HMRC has written to a number of businesses that entered into tax planning arrangements promoted by Clavis Tax Solutions Limited that involved the creation of a Special Purpose Trust (‘SPT’) via an employment reward consulting firm (often referred to as ‘Clavis Herald planning’). HMRC’s letter invites these businesses to reach a financial settlement of the disputed liabilities.
HMRC has warned that anyone refusing the proposed settlement terms risks being pursued for higher penalties on the basis that any tax lost is due to deliberate behaviour (which would trigger a penalty of at least 35% of the tax and NIC instead of 15%) and being ‘named and shamed’. HMRC also gives heavy warnings that failure to settle the planning will mean that individuals with any outstanding loans will be taxed under the new 2019 loans charge.
Any business in receipt of HMRC’s letter wanting to settle and avoid the 2019 charge must register their interest with HMRC before 1 June 2018 (note that this deadline applies to all EBT type arrangements and not just Clavis Herald).
The settlement terms being offered to these selected businesses include the following:
- The company must agree that PAYE tax and NIC is due on the employment income paid through the scheme;
- The company must accept that it failed to take reasonable care and is liable to a penalty of 15% of the tax and NIC as well as interest for years where HMRC has issued valid assessments (‘protected years’);
- Employees who are Directors must reimburse any income tax paid by the employer for protected years or otherwise undertake that the tax paid by the employer will be shown as a benefit on a P11d for the Director in line with s223 ITEPA 2003 (‘secondary charge’).
- Other standard EBT settlement terms will apply e.g. credit will be given for tax paid by employees on loans if within time to make a claim, the employer will receive relief for any additional NIC in the earliest open year.
- The offer from HMRC states that in cases of voluntary restitution (i.e. where no valid assessments are in place and HMRC is now out of time) there will be no penalty, interest or a secondary charge on the Director. HMRC’s technical rationale for this is unclear but appears to be that the tax liability being settled is voluntary, not legally enforceable and not therefore within the secondary charge legislation.
In principle we would welcome any reasonable proposal from HMRC to resolve disputed liabilities without litigation. However, some questions are likely to arise in connection with the recent approach, including the following:
- HMRC are proposing to settle these cases on the basis of an acceptance of carelessness with a warning that an allegation of deliberate behaviour may follow if the offer to settle is not taken up. Will this offer also be made to other users of the Clavis Herald arrangements who have not received the letter and if not, why not?
- Is it sustainable to view a tax planning arrangement as automatically involving careless behaviour if clients were given tax advice from a qualified professional and completed tax returns in line with that advice?
- What about those clients who believed they acted in good faith and took particular care to ensure the transaction was completed correctly?
It is worth noting that the 2019 charge is based on outstanding loan balances, so the same amount of tax and NIC is not necessarily in play. In cases where HMRC has failed to protect its position and no loans are outstanding, there will be no requirement to settle any liabilities. The funds held in the SPT will be subject to PAYE only to the extent they are paid out in future.
The fact that HMRC is offering standardised settlement terms will be a relief for many because it will avoid the need to go through an enquiry and remove the threat of more significant penalties. The far more generous terms for voluntary restitution may make the terms attractive where HMRC has failed to protect its position in all or some years. Others may well be wondering why they should accept a degree of culpability when they believe they have done nothing wrong (even if there is more tax to pay). There will be many who continue to feel frustrated that guilt by association will cost them more than those settling on standard EBT settlement terms.
Trident Tax acts for a number of Clavis Herald scheme users and if you would like to discuss your options, please contact us.
Did you calculate the CGT on cryptocurrency transactions for your tax return correctly?
…and what happens if you didn’t? read more
HMRC in their capital gains manual have set out their views on how capital gains tax (CGT) should be computed on cryptocurrency, at CG12100 (here). These rules apply only where the individual is not trading in the cryptocurrency and is not otherwise liable to income tax on the transactions. The CGT exemption for foreign currency gains will not apply because HMRC say “cryptocurrencies are not recognised national currencies”, and the exemption is restricted to gains on currency in bank accounts. So, a capital gains tax calculation is likely to be needed.
There are some surprising results;
- Swapping one cryptocurrency for another generally gives rise to a tax liability if there is a profit
- Even if you haven’t made a dollar gain when exchanging crypto, forex movements may still result in a taxable gain as acquisition cost and proceeds must be converted to £ sterling
- There is a pooling treatment for holdings of the same currency, which effectively averages the price that currency was bought at when you calculate the gain.
- Failure to inform HMRC about gains on cryptocurrencies which you made before 5th April 2017 can give rise to harsh penalties; the deadline for doing so is 30th September 2018.
When is a holding of cryptocurrency subject to capital gains?
If a profit on cryptocurrency is subject to tax as a trading profit, then it is not also subject to capital gains. The question of what trading is, is a wide subject and not addressed in this article. However, as amateur day traders in stocks and shares are not treated by HMRC as trading, it seems likely that in many cases crypto transactions will be treated as resulting in capital gains or losses.
