If non-domiciliaries thought the original proposals were onerous, they were in for a shock when the draft legislation was released.
Lawyers and accountants say it is more wide-ranging than the pre-Budget report. This is especially the case in the tax treatment of offshore trusts. Peter Harrup, tax partner at PKF, says the draft legislation will affect everyone claiming to be non-domiciled. He says: “The legislation is particularly likely to hit those with investments held in offshore trusts and companies where past income and gains going back for many years may become taxable if brought into the UK after April.
“Non-domiciled individuals may need to act before April 6 or they could be hit with big tax bills in future years.”
Deciding on what action to take is problematic, as the Government says the legislation is a work in progress and may still change. The deadline for responses to the consultation paper and draft legislation is the end of February which will leave advisers and clients with just a few weeks to plan.
The change to the taxation of trusts for non-domiciliaries is arguably the most significant aspect of the legislation. Until now, it has been possible for non-domiciliaries to remit gains from offshore trusts free of tax but this is set to change from April 6 and could lead to a significant reduction in the use of offshore trusts by non-domiciliaries.
The draft legislation says tax will be levied on gains to settlors (the person establishing the trust) within offshore settlor interested trusts as they are realised from UK-based assets. There will also be tax on gains remitted to the UK from trusts on non-UK-based assets, says Jonathan Conder, head of the private client department at law firm Macfarlanes.
The distinction between UK-based and overseas assets will make the former, such as London property, less attractive after April 6. Lawyers suggest that if trustees own a non-UK resident company that invests in UK property, a disposal of the property will lead to a capital gains tax charge for the settlor of the offshore trust.
Any gains remitted to the UK after April 6 from assets that were transferred to an offshore trust before April 5 will be subject to tax so lawyers recommend that existing trusts are reviewed. For UK-resident non-domiciled beneficiaries, all capital payments from offshore trusts will be subject to CGT from April 6. This includes realising gains on non-UK assets. This is a significant reduction in the benefits of offshore trusts.
Offshore trusts created by non-domiciliaries will also have to be reported. Conder says that if a trust is created before an individual becomes resident in the UK, it must be reported within 12 months of him or her becoming resident.
A non-domiciled resident in the UK must report offshore trusts within three months of creating them. Existing offshore trusts will have to be reported before April 5, 2009.
The Government is also proposing to change the tax treatment of offshore “close companies”, says Royal Bank of Canada. These companies are controlled by five or fewer shareholders. From April 6, it will be deemed that any gain on the disposal of assets will be attributed to the shareholders. If the asset is based in the UK, the tax charge will be levied when the gains are realised.
Non-domiciliaries have been able to gift income and gains to someone else, usually a member of his or her family, outside the UK. If the gift is not used for the direct or indirect benefit of the donor, it is possible to bring the income and gains into the UK in the future and not face a tax liability.
But the draft legislation states that where a gift has been made between “relevant persons”, who are regarded as being connected, the donor will be subject to tax. A relevant person is deemed to be a member of the donor’s family, spouse or civil partner. Conder says that gifts to trusts will be deemed to be given to relevant persons and therefore subject to tax.
It is suggested, therefore, that such gifts need to be made and then remitted to the UK before April 6, 2008.
The Government has announced a number of measures to stop non-domiciliaries remitting money to the UK free of tax.
One is known as source closing. Non-domiciliaries have been able to close down the source of income in one tax year, such as by shutting bank accounts, and then remit income from this source in a future tax year. But the draft legislation states that after April 6, income will still be taxed even if the source is closed.
Non-domiciliaries have been able to use foreign investment income to buy chattels – moveable personal property. It has been possible to bring these chattels into the UK free of tax until they are sold and money has been received.
But after April 6, any assets brought from foreign income or chargeable gains and remitted to the UK will be subject to tax. Conder says using unremitted income or gains to pay for services in the UK, such as legal fees, will be taxed as well.
If non-domiciliaries have been resident in the UK for four out of the past seven years and have stopped being resident for less than five years, they will be taxed on remittances of income and gains in the new tax year.
These and other measures in the draft legislation are a significant tightening of the remittance basis of taxation.
Conder says: “Many commonly used planning techniques, which have existed for many years, will no longer work.
“The legislation is drawn as widely as possible so any property or benefit received in the UK that has been financed out of non-UK income and gains will produce a liability to tax.
“In the past, it was possible to expand the benefits of the remittance basis of taxation so benefits could be received in the UK without tax being paid, in the future this will be far more difficult, if not impossible. This is particu-larly the case, given the res-trictions on the use of non-UK trusts and companies.”
Non-domiciliaries who have lived in the UK for seven out of the past 10 years will face a £30,000 a year charge or be taxed on their worldwide income and gains. Only those non-domiciliaries with less than £1,000 of unremitted income or gains in any tax year are exempt from the £30,000 charge.
This will be particularly onerous for US non-domiciliaries. They will not be able to offset the £30,000 charge against the tax they face in the US on their worldwide income and gains. This is because the £30,000 charge is not deemed to be a tax.
The draft legislation confirms the government’s decision to change the way tax residency in the UK is determined. Currently, there is no legislation covering residence. It is determined by case law and guidance from HM Revenue & Customs.
HMRC’s guidance comes through the IR20 document. This says that HMRC:
But in reference to the third point, from April 6, the Government will count days of arrival and departure when calculating whether individuals are tax-resident in the UK. The draft legislation suggests that people changing planes in the UK will not be counted as spending a day in the country. But Conder says that, for this to be effective, individuals have to remain in the part of the airport not accessible to members of the public. This means that if an individual lands at Gatwick, travels to Heathrow and flies out again, he or she will be deemed to have spent a day in the UK.
This could particularly have implications for people travelling from the Channel Islands through London to other countries.
The draft legislation is complex but it is difficult for non-domiciliaries to make final planning decisions until they see the final legislation. This will give them only a few weeks to restructure or unwind trusts and undertake other planning measures.
As well as leaving the UK, non-domiciliaries could hold assets in their own name. Lawyers say this will still enable them to bring capital into the UK free of tax.