eligible stakeholder company. For any other potentially chargeable event, in order to avoid a retrospective remittance charge, the entire investment must be sold and the proceeds taken offshore or reinvested within the grace period of 45 days. If the investment is unlikely to be easily saleable, provisions will need to built into the terms of investment requiring the ‘target’ to buy back or repay the investment made. Otherwise, there is a provision by which HMRC might extend the 45 day grace period ‘in exceptional circumstances’, but as an investor it would be undesirable to have to rely on this.
In its current form the relief does not extend to investment into partnerships, including limited liability partnerships (‘LLPs’), due to the risk of avoidance. However, because significant trading activity (including commercial property investment and private equity and venture capital funds) is conducted through partnerships, the Government is going to consider whether to widen the relief in next year’s Finance Act (Finance Act 2013).
The June consultation also raised the question of whether listed companies should be included within the category of permitted investee entities potentially within the scope of the relief. The difficulty of excluding them is that if a company is listed after an investment had been made into it, the company then ceases to satisfy the requirements for the relief and a potentially chargeable event is thereby triggered, requiring the investor to sell his holding. The Government has nevertheless decided not to extend the relief to companies listed on a recognised stock exchange, although according to the consultation response investments into companies quoted on exchange-regulated markets such as the UK’s Alternative Investment Market (‘AIM’) are in principle within the scope of the relief.
Apart from the points mentioned in the previous paragraph, which result from the way in which the relief in its current draft form is structured, there are a number of aspects of the relief which clients will need to bear in mind. First, any gain on eventual disposal of a target investment will be potentially liable to UK capital gains tax (‘CGT’). In order to avoid this UK resident non-domiciliaries would need to make their investment through a non-UK resident trust. If they do this, then any eventual gain on disposal of the investment will not be taxable on the trustees, who are non-UK resident. However, if a distribution were subsequently made to a UK resident, non-domiciled remittance basis user, there could be a charge to CGT if the distribution were remitted to the UK. Moreover because the investment will be made within the UK, any income arising on it, such as dividends or interest, will be UK source and as such in principle subject to UK income tax. Finally the UK resident non-domiciled investor will need to consider whether any inheritance tax planning is needed in relation to his/her investment holding which will necessarily be UK situated (therefore potentially giving rise to inheritance tax if, for example, the investor dies whilst directly owning the investment). It is possible that UK business property relief will be available in some cases, but only after the investment in question has been held for a minimum of two years. The availability of business property relief would need to be looked at on a case by case basis.
Since UK resident non-domiciliaries are likely to want to make these kinds of investments through trusts for the CGT reason mentioned in the previous paragraph, the question arises whether in fact the new relief really adds anything. If a UK resident or ordinarily resident, non-domiciled individual is beneficially entitled under a trust of which he himself is the settlor, then any trust income brought into the UK by the trustees for investment at present would normally be taxable on such an individual. In such a situation the proposed new relief is therefore helpful. However, as far as UK resident but non-domiciled beneficiaries who are not settlors are concerned, under the current rules the income/gains of an offshore trust could normally be brought into the UK by the trustees for investment without a remittance based tax charge on such individuals. (Care would be needed to avoid a charge on a UK resident or ordinarily resident settlor, as noted above). One advantage, however, of the new relief is that such investments can be made without having to go back over the history of the trust to see whether any unexpected remittance based charges might arise as the result of inward investment into the UK. Furthermore some UK resident non-domiciliaries might wish to add offshore income or gains to a trust specifically for the purpose of investing into the UK. In such cases, in absence of the relief, there would be a remittance basis charge on such an individual as the result of bringing money into the UK for investment. The new relief will obviate this. And for those individuals who do not wish to make the investment through a trust structure, the new relief is clearly beneficial.
Increased Remittance Basis Charge
With certain exceptions once a non-domiciliary has been UK resident in at least seven out of the previous nine tax years, then in order to continue to be taxed on the remittance basis, he/she must pay an annual charge, which since the charge was introduced in 2008 has been fixed at £30,000. Under the Finance Bill 2012, however, for non-domiciliaries who have been UK resident in at least 12 out of the previous 14 tax years the charge is to be increased to £50,000 per annum.
As an approximate indication, individuals at present (and from 6 April 2012) need to consider whether they will be better off by paying the £30,000 charge (and so being taxed on the remittance basis) once they have annual unremitted income in the region of at least £95,000 or annual unremitted gains of at least £120,000. UK resident non-domiciliaries potentially liable for the £50,000 charge will need annual income of at least (approximately) £140,000 or annual gains of at least (approximately) £190,000 before it would be worthwhile for them to consider claiming the remittance basis and paying the charge. However the actual figures in specific cases are likely to vary widely depending on a number of factors and the position needs to be looked at carefully on a case by case basis.