Cryptocurrency will be within capital gains tax if it is an “intangible asset”, which includes a bundle of rights arising under a contract. It seems likely that most cryptocurrencies will fall within this definition.
However, it may not apply to all forms of coins and tokens obtained in an Initial Coin Offering (“ICO”). Derivatives such as options and contracts for differences may also not fall within the capital gains tax rules in this way.
When do you crystallise a gain; moving between different types of cryptocurrency?
Generally, a gain will arise when proceeds are received in a “fiat” currency, (a “non-crypto” one), and if the proceeds are in a currency such as euro or dollars, this would need to be converted to sterling at the rate at that time. If one type of cryptocurrency is exchanged for another, the HMRC guidance says that this is regarded as a “barter” transaction. This means that one currency is treated as being disposed of at market value and the other currency is treated as being acquired at the same market value. In particular, this triggers a tax liability on the gain despite the owner not receiving a “fiat” currency such as sterling.
This would not be the case if the individual is not domiciled in the UK for tax purposes; we will consider this further in a future article.
When is a holding of cryptocurrency a “security” for capital gains tax purposes?
The capital gains tax legislation sets out specific rules, the pooling rules, which apply to “securities”. There has been debate about when cryptocurrencies are securities for regulatory purposes, but the tax definition is much wider. It applies to assets of a type which can be sold without identifying which particular asset is being sold, which includes shares, but also would generally apply to cryptocurrencies; a contract would be for the sale of a specified number of e.g. bitcoins.
Different types of cryptocurrency should not however be pooled.
How do you calculate the gains on a cryptocurrency pool?
You need to keep a cumulative total of the amounts invested in cryptocurrency, including both sterling and amounts invested via other “fiat” currencies, converted to sterling at the spot rate that day. Then for each disposal, you would calculate what percentage of your holding that represented and deduct that percentage of the cumulative cost from your proceeds. You would also deduct that cost from the cumulative cost total ready for the next calculation.
For individuals there are “bed and breakfasting” rules, which would identify an acquisition of shares with a disposal made in the 30 days previously; this acts to prevent individuals from crystallising a tax loss by disposing shortly before 5th April and then reacquiring.
The effect of this is that it averages the costs of your holding in determining what can be deducted from your proceeds. This may well be more advantageous than a “first in first out” policy would be, if you made your first purchases at lower prices. If you calculated the capital gains tax on cryptocurrency on your 2016/2017 tax return on a “first in first out” basis in error, you are still within the time limit to amend it onto a pooled basis to reduce your liability.
What happens to the pool on a “fork”?
The HMRC guidance also covers the tax treatment of “forks”, where a cryptocurrency splits. For example on 1st August 2017, each holder of a Bitcoin received in addition 1 Bitcoin Cash. You might expect that since you did not pay anything for the Bitcoin Cash, there’s nothing to deduct in calculating a gain on it. The HMRC Manual suggests that the pooled base cost in Bitcoin that you had at 30th July 2017 can be split between Bitcoin and Bitcoin Cash in the proportion that their market values had to each other on 1st August 2017.
Penalty regime unless tax is corrected by 30th September 2018
There is a tough penalty regime – Requirement to Correct – which applies to offshore assets, and for capital gains tax purposes, a holding of cryptocurrency is an offshore asset because it is not subject to UK law. So even if the individual is UK resident and makes the investment sitting at a laptop in the UK, if the platform is outside the UK, the cryptocurrency is an offshore asset.
This penalty regime applies where there has been a failure to notify; an individual who realised a capital gain in the tax year to 5th April 2017 and who has not received a tax return should have notified chargeability by 5th October 2017. If such an individual doesn’t correct their position by notifying HMRC of the gain by 30th September 2018, there is a potential exposure to penalties of up to 200% of the tax not corrected.
HMRC published their capital gains tax guidance in December 2017, so in theory tax returns for 2016/2017 which were submitted by 31st January 2018 should have been completed on the basis set out in the guidance. These returns can still be amended, and again this would need to be done by 30th September 2018 as otherwise there is a potential exposure to significant penalties.
If HMRC discover after the amendment period for 2016/17 ends on 31st January 2019 that cryptocurrency gains have been omitted from returns, for example because you did not realise that the conversion of one cryptocurrency into another crystallised a gain, then because your return was not in line with their published guidance, they are likely to be able to assess the tax anyway.
In this article, we’ve used “woolly” language, like “generally”, “may”, “could”. The HMRC guidance is written using this type of frustratingly vague language. The problem is that the tax law can only be applied to a particular situation, and as cryptocurrencies are such a fast-developing world, any definite language could be proved wrong by something new. To arrive at a definitive answer, you’ll need an adviser who will apply the tax legislation to your particular investments and situation.
