Accident of birth

KEY POINTS

• Current consultation on domicile is a chance for reform.
• Have the FA 2008, Sch 7 changes been counter-productive?
• Following consultation, the Budget 2011 Red Book promises no substantive changes in this Parliament.
• Some suggestions for change.

The UK tax system is complex. It has the kind of complexity that has developed through years of legislation being devised to deal with old concepts of what is to be taxed.

Changing the legislation is often difficult, but changing some of the concepts can be agonisingly controversial.

However, there exists at this time the opportunity to make changes that will reduce the convoluted nature of UK tax legislation, bring parts of it into the modern world and perhaps even encourage investment.

An individual’s liability to tax in the UK has its roots in three concepts: residence, ordinary residence and domicile. Closely linked with domicile is the remittance basis of taxation used to tax those who are not UK domiciled.

The residence concepts are to be formalised in legislation next year. The third concept – domicile – is something that the UK tax authorities and, I suspect, many others, would love to remove.

The legal concept of domicile can be traced back to Roman times, and in the UK and in many other countries it is used to identify which jurisdiction applies to a person. It is a basic essential in the structure of our laws and cannot be removed altogether.

The question before us now is: do domicile and the remittance basis form any sensible basis for taxation in modern times?

Further consultation on changes to these rules will take place later this year. We should seize the opportunity to press for a complete resolution rather than prolong the struggle.

The winds of change

In any time of financial difficulty, governments take the opportunity to point the figure of blame at those that do not pay their ‘fair share’ of taxes.

Tax havens, offshore companies and, in the UK, non-domiciled individuals (‘non-doms’) all receive attention.

Very often little is done, but in 2008 the UK took action that started to bring to an end an anomaly that has been allowed to exist since the earliest days of UK taxation: the right of a tax-resident individual without UK domicile (for example, because they or their father were born in another jurisdiction) to avoid UK tax on certain income and gains earned overseas unless the income or gains are brought into (‘remitted to’) the UK: in effect, being taxed according to an accident of birth.

This was not the first time that government had considered this political hot potato.

However, each time it has been raised, the nightmare of foreign investors disappearing overseas with their wealth has worn down the political will.

A Law Commissioner’s report recommending proposals for modernisation was not acted upon by the Conservative government in the 1990s on the grounds that the practical benefits did not outweigh the risks (presumably of wealthy foreign investors abandoning Britain) of proceeding with the introduction.

However, the tax law was changed to bring non-doms into the UK inheritance tax net if they had been tax resident for 17 out of the past 20 years.

This really only added to the anomaly, as very long-term tax residents could suffer inheritance tax on their world-wide assets when transferred to others even though any income or gains from those assets escaped UK tax.

Such is the nature of inheritance tax that, with reasonable advance planning, even a charge under this legislation could be prevented. (See also Not quite the same.)

The hot potato was once again picked up by the Labour governments (1997 to 2010), which had a certain zeal when it came to dealing with tax avoidance.

In 2003, a UK Treasury paper reviewing the rules of residence and domicile was issued to set out various principles underpinning modernisation, such as fairness, UK competitiveness and clarity.

The political will was strengthened by newspaper reports (perhaps politically orchestrated) when it was revealed that some substantial financial contributors to the major political parties were, in fact, paying less UK tax than one would have expected because of their non-dom status.

Changes blow in

And so – to the sound of muffled squealing from the self-interested – complex, and in some ways draconian, laws were introduced from April 2008 to widen the tax net on non-doms’ income and gains.

Much of this covered some of the more prevalent tax-avoidance techniques and, like so much of such legislation, it impacted on more innocent situations as well. Most significantly, the remittance basis of taxation (which only seeks to tax non-doms’ foreign income and gains if brought into the UK) would be brought to an end if the non-dom taxpayer had been UK tax resident for seven out of the past nine tax years.

However, two significant ‘exceptions’ were also introduced. The first was a de minimis limit on offshore income and gains which would not be taxed (if not remitted) where the burden of collection was considered to outweigh the tax haul.

The second was a fixed annual ‘tariff’ of £30,000 that could be paid to allow an individual to continue to benefit from the remittance basis. In short, and rather cynically, one prevented the burden of additional administration in government departments and the other benefitted the very wealthy. And thus the anomalies increase.

