Introduction

This article covers developments in the United Kingdom in and around a controversial proposal to change the attractive tax rules offered in the United Kingdom to “resident, nondomiciliaries,” individuals who reside in the United Kingdom but who have not formed an intention to remain there permanently. Broadly, these individuals are taxed only on U.K. source income, with non-U.K. income taxed only if “remitted” to the United Kingdom. This very advantageous regime has helped attract many significant wealth owners to the United Kingdom and has also helped to attract top finance industry personnel to London.

The final legislation announced as part of the budget published on 12 March reflects the considerable lobbying effort in and around the original proposals and has removed a number of worrisome elements of the original proposals. Uncertainties and concerns, however, still exist.  

Overall, the approach the United Kingdom took in its release of draft legislation preceding the budget was very heavy handed and reflected a failure to understand the real needs of the community of individuals who heavily contribute to the success of the United Kingdom in developing itself as a preeminent financial center. Complex proposals and a variety of suggestions for new reporting requirements on assets and income in trusts outside the United Kingdom ran contrary to a key objective of many wealth owners—to legally avoid the need to disclose worldwide holdings and to live under simple and transparent tax rules. Fortunately, the budget removed the immediate threat of trust reporting requirements, an important step back from the original proposals. The U.K. moves, described in more detail below, in the short term do not change the general approach of not taxing unremitted foreign source income, but in the medium term, they may well still encourage wealth owners to consider other tax-advantaged locations for residence, including Switzerland. For the financial services industry, Hong Kong and Singapore, with their “territorial” tax systems (foreign income is not taxed in these jurisdictions), may well benefit from the United Kingdom’s misguided approach. Unlike the United Kingdom and Switzerland, Hong Kong and Singapore offer the same attractive tax system to both their own citizens and domiciliaries and to foreigners—something that suggests that their systems will suffer less in the way of internal political pressure.

On 9 October 2007, the U.K. Chancellor of the Exchequer announced a wide range of new tax measures targeted at individuals who are resident but not domiciled in the United Kingdom. Draft legislation was subsequently published but gave rise to a flood of negative publicity. Her Majesty’s Revenue & Customs (HMRC) then made some “clarifications” in response to comments made on the new legislation, and the budget of 12 March 2008 evidenced important modifications to the original proposals—all designed to avoid alienating those taking advantage of the favorable regime. The headline points of the new rules follow.

Residence
The amount of time a person spends in the United Kingdom will determine whether he or she is resident in the United Kingdom for tax purposes. Previous HMRC practice has been to ignore days of arrival and departure when working out how long a person has spent in the United Kingdom in a tax year. As originally proposed, starting 6 April 2008, days of arrival and departure were to be counted with a limited exception for individuals passing through the United Kingdom in the course of a journey. The budget moved away from this strict approach, confirming that days of arrival and departure will not be counted in determining whether an individual has visited the United Kingdom for an average of more than 90 days in each year over a period of four consecutive years, one of the relevant residence tests. According to the budget, days are to be counted for the residence test when the individual involved is present in the United Kingdom (for other than transit purposes) at midnight on the relevant day, meaning that only overnight stays are, in effect, counted.

Remittance Rules
At present, the foreign income and gains of a person who is resident but not domiciled in the United Kingdom, or certain foreign income of a person resident but not ordinarily resident in the United Kingdom, are subject to U.K. tax only when the foreign income or gains are brought into the United Kingdom. This is known as the “remittance basis.” Starting 6 April 2008, significant changes to the remittance basis will come into force. The main points of relevance are as follows:

• A person whose foreign income and gains for a tax year exceed £2,000 will have to make a claim for the remittance basis to apply.
• A person who makes a remittance basis claim for a tax year will not be entitled to the personal income tax allowance (currently £5,225 for 2007/2008), the annual capital gains tax allowance (currently £9,200 for 2007/2008), and certain other allowances for that year.
• A person who has been resident in the United Kingdom for seven out of the previous nine tax years will have to pay a charge of £30,000 if he or she wishes to claim the remittance basis for a tax year. If the individual does not claim the remittance basis, the foreign income and gains of that tax year will be subject to U.K. tax on an arising basis, although unremitted income and gains of previous years will remain taxable on a remittance basis. The fact that a person does not claim the remittance basis in one year does not preclude him or her from making a claim in a subsequent year. If untaxed funds are remitted to pay the £30,000 charge, these funds will not themselves be subject to tax. The budget confirmed that the charge will apply only to adults, with an exemption provided for minors.
• The “source ceasing” rules will be abolished as of 6 April 2008. These rules allow income of one year to be brought into the United Kingdom tax free in a subsequent tax year on the basis that the source of the income is no longer in existence.
• Previously, for certain types of foreign income, it has been possible for a non-U.K.-domiciled person to claim the remittance basis in one year and not in the next. That person would then bring the foreign income into the United Kingdom in that subsequent year and could argue that it was not subject to tax. Under the new rules, this practice will not be possible starting 6 April 2008.
• The rules as to when a remittance occurs have been changed. The new definition has much wider application. Very broadly, for foreign income arising after 6 April 2008, a person will remit foreign income/gains when property representing the income/gains or property derived from it is brought to, or received or used in, the United Kingdom by or for the benefit of a “relevant person.” It also applies when payment is made for a service provided in the United Kingdom to or for the benefit of a “relevant person.” The meaning of “relevant person” is broad and includes a spouse, a relative, a relative of a spouse, a spouse of a relative, trustees of a trust set up by a person, and a company controlled by a person.
• The new remittance rules will also apply after 6 April 2008 to foreign income and gains that have arisen before 6 April 2008 so that references to a “relevant person” in the new definition are read as references to that individual.
• HMRC has confirmed that an individual will not have to disclose the source of foreign income and gains. It is not clear whether HMRC will use other rules to seek this information.
• Under the draft legislation, certain types of foreign income were not to benefit from the remittance basis. HMRC has in the budget confirmed that these types of foreign income should benefit from the remittance basis.