5th July 2016 was the commencement date for the very broad “transactions in land” legislation. Non-UK resident companies are within the scope of the legislation if they are dealing in or developing UK land, or if they have acquired UK land with the intention of realising a gain from its disposal or development. They are also within the scope if they dispose of shares in a company, at least 50% of whose value derives from UK land, as part of an arrangement to realise a gain on UK land. The double tax treaties with Jersey, Guernsey and the Isle of Man were altered at this time, so that a company resident in those jurisdictions would not have protection from a double tax treaty on such a profit or gain. The profits are taxed as trading profits.
In particular, a non-UK resident company, selling shares in a non-UK company to a buyer who is also a non-UK company, can have a UK corporation tax liability on the disposal, if the company being sold holds UK land.
Where a company was already part of an arrangement within the scope of this legislation when it was introduced, then it is deemed to have an accounting period starting on 5th April 2016, and ending on the next date to which the company has drawn up accounts. For example, that accounting period might have ended on 31stDecember 2016. If the company does not have a UK permanent establishment, or is otherwise not registered with Companies House, then it will not have been sent a UTR, and will not be on HMRC’s records. In this case, there was an obligation to notify chargeability before 31st December 2017.
It should be noted here that the amount of the corporation tax profits could be more than the company’s profits, because of the application of the anti-fragmentation rules. For example, if an offshore shareholder has lent money, it is possible that the interest cost is effectively disallowed in computing the borrower’s corporation tax liability. These rules could therefore mean that there is a taxable profit in the company in an accounting period in which there has been no disposal of the land (because of the effective add-back of interest).
Where a company has not notified chargeability by this date, it is within the “requirement to correct” rules, and unless it notifies and corrects its position by 30thSeptember 2018, it could be liable to penalties of up to 200% of the tax that has not been corrected.
The company will also have failed to pay its first corporation tax liability on time, incurring further penalties.
If you require help or advice please do not hesitate to contact one of the client team.
Trident Tax has been helping trustees outside the UK to identify possible UK tax issues ahead of the 30 September 2018 deadline for Requirement to Correct. The UK tax legislation will allow for swingeing “Failure to Correct” penalties to be charged if UK tax liabilities arising from non-UK assets are not disclosed by this date. With only 6 months left to identify any problems and disclose them to HMRC, we thought it would be useful to share our experience to date.
The first step in the process is for Trustees and CSPs to complete our anonymous questionnaire, which is designed to collect information on the background and history of a trust or company in order to identify any UK tax issues that they will need to address. Trident Tax will produce a report free of charge summarising any areas of risk or recommended actions. Some common problems have emerged that are typically caused by the actions of third parties, unbeknown to the trustees:
UK-sourced income giving rise to a trustee income tax liability
A non-UK trust is not liable to income tax in the UK on certain classes of UK sourced income providing there are no UK resident beneficiaries. This may appear straight forward, but trustees are reliant on beneficiaries keeping them informed of their tax residence status. It is not uncommon to find that a settlor’s children or grandchildren have moved to the UK to study or work without telling the trustees and inadvertently triggered a UK tax liability for the trustees on UK investment income. Similarly, we have seen cases where there has been a change of investment manager but the original instructions to avoid UK investments because the trust has UK resident beneficiaries has not been communicated in the handover to the new manager.
UK Inheritance Tax (IHT) on relevant property
The mistake whereby an investment manager makes investments in the UK without checking with the trustees also has a potential IHT impact for what would otherwise be excluded property trusts. The UK situs investments are relevant property and can trigger IHT anniversary or exit charges if the value of the assets exceeds the trust’s nil rate band.
A much easier trap to fall into is for trustees to make loans to UK resident beneficiaries. Recent case law suggests that the situs of a loan is usually in the place where the borrower resides, as this is where collection of the debt can be enforced. This means loans to UK beneficiaries are normally UK situs assets that are liable to IHT under the relevant property regime.
A far more difficult problem for trustees is to understand whether assets settled in trust are relevant or excluded property when settled. The question of an individual’s domicile or deemed domicile status is complicated but we have seen cases where settlors who are non-UK domiciled when a trust was settled with excluded property have either become UK domiciled or deemed domiciled before settling further property or have settled UK situs assets into trust believing them to be excluded property.
Another common compliance problem is overlooking the requirement to make ATED Relief Declaration Returns in circumstances where an ATED property is exempt from charge. For example, UK residential property held through a company is exempt from the ATED provisions if the property is rented out on a commercial basis or is held as part of a property development trade. However, the directors of the company, must still submit an ATED return to declare the exemption. Late claims for relief can be made but significant penalties can still arise, even when there is no ATED charge due to an exemption.
Issues for UK beneficiaries
There are a number of ways in which a UK resident individual can be liable to tax in the UK as a consequence of being the beneficiary of a non-UK resident trust. Without understanding whether the individual has taken UK tax advice and made appropriate disclosures to HMRC, it is not possible to be clear whether the individual has a requirement to correct. We have identified a number of situations where there is a high degree of risk for UK beneficiaries and we have recommended, via the trustees, that individuals take urgent advice ahead of the 30 September deadline.
