New emigrants to the UK from Hong Kong coming to live in the UK – the risks and steps to take

From 31st January 2021, a new British visa is available for Hong Kong British National (Overseas) citizens and their close family members. This serves to highlight a particularly unfortunate tax pitfall that can trip up the unwary.

Based on our experience of HMRC’s approach, we think it is likely that HMRC will argue in many cases that such individuals become UK domiciled for tax purposes as soon as they arrive. You are UK domiciled if you begin to live here and intend to make your home here until the end of your days unless and until something specific happens. Where someone’s hope of returning home depends on very significant political change happening in their homeland, HMRC tend to regard this as too vague an intention to prevent UK domicile being acquired.

If someone applies for citizenship, and states that they intend to remain permanently in the UK, then that will be regarded as evidence that they have acquired a domicile of choice in the UK.

This problem of immediately acquiring a UK domicile of choice is obviously not unique to Hong Kong residents. From a tax perspective, someone coming to live in the UK in these circumstances will be UK tax resident and domiciled and subject to UK tax on their worldwide income and gains, and to UK inheritance tax on the whole of their worldwide wealth. This means they will not be able to utilise the remittance basis of taxation favoured by many non-doms.

For someone with significant wealth, it is worth considering investing this in a single premium offshore life assurance bond. Such bonds are subject to a specific tax regime; income and gains which arise within the bond are not subject to UK tax even where the bond is held by a UK resident. It is then possible to withdraw each year 5% of the original premium, without any UK tax charge. This means that if a non-dom individual invests in such a bond and puts the bond into trust before they become UK resident, then the trustees can make 5% annual withdrawals of the premium to pay to the individual, tax-free, and also the investment return in the bond is not subject to UK income or capital gains tax, and the assets are outside the scope of UK inheritance tax. There is an income tax charge on withdrawals from the bond after the original premium has been extracted, which is again subject to a specific regime which can significantly reduce the effective rate.

If the investment in the bond is not made until after the individual has arrived in the UK and a UK domicile of choice has been acquired, then it is within the scope of UK inheritance tax and in general there would be a tax charge on putting it into a trust. However, such bonds are usually written in £10,000 tranches, so that they can be used to make gifts to (for example) family members as potentially exempt transfers.

Often, someone coming to live in the UK for the first time would set up a “protected trust”, before they arrive, but if they become domiciled immediately, then the income and capital gains tax advantages of such a trust are immediately lost. However, if a trust is settled before a person comes to the UK, and it invests in non-UK situs assets, then the assets can be outside the scope of UK inheritance tax, and in particular, outside the scope of the 6% ten-yearly anniversary charge on trusts.

Domicile depends on a person’s particular circumstances, and specific advice should always be taken. There are steps that can be taken before arrival to improve the UK tax position, but this is heavily dependent on the facts and individual circumstances.

If you would like to discuss this topic in more detail please contact us

At the time of writing, Bitcoin is trading at $53,000 (over £37,000).

A few days ago, its value reached an all-time high of $58,000. Other cryptotokens have also soared in value.

Given the surge in cryptoassets values, it is even more important for investors, and their advisers, to be familiar with how crypto profits are taxed.

Cryptocurrencies and capital gains tax

UK tax legislation is silent on the taxation of cryptoassets. However, HMRC has set out its current approach to the taxation of cryptocurrencies in its December 2018 and December 2019 policy statements.

Firstly, HMRC does not accept that Bitcoin and other cryptoasset are “currencies”.
It considers that the gains of most individuals on the disposal of cryptoassets will be subject to capital gains tax rather than income tax.

HMRC considers that cryptocurrencies are subject to the share pooling rules that require disposals to be matched to acquisitions in the following order:

1. To acquisitions of the same token on the same day;
2. To acquisitions of the same token within the next 30 days;
3. To a pool of the same token.

Where there has been a high volume of transactions, the application of these rules can be complex, particularly as cryptocurrency platforms do not provide their users with end of tax year reports showing their gains and income for UK taxation purposes.

What is a disposal?

Disposals include sales of cryptoassets for “fiat currencies” (i.e., sterling, dollars, euros, and other currencies), gifts to other persons, companies and trusts and, crucially, the exchange of cryptoassets for other cryptoassets.

Therefore, it is essential to appreciate that gains and losses must be calculated each time a cryptoasset is exchanged for another. It is not sufficient to calculate the gain with reference to an initial investment (e.g., in sterling) with what is ultimately received (again, e.g., in sterling) when the cryptoasset is disposed of for cash. Rather, each transaction must be converted into sterling at the date of the transaction and a gain or loss calculated at that point.

Such calculations may be challenging, particularly if there is a high volume of transactions.

It may mean that individuals, especially those who undertaken a high volume of transactions between different cryptoassets, may not have an accurate view of their capital gains tax position unless they regularly recompute their gains and losses with reference to sterling. As such, it is possible for an individual who may have invested, for example, £100,000 into cryptoassets, and to have received (say) only £50,000 back to consider that he or she has made a loss but nonetheless for UK taxation purposes to have realised net gains because of the gains and losses realised on individual transactions.

It would therefore be prudent for investors to review their capital gains tax position on an ongoing basis, rather than after the end of the tax year, to ensure that they reserve sufficient fiat currency to meet any capital gains tax liability that arises. If not, there is a risk that they might realise unexpected capital gains, yet because of adverse movements in values of cryptoassets, to have a portfolio worth less than their tax liability when they come to pay the liability by 31 January following the end of the relevant tax year.

