In October’s pre-Budget report, the Government proposed a tighteningof the regime for wealthy non-domiciles amidmuch fanfare.
The Treasury announced it was to impose a £30,000 charge on non-domiciled UK residents who had lived here for seven years in return for not paying taxon foreign income they keep outside the UK.
It was a policy designedto hearten the Labour faithful and to respond toa Tory pledge for a flat charge for non-doms.
But the draft legislation to accompany the proposals was only published last month, which raised alarm bells with tax advisersand specialist IFAs overthe retrospective tax hiton assets accrued in offshore trusts.
The Treasury also seemed to want to look much more closely at the income from UK-based residents and non-residents held in overseas trusts.
BDO Stoy Hayward senior tax partner Stephen Herring says: “In the pre-Budget report, it sounded like the big issue was the £30,000 charge. But when the draft legislation actually came out, we found it was much more far- reaching than that.”
Up to now, there have been important capital gains benefits in using an offshore trust. Non-doms are not charged tax onany capital gains within their offshore trustsunder existing rules.
PKF national director of tax Lisa MacPherson says: “When trusts made gains, capital gains tax was not attributable to the beneficiaries. There would only be a problem if a benefic-iary was a UK resident.”
But now tax adviserssay the proposals have significantly weakenedthe tax advantages ofan offshore trust.
Under the changes, non-doms are to be taxed on income and gains remitted in the UK under an offshore trust. This, says tax advisers, has the potential to disrupt a client’s offshore share portfolios, assets and property held in the ownership of trustees.
MacPherson says rules relating to the attribution of gains in an offshore trust to UK resident settlors will be particularly draconian. For legal purposes, a UK- resident settlor is the person who creates the trust. The new rules can apply where a member of the settlor’s family has an interest in the settlement.
She cites the potential impact on one of her clients. In 1980, while resident and domiciled in Chile, her client set up an offshore trust for his son. Fast-forward 28 years and the son now lives in the US but because the client has since settled in the UK, under the proposed changes, he will be taxedon gains realised fromthe trust.
MacPherson says: “TheUK-resident settlor will be taxed on them, even though he gains no benefit fromthe trust and his only connection to the UK isthat he happens to be currently living here.”
Moreover, until last Tuesday, clients looked like they faced a flurry of retrospective tax bills dating back to 1998.With the rule change looming in April, exasperated tax advisers were unclear whether they should be urging their clients to dump their offshore trusts altogether.
In a hastily prepared letter to tax partners sent last week, HMRC acting chairman Dave Hartnett sought to allay fears.
Harnett insisted the intention was not to pry into foreign earnings, explaining that non-doms would not have to make additional disclosures about income and gains arising abroad.
He resisted calls forthe £30,000 charge to be scrapped but notably said the Government would not seek to retrospectively tax offshore trusts. Now only income and gains remitted to the UK will be taxable.
Herring says the Government has been “ham- handed” in its handling of the issue. He says Chancellor Alistair Darling would have been well advised to introduce only the £30,000 charge and not any of the additional measures.
He says the Governmentis playing a risky strategy with the ultimate reaction of affluent foreign City workers and the mega-rich still largely unclear. Herring says: “He would have been better off merely introducing the simple charge. It is a leap intothe unknown.”
Grant Thornton tax director Chris Mills insists that even with the changes, offshore trusts retain their IHT benefits. Offshore trusts have long been used bynon-doms as a haven against UK inheritancetax on offshore assets accumulated before they came to the UK.
Mills says they remain useful for inheritance tax purposes as clients can maintain control and flexibility of assets after family members have died. He says: “Trusts are no dead in the water.”
But as the legislation unravels, tax advisers have clamoured to urgea postponement of the new regime, at least until 2009.
Society of Trust and Estate Practitioners deputy chairman John Riches says the technical complexity of the provisions means it is highly unlikely that all issues will be fully resolved before the April deadline.
He says: “In the absenceof a postponement, we are still fearful that the flightof individuals and capital will continue.”
MacPherson considers that the continuing lack of clarity is causing “confusion and chaos”. She says: “We are facing a situation where clients are liquidating offshore companies and trusts which they may not have needed to do. It currently is not clear what taxpayersshould be doing.”
“There is a risk that, until this is clarified, people are still going to be leaving the UK and thinking about removing their capital.”