Our advice to any beneficiary of a non-UK resident trust is to take UK tax advice from a specialist advisor, even if advice has been taken in the past. The consequences of failing to correct are too significant to risk getting it wrong. Please contact a member of our team to discuss any of the above issues in more detail.
For fairly obvious reasons, many high net worth individuals (HNW’s) with links to the UK choose not to be UK tax resident. This is becoming even more prevalent now, with some long term UK resident non-doms choosing to leave the UK to avoid becoming deemed UK tax domiciled under the “15 out of 20 years rule” introduced with effect from April 2017.
Becoming non-UK tax resident is arguably much easier than it was previously, in view of the certainty provided by the Statutory Residence Test (SRT). Rather than relying on case law and, in many cases, having to make a “distinct break” from the UK to cease UK tax residency (which was always a very subjective test) the SRT legislates very prescriptively as to what one must do to avoid UK residency status. It is then just up to the taxpayer in question to follow the rules.
So leaving the UK may be the easy part. The hard part, it would seem, is deciding where to go. In some instances, this will be a low/no tax jurisdiction, which limits the options somewhat. Monaco has traditionally been a favoured location but in our experience it is often disliked by clients – difficulty in finding suitable accommodation, the perceived glamour limited to the Grand Prix weekend only and extremely high costs being just a few examples of the complaints raised.
So where else may HMWs move to? The Channel Islands is a possibility but they are small and the climate is not always seen as a particular attraction. Spain has its own non-dom regime (the Spanish Impatriates tax regime or “Beckham Law” as it is commonly known) which broadly limits the HNW’s liabilities to Spanish source income only. It does however, generally require the HNW to have a labour contract with an unconnected Spanish employer – which may simply not be feasible. There has also been talk of a similar regime being introduced in France but, as yet, this has not materialised.
In December 2016, Italy introduced what is in effect its own non-dom regime called the Italian flat tax. Whilst bearing a number of similarities to the UK non-dom regime, it is actually far more generous. The key features of the regime are as follows:
- To be eligible for the regime, the HNW simply needs to acquire a property in Italy (purchased or leased) and to be registered at the Italian General Register Office of any Italian city for more than 183 days within the calendar year. Having done that, there is actually no legal requirement for Italian tax purposes to spend any time in Italy at all. Albeit we have yet to see how the regime will work in practice. The rationale for spending considerable time in Italy would therefore be to avoid any risk of Italian residence being seen as artificial and to prevent other jurisdictions claiming tax residence elsewhere instead.
- A charge that is the rough equivalent of the Remittance Basis Charge (RBC) of a flat tax of €100,000 per year to benefit from the regime
- No tax on income and gains generated outside Italy (save for on certain capital gains derived from transfers of shareholdings in non-Italian companies)
- No tax on the remittance of any non-Italian income or gains – therefore no concerns about creating a source of clean capital, a considerable boon compared to the UK non-dom regime
- No wealth tax equivalent on financial assets and properties owned outside of Italy
- Full exemption from Italian Inheritance tax and gift tax on non-Italian assets
- Automatic renewal of the regime every year for up to 15 years – the maximum time that the regime can apply
- The ability for other family members to benefit from the regime at a cost of €25,000 per year
- The option to obtain an advance ruling from the tax authorities that the regime will apply – the less previous links to Italy, the more likely the regime will apply
So, at a cost similar to the RBC, non-doms can continue to enjoy non-dom status, in a warm climate and without having to worry about making taxable remittances. Like anywhere, there are pros and cons to Italy but in many non-doms eyes it may be preferable to the alternatives.
We have experience of taking clients into the Italian flat tax regime; if you have any further queries please do not hesitate to contact one of the client team.
Tax risk: an opportunity for radical improvement – let’s not miss it this time!
HM Revenue & Customs (HMRC) has just published a summary of responses to its consultation document (issued in September 2017) which asked for views on how the current approach to risk assessment for large businesses could be improved.
We welcome many of the suggestions but remain concerned that the opportunity to make improvements might be missed.
The published document sets out the following potential areas of improvement suggested by respondents (almost two thirds of whom were large businesses; the majority of others were professional bodies and professional services firms), together with the Government’s own thoughts on the issues raised. We have also included some very brief commentary of our own:
- The current binary ‘low risk/non-low risk’ classification in the Business Risk Review (BRR) process is often too narrow to reflect the differences across the large business population. The Government accepts this view and is proposing to pilot a new version of the BRR later this year with a view to a wider roll-out in 2019/20. The new version will almost certainly include significantly more than two risk classifications (yet to be determined).
Trident comment: Any approach which allows for greater differentiation and accuracy is to be welcomed. However, we are concerned that there remains confusion in practice as to what is meant by ‘risk’ in this context. Many BRRs in our experience produce not much more than a list of specific technical enquiries or proposed audit reviews, based on historical data. This could be because HMRC’s approach is grounded in an historical (backward-looking) perspective, rather than a more current and forward-looking analysis. We believe that, to improve the BRR process, all sides should start with a common understanding of its objectives and concepts. The current review begins with an assumption that the original BRR is the right place to start: this may be a missed opportunity to get full value from existing risk management provisions.
