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.