The current coalition government has announced that it will again review the taxation of non-domiciled individuals. At present it is proposed to:

• exempt from UK tax foreign income or gains if remitted to the UK by a non-dom for the purpose of commercial investment in UK businesses;
• simplify some aspects of the current rules to reduce administration; and
• increase the £30,000 tariff to £50,000 for non-doms who are UK tax resident for 12 or more years if they wish to make use of the remittance basis of taxation.

Following consultation, there will be no substantive changes to the non-domicile rules for the remainder of this Parliament. So this is an opportunity for change that is not to be missed.

Non-reform: the case against

Those against reform often argue that changing the non-domicile rules and remittance basis will lead to fewer wealthy individuals coming to live in the UK, less investment and fewer jobs.

Those already here will leave. Some argue that removing tax non-domicile status is ‘anti-business’ as some of our leading entrepreneurs are non-doms.

Hence the government’s current proposal to allow non-doms to remit foreign income and gains for UK investment tax-free.

In support of the non-reformists’ argument it has been claimed – based on some HM Treasury statistics – that the 2008 tax changes may already be leading to an exodus of non-doms.

The number of non-doms claiming this status on their tax returns fell by approximately 16,500 in 2008/09 and only about £162 million was raised from the £30,000 tariff – considerably less than HM Treasury had hoped for.

These figures in isolation prove nothing, and there seems to be little more than anecdotal evidence that the changes so far have had a material effect on government revenue or non-doms investment behaviour.

The first statistic is based on the numbers of tax returns on which the taxpayer has ticked a box claiming non-domicile status. Many may simply not bother now.

The fact that the £30,000 tariff raised less than expected perhaps demonstrates that there is less tax at stake, and so less risk to the economy from changing the rules.

Furthermore, the benefits of the UK tax non-domicile rules cannot be the only reason for a person to come to the UK to work or invest. It might help, but a country’s attractiveness to business is only brought about through a mix of other factors: the existence of skills, a stable political environment, availability of finance, markets, workforce and infrastructure to name but a few.

The tax system will be a part of that mix and both business and individuals need to accept that – to support a country’s political, legal and business environment and so enable them to earn money themselves – taxes must be endured.

The focus should be on ensuring that tax on money earned by those who benefit from the UK environment is set at a more acceptable level and that it is collected across the population fairly, reflecting risk and reward.

The opportunity

It is clear from the 2003 Treasury paper, the 2008 legislation (albeit put in place by a government which took a different point of view), and increased public hostility, that the non-dom concept in tax is nearing an end.

Currently – and no doubt as a result of the proposed reforms – it is gradually being strangled (for most people) by legislation. Rather than prolong its life unnecessarily, perhaps the humane thing would be to dispatch
it now.

It is well recognised that this ancient concept of domicile has been much abused by long-stay UK tax residents.

There are many cases of individuals who were born and raised in the UK who are still able to establish that they are non-doms.

With public figures now renouncing their tax non-domicile status (presumably by not claiming the benefit of the relief – and so contributing to the statistics above) and continued political pressure to reform, this surely creates the right opportunity to introduce some modern thinking that will be attractive to globally mobile workers and investors.

The saga in dealing with the UK tax non-domicile rules, the related remittance basis and perceived tax avoidance demonstrates the typical pattern of UK tax legislation.

A long-standing anomaly is identified; papers are prepared and consultations take place; there is much discussion and views are expressed and noted; changes are made; and complex legislation ensues.

Then more complex legislation on exemptions or exceptions is overlaid where oversights are spotted or political pressure is brought to bear. In time, further anti-avoidance measures may be added.

As Sir Humphrey Appleby (in Yes, (Prime) Minister) might have put it, ‘Years of fruitful work for government departments’ – and not a few lawyers and accountants in trying to make sense of it all.

Taking the pledge

A pledge was made before the last election to simplify the tax legislation.

We have seen some tentative steps taken towards this in other areas and any changes to the taxation of non-doms now should not only be clear as to purpose, but they should also be long term and with little risk of tinkering to restore the confidence of those coming to add value to the UK economy.

In addition to adding certainty in the law, it is essential to retain the attractiveness of the UK to overseas investors and businesses.

So the government needs to balance fairness (by taxing long-term tax residents on a similar basis) with the need to encourage newcomers.

In addition, they should also be encouraging wealthy individuals to stay in the UK and retain their wealth here rather than return to their country of domicile.