- The BRR process should take more account of the tax risk management work already required of large businesses, such as the Senior Accounting Officer (SAO) provisions and the publication of tax strategies (PTS). The Government accepts this view but has not yet explained how it proposes to do this.
Trident comment: We strongly agree with this. Our view is that, taken together, the SAO and PTS provisions provide the fundamental building blocks of tax risk management. If these building blocks were optimised by HMRC and large business, the areas for deeper focus (audits and enquiries) would emerge naturally and the potential for disagreement as to their scope would be minimised. We do not believe that HMRC has yet fully grasped the opportunity that SAO and PTS provide in this regard; neither do we believe enough large businesses have fully recognised and leveraged the opportunity they provide (e.g. to make investments in new technology, the skills and capabilities for the future, and the behavioural changes required at the individual, team and enterprise levels). Our view is that much more work is required in the SAO and PTS areas and, once that has been done, the BRR process can be improved in the appropriate context.
- The BRR process as a whole should be more interactive and iterative, that prompts continuous dialogue on reducing risk. The Government accepts this view and suggests that the BRR should ‘provide customers and HMRC with a clear set of actions and timelines which need to be regularly updates (sic) and discussed between the parties’.
Trident comment: In principle we would agree that dialogue is helpful. However, we believe that the objective of all stakeholders should be to make the tax system work better for the common good; and this requires reducing complexity, increasing transparency and restoring trust. The ‘Making Tax Digital’ project and the inevitable trend towards increased automation and real time connectivity would not lead us to expect a significant increase in dialogue (perhaps the opposite?). If SAO and PTS were optimised in this environment we would expect a reduced need for continuous dialogue; rather, we would expect dialogue to be focused on material issues as they arise. We’re not clear why the Government chose to focus on having clear actions and timelines in this context (these are basic project management tools).
- There should be clear advantages and disadvantages of being assessed in each risk category. The Government accepts this view but with the caveat that ‘it needs to create a consistent and level playing field for all HMRC’s customers’. The Government is explicit however that only those large businesses whose approach to risk aligns with best practice e.g. the OECD’s ‘Tax Control Framework’ (TCF), will be judged as low risk.
Trident comment: We strongly agree that established best practice approaches to risk management are important elements here; and we strongly agree that HMRC’s approach should be differentiated. If a differentiated approach is rational and evidence-based then it would not compromise the obligation on HMRC to act consistently and to support a level playing field. There are existing examples of differentiation in the tax system: for example, the trend in enforcement legislation over recent years has been increasingly to differentiate based on taxpayer behaviours (e.g. penalties for errors in documents; ‘naming and shaming’; ‘special measures’; assessing time limits). The key here in our view is that differentiation should be rational and evidence based. Again, we call on HMRC and large businesses to look again at how the approach to SAO and PTS can be optimised before improving the BRR process.
In conclusion, we would encourage HMRC and large businesses to make the most of this opportunity to improve the approach to risk management. Our concern that this should not be an opportunity missed is exacerbated by the failure so far, in our opinion, for the opportunities presented by SAO and PTS to be fully realised. We consider this to be a necessary pre-requisite.
Finally, we should acknowledge that we missed our own opportunity to make suggestions during the consultation period. HMRC’s proposal to undertake a pilot during 2018 has encouraged us to share some thoughts now; we would be pleased to discuss them further.
If you would like to discuss any of the issues raised in this article, or find out how we can help you manage tax risks in your business, contact us here.
The published document can be found here.
Trident Tax is pleased to announce the launch today of a new electronic diagnostic tool and review service for professional advisers with individual employee and employer clients who have disputed liabilities under disguised remuneration schemes (EBT/EFRBS).
The diagnostic tool and review service is provided free of charge on an anonymous basis and provides an indicative settlement figure (with a breakdown between the various taxes included in the figure) based on information provided by your client.
A better understanding of the settlement liability should allow clients to more accurately evaluate their current position and to decide whether to register for the latest settlement opportunity with HMRC prior to the 31st May 2018 deadline. In addition, the tool will enable a consideration of the critical question as to whether and how the company (or employee) is able to fund such a liability in the short to medium term.
Following an embargo on settlements, HMRC published its latest guidance taking account of the decision of the Supreme Court in the case of RFC 2012 plc (in liquidation) (Formerly The Rangers Football Club plc) v Advocate General for Scotland. The guidance provides some welcome clarity on the current settlement terms including confirmation of corporation tax relief on a scheme promoter’s fees (backdated to the year of the contribution if the year is “open”) and, the basis on which HMRC expect to be able to transfer PAYE and NIC liabilities to employees.
The many variables in the mix can make it difficult for clients to identify the right course of action at this time, with many feeling abandoned or distrustful of advice from the original scheme providers. The introduction of the disguised remuneration loan charge in April 2019 means, for most participants in disguised remuneration schemes, that “doing nothing” is no longer a viable option and a decision on whether to register under the settlement opportunity now needs to be made.
