Too Good To Leave

GRAHAM CALLARD presents some practical points in respect of non-domiciliaries who are resident in the United Kingdom.

THE CONTROVERSIAL TAX breaks afforded to United Kingdom resident non-domiciliaries have attracted many wealthy people to the United Kingdom but, despite media attention, successive Chancellors have not legislated against this perceived tax leakage.

The Chancellor has, however, announced that the Government will be reviewing the tax treatment of non-United Kingdom domiciliaries, and it is likely that the consultation will begin in the autumn. This article will cover the key practical points to the current tax treatment of resident non-United Kingdom domiciliaries.

Statutory references are to the Taxes Act 1988 unless otherwise specified.

What the terms mean

Domicile

At birth every person is attributed a domicile of origin taken from the person upon whom he or she is dependent, for example the child's father. Later a domicile of choice may be acquired by residing in another country with the intention of staying there indefinitely.

Residence

Broadly, an individual is resident in the United Kingdom if:

• he is physically present in the United Kingdom for over 183 days during the tax year; or
• on average spends over 91 days over four consecutive years; or
• arrives in the United Kingdom with the intention of staying for over three years.

Ordinary residence

There is no formal definition of ordinary residence, but it is generally understood that a person will be treated as ordinarily resident if he habitually spends substantial periods of time in the United Kingdom. The Inland Revenue booklet IR20 gives practical guidance, and indicates that a taxpayer becomes ordinarily resident after three years.

Domicile rulings

Generally, the Revenue will not give rulings on domicile unless there is an actual tax liability at issue. In some instances it may be necessary to generate overseas income or gains to facilitate a ruling. In such circumstances, the Revenue form DOM1 should be completed in order to obtain a domicile ruling, which is vital prior to giving any practical advice.

Remittance basis

United Kingdom resident non-domiciliaries are subject to the remittance basis on their foreign source income and gains. This position has arisen by the gradual erosion of the original remittance basis established in the early part of the nineteenth century. Indeed, the first inroads into the general use of the remittance basis for all taxpayers was in respect of income from offshore securities and rent which, up to 1914, were taxed on a remittance basis. However, following the enactment of section 5, Finance Act 1914, the basis of assessment for these sources of income was changed to arising basis. Further restrictions to the application of the remittance basis were made in the Finance Act 1940 in respect of overseas trades and employment, then again in the Finance Act 1974 after some aggressive post war tax planning schemes were litigated.

The current position is that the remittance basis applies to receipts in the United Kingdom by resident non domiciliaries in respect of the following sources:

• capital gains on assets situated outside the United Kingdom;
• income assessable under Schedule D, Cases IV and V;
• foreign emoluments (as defined in section 192, Taxes Act 1988) assessable under Schedule E, Case III;
• income assessable under sections 739 and 740;
• overseas income from settlements assessable under Part XV, Taxes Act 1988;
• offshore income gains assessable under section 761, Taxes Act 1988.

The remittance of overseas income or capital gains is clearly a question of fact and the rules applying to all sources of income and gains are generally similar. There are, however, slight variations in the rules depending on whether the remittance is of Schedule D income, Schedule E income or a capital gain. For example, the remittance basis for Schedule D, Cases IV and V must be claimed under section 65(4), whereas the remittance basis will automatically apply in respect of Schedule E, Case III income and remitted offshore capital gains. When making a claim under section 65(4), taxpayers should be aware that under section 1A, interest taxed on an arising basis is normally assessed at the starting rate of ten per cent, then the lower rate of 20 per cent, and finally higher rate of 40 per cent. However, when the remittance basis applies to Schedule D, Cases IV and V income, the provisions of section 1A(4)(a) withdraw those rights from application and the taxpayer will be assessed to tax in accordance with the rates under section 1. This effectively means that overseas income assessable under Schedule D, Case IV or V on a remittance basis will be taxed at the basic rate, 22 per cent, rather than the lower rate.

In addition, the Revenue considers that overseas dividend income on the remittance basis is also taxed under the section 1 rate of ten per cent, 22 per cent and 40 per cent, rather than the rates normally applicable to dividend income of ten per cent and 32.5 per cent. Thus, if substantial overseas dividend income is to be remitted to the United Kingdom, the taxpayer would be advised to consider the merits of whether a claim under section 65(4) should be made.

The provisions of section 65(6) to (9) were passed to prevent the avoidance of tax by borrowing from a bank and repaying the debt offshore from overseas income, thereby avoiding the impact of the remittance basis.