Mixed Funds
For different types of income and gain mixed in one account, new rules determine the order in which those types of income and gain come out of that account. In particular, if an account holds the proceeds of sale of an asset that has realized a gain, the gain will be washed out before the capital, rather than on a pro rata basis as is currently the case. These rules apply only when there has been a remittance and not to any other transfer of funds.

Attribution of Income Rules
The antiavoidance rules that treat income arising in an offshore structure as being that of the transferor or a person who receives a benefit from the structure continue to apply but are amended to take account of the new remittance rules.

Attribution of Capital Gains Rules
The antiavoidance rules that treat capital gains arising within an offshore structure as those of the settlor, or of beneficiaries who receive benefits from the structure, are extended so that:

• Trust gains, including gains made by offshore companies owned by a trust, are treated as being gains of a settlor if the settlor is resident in the United Kingdom and irrespective of his or her domicile. A non-U.K.-domiciled settlor can claim the remittance basis in respect to foreign gains made by the trustees.
• Gains made by companies owned by resident but not domiciled individuals will be attributed to those individuals so that the remittance basis will be available for foreign gains.
• Trust gains that are not subject to tax in the hands of the settlor (including foreign gains on which the settlor would be taxed if they were remitted) will be taxable as gains of U.K. resident beneficiaries who receive benefits from the trust irrespective of their domicile.
  • The changes in the draft legislation stated that gains attributed to non-U.K.-domiciled beneficiaries would be taxable on an arising basis, but the budget confirms that this was a mistake and that the remittance basis will be available to non-U.K.-domiciled beneficiaries.
  • Under the draft legislation, the rules were to operate by matching trust gains with benefits received so that the beneficiary would be deemed to make a gain in the tax year when the matching occurred. This meant that a deemed gain could arise to a beneficiary after 6 April when the new rules applied, even though the trust gains were made, or benefits received, in tax years prior to 6 April 2008. If this approach had been taken in respect to the deemed gain, it would have been taxable in the hands of a U.K. resident but not domiciled beneficiary. Under the current rules, that beneficiary would not be taxed on the deemed gain. Through the budget, HMRC confirmed that the new rules will not apply to gains made prior to 6 April 2008. Furthermore, the budget permits the trustees of non-U.K. trusts to make a one-time election to treat all assets held by the trustee or underlying companies as if they were sold and reacquired, thereby providing a “step-up” in basis. This election needs to be made on or before 31 January of the year following the tax year in which a capital payment is made to a U.K. resident beneficiary or where part of the trust fund is transferred to another trust.

Notification of Offshore Trusts
Under the draft legislation, a non-U.K.-domiciled person who set up a trust after 6 April 2008 would have had to notify HMRC that he or she had done so and give details of the trustees within certain time limits if he or she was a U.K. resident or if he or she were to become a U.K. resident. These rules were also to apply to non-U.K.-domiciled settlors who set up trusts since 19 March 1991 and did not otherwise notify HMRC that they had set up such trusts. The rules did not require disclosure of any of the assets put into the trust but were still a cause for great concern. The budget has confirmed that there are to be no new reporting requirements in relation to trusts created by those who are resident, nondomiciliaries.

Irish Income and Gains
The remittance basis has not applied to Irish income and gains in the past. Starting 6 April, it will be treated in the same way as other foreign income and gains so that the remittance basis will be available.

Capital Gains Tax
The capital gains tax rules are to be simplified. The indexation allowance and taper relief will be abolished for gains made by individuals and trustees after 6 April 2008, and the rate of capital gains tax will be fixed at 18 percent. This change will benefit some people but not others.

Summary
There were a number of errors and uncertainties in the draft legislation, and the 12 March budget has addressed many of these. A particular concern for U.S. citizens resident in the United Kingdom related to the question of whether the payment required of longer term residents claiming nondomiciled status would be creditable for U.S. tax purposes. As originally proposed, the charge was stated to be a “fee” rather than a “tax,” a problem under U.S. tax law, which provides credits only for foreign taxes or certain equivalent charges. The budget has now moved to address this issue by treating the payment as a tax.

Despite the softening of the approach originally announced, the changes will have a profound effect on individuals who are resident but not domiciled in the United Kingdom and on offshore structures that they have set up or from which they can benefit.

This news item is from the Private Banking Helpdesk, an online information and training service offered by LawInContext, the interactive knowledge and training venture of Baker & McKenzie. This contribution on the United Kingdom was updated by Philip Marcovici, CEO of LawInContext Pte. Ltd. in the Zurich Office of Baker and McKenzie, and based on an original article written by Nigel Beadsworth of the London office of Baker & McKenzie.