The anonymous diagnostic tool and review service provides a no cost option to support professional advisers and their clients in making that decision, based on the fact patterns of each case.
The EBT/EFRBS diagnostic tool and the current HMRC settlement opportunity will also be the subject of discussion in April at the next session of our Breakfast Tax Club to be held in our offices at 25 Bedford Square, London WC1B 3HH (further details to follow shortly).
If you would like to arrange to arrange to receive a copy of the diagnostic tool for any of your clients and/or details of how to attend the April Breakfast Tax Club, please contact us here.
Finance Act No.2 2017 creates a new category of “Protected trusts”, where the settlor is not actually UK domiciled, but becomes UK deemed domiciled under the changes in this Act.
This article considers the position for a trust which has been and is settlor-interested for income tax, and which holds income which arose before 5th April 2017 which has not been remitted to the settlor.
We are assuming here that the trust has segregated its capital, income and gains so that it can choose the source of the funds to be invested in the UK. We also assume that the income is segregated into pre and post 5th April 2017 accounts.
Trustees can use clean capital to invest in the UK without triggering a tax charge on the settlor. We consider in this article which other funds the trustees can invest in UK assets without a tax charge, and how this investment might be structured.
Treatment of income from UK assets in a protected trust
Under the new protected trust rules, trust income and gains arising after 5th April 2017 would not become chargeable to tax if the trustee invested the money in UK assets directly. This is because the effect of the protected trust rules is that the income and gains of the trust are not treated as being those of the settlor, whether or not they have become deemed domiciled in the UK.
However, if the assets give rise to income at trust level, this is UK source income and taxable, and so normally an overseas underlying company would be used to make UK investments. This ensures that no UK income arises at trust level, when it would be assessable on the settlor. As we explain below, in some circumstances it won’t be beneficial to use an overseas company to ensure UK income tax is not payable, as this will negate the ability to invest historic overseas income in the UK without a taxable remittance.
There are also transition provisions for pre 5th April 2017 income, which apply where the trust was settled by an individual who
- has been UK resident since the settlement was made
- was non-domiciled and assessable on the remittance basis throughout the period to 5th April 2017, and
- was “interested in” the trust for income tax purposes.
The income also has to have arisen post 5th April 2009. If all of these conditions are met it follows that the income won’t have been subject to UK tax, as the remittance basis would have applied.
The transition provisions allow the pre 6th April 2017 income to be invested in the UK without triggering a tax charge, by defining this as not being a remittance of the income which had arisen under the old rules.
The legislation works by treating the trustees themselves as not a “relevant person” for the purposes of determining whether there has been a remittance to the UK.
One practical issue is that the transition exemption only applies where the trustees remit pre 5th April income to the UK. If the trustees lend or subscribe this money to an overseas underlying company, and that company (a relevant person) invests in the UK, then there will be a tax charge.
The second practical issue is that the transition exemption only applies for the purposes of the income tax settlement legislation, and not for the purposes of the transfer of assets abroad legislation. So, if the trustees have an account comprising only pre 5th April 2017 income, but haven’t split this between income taxable under the settlements legislation and income taxable under the transfers of assets legislation, then this may prevent the income being used because it is not clear what part of it if any falls within the transition provisions.
Possible strategy- use of UK underlying company
One point to consider is whether using a UK underlying company to invest in UK assets would be appropriate. If the trust funds either debt or equity of such an underlying company with pre-5th April 2017 income, in addition to clean capital and post 6th April 2017 income and gains, then this is not a taxable remittance.
The use of an overseas underlying company no longer provides CGT or IHT protection for UK residential property, and if the current proposals are enacted, it will not provide CGT protection for any UK real property. The IHT protection for non-residential property may well be lost in future.
If the UK underlying company invests in UK shares, it may be a low tax vehicle as a result of the Substantial Shareholdings Exemption (where investments in shares are of more than a 10% holding) and the distribution exemption, which means that UK companies don’t suffer corporation tax on dividends from other UK companies. The shares in the UK underlying company are within the scope of UK IHT.
Thus a UK underlying company may be worth considering.
Income arising in that underlying company is not arising to a person abroad so if benefits are provided, this does not create an income tax charge under the transfer of assets abroad. The income in that UK company can be retained and potentially used to make loans to other underlying companies of the same trust, which should not taint the trust and thus can be interest free.
Therefore, if the trustees can identify the pre 5th April 2017 income which is within the transition provisions, this offers more flexibility for investments in the UK than would be available under Business Investment Relief.
The transition provisions were designed to encourage trustees of protected trusts to invest in the UK, but the fact that they don’t cover income assessable under the transfer of assets abroad legislation significantly restricts their usefulness in practice.
For a trust which can be confident in identifying that these provisions apply, it may be worth considering using a UK underlying company rather than an overseas underlying company.