Simplifying the Existing Remittance Basis Rules
De Minimis Remittance of Nominated Funds
In connection with paying the £30,000 charge mentioned above a taxpayer must nominate specific unremitted income and gains to be ‘matched’ against the £30,000 charge. Such nominated income and gains are treated as already having borne tax. The purpose of the legislation in requiring such matching is to enable the £30,000 charge to be recognised as a credit, if necessary, under a double tax treaty. However, individuals who do not need to rely on a double tax treaty can rely on a deeming provision in the legislation which treats them as having nominated the full £30,000 even if they have nominated less than this.
There is, however, a complication in that if any of the nominated income or gains are in fact brought into the UK before any funds not so nominated then the so-called mixed funds rules come into play. These rules determine the order in which income and gains are to be treated as coming into the UK from mixed funds, that is, from bank accounts in which income and gains from different sources have been mixed. Under these mixed funds rules the taxpayer is usually deemed to have brought into the UK first the slice of income or gain which bears tax at the highest rate. The rules are moreover complicated to apply. It is therefore usually important, wherever possible, to avoid the mixed funds rules from becoming applicable.
In order to avoid bringing the mixed funds rules into play, standard advice to UK resident non-domiciliaries paying the £30,000 charge, is to open a separate bank account to generate sufficient income to be nominated in each year in respect of the £30,000 charge. Such an account can then be ring-fenced with no remittances being made from it to the UK. As mentioned above, individuals not needing to credit the £30,000 under a double tax treaty do not have to nominate the full amount of the £30,000; such individuals might nominate annually as little as £1 of income. They are likely therefore to maintain a bank account holding a small amount for this purpose.
The proposed simplification under the Finance Bill 2012 is that a taxpayer may remit to the UK up to £10 of income or gains, which they have nominated for purposes of the annual remittance basis charge without bringing the mixed funds rules into play. This should mean that for individuals who choose to nominate only £1 of income, it will no longer be necessary to operate a separate bank account to hold nominated income without being taxed on that remittance.
Foreign Currency Bank Accounts
At present foreign currency bank accounts are chargeable assets for capital gains tax purposes (subject to an exception for sums used for personal expenditure outside the UK). This means that each withdrawal of funds from such an account constitutes a part disposal on which a gain or loss can arise. The calculation of such gains and losses is complicated. However, HMRC has concluded that over time the gains and losses on such accounts tend to balance out. Under the draft provisions of the Finance Bill, foreign currency bank accounts held by both domiciliaries and non-domiciliaries would no longer be chargeable assets (although neither will they be capable of generating losses). This simplification is extremely welcome. Note though that currency gains and losses will still need to be calculated where assets, such as shares of foreign companies, are purchased using non-UK currency or where the taxpayer takes out a loan in a non-UK currency. Great care also needs to be taken with the definition of foreign currency bank account. Many investment managers hold ‘cash’ through forms of liquidity or money market fund which are not bank accounts, and so will not benefit from the new relief.
Taxation of Assets Sold in the UK
Under the current rules, bringing assets purchased overseas into the UK results in a remittance of offshore income or gains used to purchase such assets, although an individual may bring certain ‘exempt’ assets into the UK without charge. Exempt assets must satisfy certain conditions but fall within the following broad categories:
However, under the existing rules if any exempt item is sold in the UK, the individual is at that point liable to UK tax on remittable income or gain used to purchase the asset in question.
The new rule in the Finance Bill 2012 would remove the remittance based tax charge on an arm’s-length sale (other than to a relevant person) of an exempt asset in the UK. Under the draft legislation the sale proceeds would have to be paid to the vendor within 95 days of the sale and within a further 45 days after the final instalment of payment to the seller, the sale proceeds would have to be removed from the UK or used to make a qualifying investment under the new relief. This is a great deal more generous than the two weeks envisaged by the June consultation document for removing funds from the UK or for reinvesting them and, amongst other things, should render the relief more workable where assets are sold at auction (where time scales for payment can vary). Any gain realised on the sale would be subject to capital gains tax in the usual way.
We see as the most significant of the above proposals the relief for qualifying investments by UK resident non-domiciliaries into UK companies. The relief is widely framed and will certainly be of interest to UK resident non-domiciliaries wishing to invest in the UK, enabling them to do this more easily.
The various proposed simplifications of the remittance rule are potentially helpful in reducing the burden of administration for UK resident non-domiciliaries who are taxed on the remittance basis. Also welcome is the removal from the capital gains tax net of foreign currency bank accounts for domiciliaries as well as non-domiciliaries. Nevertheless in certain respects, including in relation to “mixed funds”, the operation of the remittance rules remains unduly complex and much scope for further simplification remains.
Piers Master Partners
Lyndsey West Professional Support Lawyer
Charles Russell Speechlys Cheltenham, Doha, Dubai, Geneva, Guildford, Hong Kong, London, Luxembourg, Manama, Paris and Zurich.