A deemed remittance will arise under section 65(6) to (9), when non United Kingdom domiciliaries who are ordinarily resident in the United Kingdom use overseas income to satisfy any United Kingdom loan or interest on such loan, any offshore loan brought into the United Kingdom and any debt incurred in satisfying any of those borrowings.

Tracing funds

The basic principle of tracing is in theory straightforward and operates where overseas income is converted into offshore assets, which are subsequently realised, and the proceeds transferred to the United Kingdom. The transmission of the proceeds will be treated as a remittance of the overseas income which then crystallises a tax charge.

The actual mechanics of the remittance is irrelevant provided that, as the Revenue Inspector's Manual at paragraph IM1564 indicates, the proceeds are in a 'commercially recognised form of money, for example cash, notes, cheques, promissory notes, bills of exchange or financial credit'. The paragraph goes on to make clear that the 'money does not have to be physically imported. It may be received from another United Kingdom resident in respect of the transfer to him abroad of money or assets representing the income. The money need not be received by the taxpayer himself but by a third party on his authority, for example in settlement of a debt between the taxpayer and the third party'.

In addition to this, and to clarify matters, the Revenue has confirmed that overseas income used to acquire assets abroad which are then subsequently brought to the United Kingdom will not constitute a taxable remittance provided that the assets are not in one of the commercially recognisable forms of money. Therefore, the purchase of an antique piece of furniture or a valuable painting would not be a remittance until the asset was actually sold.

Mixed funds

If the overseas income taxable under the remittance basis were to be mixed with funds which were either not taxable or taxable on an arising basis because either the income accrued when the non domiciliary was not United Kingdom resident or the income had been subject to tax already, then the Revenue has confirmed in its Inspector's Manual at paragraph 1568 that any subsequent remittance will be deemed to be made in respect of the non taxable arising basis income first. This decision has been largely based on the facts that arose in the Duke of Roxburghe's Executors v Commissioners of Inland Revenue 20 TC 711.

On the other hand, if the mixed fund consists of income and capital gains taxable on the remittance basis, plus capital arising from other sources such as gifts or capital gains that have already suffered United Kingdom tax, then it is the Revenue's view that the Lord Chancellor's ruling in Scottish Provident Institution v Allan 4 TC 591 is authority that remittances to the United Kingdom will be deemed to be made from income and gains taxable on the remittance basis first.

Where there is a danger of income and gains being remitted to the United Kingdom which will result in a United Kingdom tax charge, most well advised resident non domiciliaries will arrange their affairs so that taxable income and gains remain abroad, and only sums not subject to the remittance basis come to the United Kingdom.

Credit and charge cards

Many offshore banks and credit card companies provide credit and charge cards to United Kingdom resident non- domiciliaries for use in the United Kingdom and the rest of the world. Payments for these credit facilities from foreign income, according to the Revenue (see Inspector's Manual at paragraph IM1569), can amount to a taxable remittance even if made direct to the offshore lender.

The rationale behind the Revenue's thinking is that the lender is merely acting under the authority of the non-domiciliary in settling the account of the United Kingdom supplier of goods and services, thereby constituting a taxable remittance. A number of commentators consider this view to be flawed, since there will be a contractual relationship between the lender and the supplier of goods and services, plus another separate contract between the lender and the non domiciliary.

In law there is no contractual relationship between the non-domiciliary and the supplier that results in a debt between the two, and this makes the Revenue view all the more curious. Since the Revenue seems to be entrenched in its view regarding credit cards, if the non-domiciliary prefers not to incur professional costs in arguing a case, it would be advisable to settle credit and charge card liabilities from sources not subject to the remittance basis.

Dual or split employment contracts

It is important for United Kingdom resident non- domiciliaries employed in the United Kingdom who are in receipt of foreign emoluments to arrange their employment contracts in a tax-efficient way. Section 192(1) defines foreign emoluments as emoluments of a non-United Kingdom domiciliary from an office or employment with an employer not resident in the United Kingdom. Section 192(2) states that foreign emoluments in respect of non-United Kingdom duties from an office or employment are exempted from Case I of Schedule E. Section 19(1) further provides that foreign emoluments of an employee resident in the United Kingdom will be assessed on a remittance basis under Case III of Schedule E.

Non-United Kingdom domiciliaries who carry out their employment duties partly in the United Kingdom and partly abroad often have two contracts of employment with their non-resident employer. The first contract deals with the employee's United Kingdom duties, and emoluments from this contract will be assessable under Schedule E, Case I. The second contract deals with the employee's overseas duties and emoluments from this contract will be assessable to Schedule E, Case III on a remittance basis under the provisions of section 202A(1)(b). In addition to this, section 132(5) also makes it clear that the deemed remittance provisions of section 65(6) to (9) applicable to Schedule D, Cases IV and V, also apply to Schedule E, Case III.