As is often the case with the non-domicile changes in Finance Bill No 2 2017, the practical application is complex and offers many traps.
If you would like to discuss this or any of our other newsletter content in more detail then please contact us.
Finance Act No 2 2017 provided a “one-off” opportunity for individuals who are non-UK domiciled and who have a cash mixed fund account to cleanse that account in the period from 6 April 2017 to 5 April 2019. Disappointingly, HMRC only issued their guidance on 31 January 2018, having used up 10 months of the 24-month cleansing period.
What is cleansing?
Cleansing is a process of transferring funds from one offshore account to another, nominating the transfer and specifying whether the transfer is of income, gains or capital. This is very significant because if such a transfer (an offshore transfer) is not within the cleansing regime, the funds transferred are treated as a mixture of income, gains and capital in the same proportion as were in the transferor account.
Cleansing offers the opportunity for the money to be transferred into separate accounts for income, gains and clean capital, without triggering a tax charge. Cleansing can also segregate different types of income and gains, for example, foreign earnings can be split from foreign interest income. This would be beneficial where different income and gains had been subject to different foreign tax. Where a mixed fund contains taxed UK income, this can also be segregated out.
Cleansing allows the mixed fund to be segregated into separate accounts: one for each type of income or capital, and then the individual can choose to make remittances from those accounts where the tax charge will be lowest.
Theoretically, a well-advised non-dom will have used segregated accounts for different types of income and capital. However, even a perfectly operated segregation policy will have accounts which contain the proceeds of capital gains on an asset bought with clean capital, which are a mixed fund of capital gains and clean capital. Cleansing allows the clean capital to be remitted before the gain, without a tax liability.
Why act now?
As noted below, for many individuals there will be detailed work to be done to identify the composition of mixed funds and determine what nominated transfers should be made; identifying the composition of a mixed fund may involve re-calculating the composition of the fund on hundreds of occasions over the history of the account because the categories of money in the fund are altered every time funds are received into or paid out of the mixed fund. Therefore, although the window for cleansing is still open, the publication of the guidance may mean that it is now time to take action.
The fact that the cleansing guidance has been published 10 months after many individuals became deemed UK domiciled on 6 April 2017 gives rise to another practical issue. Where the individual holds an overseas asset which itself is a mixed fund (e.g. a capital asset which was purchased with clean capital and/or income), then in order to cleanse this, the asset will need to be sold because only cash can be cleansed. This then means that the capital gain will be realised. Most such non-doms will have paid the Remittance Basis Charge at some point and are therefore able to rebase their overseas assets at 6 April 2017. Thus, selling the asset in order to cleanse it will crystallise a gain on the increase in value since 6 April 2017, which is another reason to look at the scope for cleansing as a priority.
Each mixed fund can be cleansed on a different date from any other held by the same person. The legislation says that once a nominated transfer from one offshore account (A) to another (B) has been made, you cannot nominate another transfer from A to B.
All of the examples in the HMRC guidance deal only with transfers where all of the nominated transfers out of account A are made on the same day, i.e. a nominated transfer of income from A to B is made on the same day as a nominated transfer of gains from A to C. The guidance says “You also don’t need to completely empty the original mixed fund account, but once a nominated transfer from an account has happened it can’t be nominated again into that same account.” We understand that this has been discussed with HMRC in consultations, and although it is not made explicit, HMRC do appear to interpret the legislation as requiring each mixed account to be cleansed on one day, where all of the nominated transfers take place.
Additionally, it is not possible to work around this restriction by making a nominated transfer of “mixed” cash into a new account, in order to create a second opportunity to cleanse into the same receiving accounts.
If the mixed account includes clean capital and UK taxed income, then in practice, these can both be cleansed into the same account and used to make remittances to the UK; however, this can’t be done by a nominated transfer of clean capital followed on a later date by a nominated transfer of taxed income.
Cleansing and rebasing
When an individual sells an overseas asset which qualified for rebasing at 6 April 2017, the proceeds of that gain will be a mixed fund, which comprises the original investment, the uplift to the rebased amount, and the capital gain. The uplift to the rebased amount is clean capital and cleansing the account which holds the proceeds will enable that amount to be remitted to the UK tax-free.
Dealing with uncertainty
The guidance gives a number of examples, and in all but one of these, the individual knows the composition of the mixed fund. In practice, it is often very difficult to establish this. The guidance says that if the individual does not know what the nature of a nominated transfer is, it will be treated as income. That does mean that if the transferred money is remitted, income tax will be due, i.e. it is the most unfavourable category for the individual. This confirms what we have seen in practice, that HMRC will not accept a best estimate of what the clean capital and gains are, they will only accept nominated transfers of known amounts of clean capital and gains.
There is a distinction though between cash for which the individual cannot identify the nature, and cash where the individual identifies the nature incorrectly. The guidance says that if it turns out that it is possible to identify the amount of income in the account, and the individual nominates and makes an income transfer which turns out to be a transfer of £1 more than the actual income, then the nomination is not valid. This means that the transfer is an offshore transfer which takes some clean capital out and leaves some income in the original account.