The current remittance basis – with, since 2008, its increasingly complex and very difficult-to-manage rules – merely means that anyone who can afford to keep foreign income and gains outside the UK will do so.

Non-doms are discouraged from bringing wealth to the country by taxes on what is brought in and happily ignoring what is not.

It would be interesting to compare the tax raised from the remittance basis of taxation with the additional spending and investment power that is being denied.

The proposal to introduce a UK tax exemption for income and gains remitted by non-doms if invested in UK businesses will bring a raft of terms and conditions to ensure there is no tax avoidance.

Layered on top of already convoluted legislation, we merely create a more complex situation for the UK. Detailed terms and conditions and anti-avoidance legislation will inevitably form a barrier to investment.

If fairness with other UK-resident taxpayers is to be sought, any relief offered to tax-resident non-doms surely cannot go beyond that offered to others.

Some modern thinking

So when it comes to consultation later this year on changes to the non-domicile rules, let us press for some common sense.

First, domicile. Remove the domicile rules from UK tax legislation. Tax individuals in accordance with their temporary tax-resident and habitual tax-resident status (see below) only.

Second, temporary tax residence. A simple but precise statutory definition and test for tax residence similar to the current ‘resident’ test. There are already proposals to do this but the tests should be mechanical and with limited anti-avoidance provisions or exceptions.

Third, habitual tax residence. This should also be defined in legislation along the lines of ‘ordinarily resident’. It should be automatically obtained where there has been a defined substantial period of tax residence – say seven out of the past nine tax years – or sooner if the taxpayer elects or arrives with the intention of settling in the UK.

Habitual tax residence should be the trigger to bring foreign income and gains into the charge to UK tax, but only after the assets have been revalued.

Before becoming habitually tax resident, income and gains on foreign assets should be allowed to be remitted to the UK tax-free. A UK tax holiday?

Not really: it would discourage the hoarding of assets abroad that could be used to benefit the UK economy; and it would remove the need for much anti-avoidance legislation and for a complex exemption for income and gains remitted for investment in UK businesses; none of which add substantially to government revenue or the wit and knowledge of mankind.

Fourth, revaluation of foreign assets. A revaluation of foreign assets on the triggering of habitual tax-residence status to prevent the taxing of gains made on foreign assets before that status was achieved.

Other jurisdictions apply similar rules. Individuals should not be required to contribute to the UK government from gains accumulated until there is an established nexus with the UK.

Fifth, ceasing to be habitually tax resident. The objective of taxation is to raise funds for government and it should be paid by those who enjoy the benefits that government brings.

The longer they enjoy them, the more they benefit. So, temporary tax residents only pay tax on money they earn here and habitual tax residents should continue to be liable to UK tax for a period of time once they leave the UK, with of course relief for any foreign taxes paid.

If there is a fixed intention to leave for a long period or not to return, that habitual tax-resident status should be removed and liability to UK tax also.

Just as those coming to the UK who are not habitually resident should be encouraged to remit foreign income and gains, so those going abroad should be encouraged to send money home by making no difference in tax terms as to whether income and gains are remitted or not.

There should be alignment between income tax and (existing) capital gains rules in temporary non-residence.

Finally, abandon the remittance basis. As already noted, the above presents the opportunity to remove the complex legislation introduced to charge foreign income and gains and prevent avoidance under the remittance basis.

The removal of the £30,000 tariff would also follow. The level of charge has no reason behind it, it is unlikely to be credited against tax suffered in other jurisdictions and, frankly, has the appearance of a ‘facilitation payment’ accepted in some lesser tax havens. (‘Just call it 30 grand, mate and we’ll say no more about it.’)

Less is more

Too simplistic? Too difficult? Will mechanical rules make it too easy to avoid UK tax? Is there a high risk of loss of tax revenue on introducing these rules?

Will people really bring assets into the UK rather than hiding them offshore? Will it discourage people taking short-term assignments overseas? Perhaps. There is always room for debate, but we should never ignore the chance to reform because of fear.

Tax is never perfect and we should not try to make it so by complexity. Most of the proposals above are within reach of the current system.

But to continue to tax individuals in an increasingly mobile world on the basis of cash (or asset) movements and an advantageous parentage can be justified no longer.

Issue: 4305 / Categories: Comment & Analysis , Residence & domicile