If the Revenue believes that the taxpayer has allocated a disproportionate amount of the total emoluments to the contract dealing with overseas duties, then the Inspector may consider challenging the taxpayer under paragraph 2(2) of Schedule 12, so that the emoluments are apportioned on a more commercial basis. Care has to be exercised here that the split of United Kingdom and overseas duties as a matter of fact reflect the true position.

United Kingdom property

Resident non-United Kingdom domiciliaries invest in United Kingdom property assets for a number of reasons. It may be that the property is to be used as the principal private residence for the investors themselves, or a relative. Alternatively, the property may have been acquired purely for investment purposes to provide an income stream and capital growth. Ownership of the property may be held personally by the investor, a non-resident company, a trust, or a combination of any of these.

The most appropriate structure for holding the investment will, to a very large extent, be governed by the reasons and motives behind the acquisition. For example, if the property were acquired for investment purposes, it would normally be directly owned by a non-resident company. Care has to be exercised to ensure that the effective management of the company is not within the United Kingdom; otherwise the company will be treated as United Kingdom resident irrespective of where it was incorporated. If the non-resident company were owned and the company controlled by the trustees of an offshore trust, then provided that the United Kingdom resident non-domiciled investor takes no part in the effective management of the company, it is hard to see how a challenge to the company's residence could be substantiated.

If the company is treated as non-resident, it will not be subject to corporation tax on its chargeable gains and, since the anti-avoidance provisions of section 13, Taxation of Chargeable Gains Act 1992 do not apply to non-United Kingdom domiciliaries, any property investments sold by the company will escape United Kingdom tax completely. The only tax charge that will arise is in respect of rental income since it is paid to a non resident landlord and will be subject to income tax deduction at the basic rate, currently 22 per cent. Under section 42A, the offshore company as a non-resident landlord may apply to the Revenue's Financial Intermediaries and Claims Office to fall within the self-assessment régime, and therefore for approval to receive rents gross without income tax deduction. Revenue approval will only be granted if:

• the landlord's tax affairs are up to date;
• the landlord has not had any United Kingdom tax obligations in the past; or
• he does not expect to be liable for United Kingdom tax on those rents.

Failure to obtain approval requires agents or tenants, if no agent acts for the landlord, to deduct income tax from the rents paid to the landlord and account for this to the Revenue on a quarterly basis.

Overseas asset disposals

Under section 12(1), Taxation of Chargeable Gains Act 1992, individuals who are resident or ordinarily resident non-United Kingdom domiciliaries will be assessed to capital gains tax on remittances to the United Kingdom of overseas capital gains. Unlike Schedule D, Case IV and V income, there is no claim to be made as the remittance basis is automatic and whether a remittance has been made will be a question of fact.

The Revenue says that partial remittances of the proceeds of disposal of an overseas asset on which a capital gain has been realised will be deemed to include a proportion of the gain arising. For example, where the proceeds of an asset sale were £10 million and the capital gain £1 million, if proceeds of £2 million were remitted to the United Kingdom then ten per cent of the gain would be deemed to have been included in the remittance and therefore taxable. If the non domiciliary settled the asset in an offshore trust prior to disposal, any resulting capital gain will not be represented by money or money's worth and, as such, the settlor is unable to remit the gain to the United Kingdom; therefore, it will entirely avoid United Kingdom tax. The Revenue confirms this position in its Capital Gains Tax Manual at paragraph 25331 when it says, 'the gains arising on the making of the gift can therefore never become assessable'.

Any capital gain on a subsequent sale of the asset by the trustees will be within the provisions of sections 86 and 87, Taxation of Chargeable Gains Act 1992 and, since they do not apply to non-United Kingdom domiciliaries, all gains remitted to the United Kingdom would not suffer United Kingdom capital gains tax at all. This is likely to be an area of the legislation that the Chancellor will review closely.

Future changes?

Many commentators believe that if the Chancellor were to introduce changes to the current tax treatment of non-United Kingdom domiciliaries, it will be to the remittance basis rules. The Chancellor could introduce a new capital gains tax deemed domicile rule which would withdraw the remittance basis to non-domiciliaries if they reside in the United Kingdom for 17 out of the last 20 years.

Graham Callard LLB (Hons), barrister, is a tax adviser at Howard Kennedy, Solicitors and can be contacted on 020 7546 8967 or on g.callard@howardkennedy.com.

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