This means that individuals will have to weigh up whether it will be cost-effective to do more work to identify clean capital and gains in order to be able to cleanse and then remit with a lower tax charge.
The account does not have to be emptied as part of the cleansing, but in general the money which is left should only be of one category, as it is not possible to make a second nominated transfer into the same transferee account.
It is then necessary to consider carefully whether it would be safest to compute which elements of the mixed account comprise known amounts of clean capital, different categories of gains, and any categories of taxed income, and then nominate transfers of these, leaving untaxed income in the mixed account, together with any sums which can’t be identified.
The guidance says that joint mixed funds can be cleansed even if only one of the holders is a qualifying person for the purposes of the legislation. This might be the case, for example, if one spouse was born in the UK with a UK domicile of origin.
The guidance says that the person who does qualify can identify which funds are theirs, and then make nominated transfers. This does appear to be a concession.
The guidance notes that where interest arises in accounts to which funds have been transferred on the cleansing, this will make those accounts mixed funds, unless the interest is paid into a separate account. The interest will be taxed on an arising basis, so for remittance purposes it is like clean capital, and thus the interest could be paid into a clean capital account.
Although no formal claim has to be made to cleanse accounts, it is essential to retain records of the nominated amounts and the type of income or gains which are specified.
Pre-April 2008 funds
Where transfers into and out of the mixed fund were made before 6 April 2008, the guidance gives examples of applying a percentage approach to determine the amount of income and gains in the account.
Cleansing mixed funds is potentially a great opportunity for many non-doms but great care needs to be taken in identifying the composition of funds and in the execution of the cleansing itself. There is also a danger of embarking on time-consuming and costly exercises, only to find that the amount of clean capital that can be identified and cleansed is disappointing in comparison to the time, effort and costs of the exercise. For that reason, we recommend that a feasibility study is conducted as the first step to determine the likely benefits of cleansing.
If you would like to discuss the scope for cleansing mixed funds please contact us.
Trustees need to act now to ensure protected trusts retain that status after 5 April 2017.
Finance Bill 2017 No.2 includes legislation to protect trusts settled by individuals before they became deemed UK domiciled from the full impact of the changes to the taxation of non-domiciles. Our previous article How Do You Avoid Tainting Protected Trusts? set out the importance of ensuring that such trusts are not “tainted” by an addition of value after 5 April 2017.
Once the settlor has become deemed UK domiciled, a trust can be tainted where property or income is provided directly or indirectly for the purposes of the settlement by the settlor, or by the trustees of any other settlement of which the settlor is a beneficiary or settlor. In particular, a loan to a protected trust where the interest is below the amount which would be charged on arm’s length terms could taint the trust; the legislation defines arm’s length by reference to the official rate of interest.
There is a transition period which allows existing loans to be put onto an appropriate basis before 5 April 2018. Where an individual became deemed UK domiciled on 6 April 2017, a loan will not taint the trust provided that the loan becomes a loan on arm’s length terms before 6 April 2018. It is also necessary for interest to be paid before 5th April 2018, as if those arm’s length terms had been in place for the whole of 2017/18.
The steps which need to be taken in respect of a loan are not complex, however, the practical difficulty is likely to arise in ensuring that all of the loans which could taint the trust have been identified.
This legislation applies to loans to and from the trustees of the protected trust. But a trust could also become tainted if a “cheap” non-arm’s length loan was made to an underlying company of the trust, since that would be a provision of property, and the legislation does not specifically cover this. The HMRC guidance on protected trusts (issued on 31 January 2018) does not address this directly, however, it seems prudent to ensure that loans to underlying companies are also put onto the correct basis before 5 April 2018. While a trust is not tainted where property is provided with no intention to confer gratuitous benefit, this exclusion does not apply where property is provided under a loan. Therefore, a loan to an underlying company which is not on the defined arms’ length terms does appear to create a risk of tainting.
If a company owned by the settlor makes a loan to a protected trust or an underlying company of a protected trust, then if it is not on arms’ length terms this could be an indirect provision of property by the settlor, depending on the circumstances. Similarly, the trustees of another trust might add value to the protected trust where there is a loan from that trust or its underlying companies to the protected trust or its underlying companies.
It is also possible that an interest-bearing loan from a trust to a settlor could taint the trust, although this is more unusual.
There could therefore be a reasonably substantial exercise to identify all of the loans which have the potential to taint a protected trust. Trustees will need to start work on this in good time to be able to ensure that interest payments are made before 5 April 2018.
An individual who is not yet deemed domiciled can settle a trust which can be a protected trust. Here, there are no transition rules for loans, and so loans will need to be considered and put on arms’ length terms before the date on which the settlor does become deemed domiciled. This will be an important issue to consider if the settlor will become deemed domiciled on 6 April 2018.
If you would like to discuss this or any other tax issues, please contact us.