Non-dom taxpayers and cryptocurrencies

Non-UK domiciled individuals may elect for the remittance basis of taxation so that foreign income and gains are subject to UK taxation only to the extent that they are remitted to the UK.

It might be thought that cryptotokens, relying on distributed ledger technologies which are in effect “nowhere” would be non-UK situs assets and, as a result, non-dom taxpayers would be able to elect for the remittance basis of taxation so that gains on the disposal of cryptotokens were not taxable in the UK unless the proceeds were remitted.

HMRC’s view, in its policy statement of December 2019, is that the situs of cryptotokens (specifically, “exchange tokens”) follows the residence of the beneficial owner. Consequently, if an individual is UK tax resident, then cryptotokens, such as Bitcoin, that they may hold, will also be UK situs, and therefore, gains arising on the disposal of such tokens, will (in HMRC’s view at least) be subject to UK taxation, even if the individual elects for the remittance basis of taxation.

Non-dom taxpayers may therefore wish to consider alternative structures for holding cryptoasset investments. For example, if the individual settled a non-UK trust which, in turn, held a non-UK company which invested in cryptoassets, the gains arising on the disposal of the investment would be taxed on them only to the extent that they were distributed to them. However, given HMRC’s argument that cryptoassets are UK situs, care would be required if existing holdings were transferred into trust since this could give rise to an immediate charge to inheritance tax.

Losses

In particular, following the appreciation in values of tokens in the 2020/21 tax year and the potential for significant gains, cryptoasset investors should also ensure that they have claimed any available capital losses.

Capital losses on cryptoassets, or any other assets, are available to set against gains of the same or future tax years.

Losses must be claimed within four years of the end of the relevant tax year, whether through the tax return, or by separate claim to HMRC. Losses for the year ended 5 April 2017 must therefore be claimed by 5 April 2021. Claims for previous years are out of time.

HMRC’s guidance on cryptoassets has clarified also that claims for losses might also be possible where individuals lose private or public keys to their cryptoassets and where there has been theft or fraud.

If an individual misplaces their private key, they will not be able to access the cryptoasset in question. Even though the key might be misplaced, the cryptoasset in question would still exist on the distributed ledger and, as a result, the loss of a key would not count as a disposal for capital gains tax purposes. However, HMRC consider that if it can be shown that there is no prospect of recovering the private key, or otherwise accessing the cryptoassets held in the corresponding wallet, a negligible value claim might be possible. If such a claim is accepted, the individual will be deemed to have disposed of the asset, and reacquired it on the same date for nil consideration, with the result that they crystallise a loss equal to the acquisition cost of the asset. That loss will be available to set against gains of the same or future tax years.

Negligible value claims might also be possible where the holder has been the victim of theft or fraud.

If HMRC accepts the negligible value claim, the individual would be treated as if he or she had disposed of the cryptoassets and bought them back for nil value, thereby creating a loss, at the earlier of the date the claim is made and a date in the previous two tax years if the cryptoassets became worthless at that time or earlier.

HMRC compliance activity

HMRC shows growing interest in the taxation of cryptoasset. In August 2019, it contacted at least three UK exchanges to request information on the users of its platform.
At least one of the exchanges, Coinbase, agreed to provide customer information to HMRC where they had deposits, sold, etc., more than £5,000 in the year ended 2019.

Given HMRC’s increased activity, it is particularly important that taxpayers consider carefully whether their cryptoasset activities have been disclosed on the relevant self-assessment tax returns.

If you wish to discuss any of the above or other aspects of the taxation of cryptoassets, please contact us.

Speculation about an imminent rise in the rate of capital gains tax has led some business owners to accelerate their exit plans to “lock in” gains at current tax rates. While in principle if the business is sold before any increase, shareholders should benefit from current tax rates, in practice finding a suitable buyer in current economic climate may be challenging.

The most common exit routes include trade sales (to third parties) and management buyouts (to the existing management teams). However, a sale to an Employee Ownership Trust (EOT) is another option.

The Government introduced EOTs in 2014 to encourage owners of trading companies to sell their shares to their employees. Shareholders can sell shares to an EOT and pay no capital gains tax on the sale provided the trust acquires at least 51% of the company’s ordinary shares.

High profile examples where owners have sold to EOTs include Aardman Animations and Richer Sounds but a growing number of less well-known businesses have also been sold to their employees. If capital gains tax rates do rise, sales to EOTs might become even more attractive. However, shareholders should carefully consider the tax and non-tax implications of choosing to sell to an EOT rather than an external third party or management team.

We highlight some tax issues arising from using such a trust to crystallise a gain.

Funding the sale proceeds

It is the trading company itself which must fund the EOT by contributions to pay the exiting shareholders.

If a business does not have significant assets, and is valued and sold on an earnings basis, the price is a multiple of earnings. The company may be able to borrow e.g., by factoring its debtors, but this will be in line with earnings. Consequently, it may be years before the exiting shareholders can be paid out in full, and if they are issued with loan notes, they run a risk of not getting their money in full if the fortunes of the company change.

Where shareholders can sell their shares in instalments, they may be able to negotiate increasing prices for each subsequent tranche if the earnings rise. However, if they sell to an EOT, capital gains tax relief is only available on the disposal by which the EOT acquires control of the trading company. By selling a controlling shareholding to the EOT, the shareholders therefore peg themselves to a value based on the earnings at that time and lose out on any growth in value from future higher earnings.

In a context where there is no external purchaser providing a value, the price is negotiated with the trustees and might not be the highest achievable, the price will be received over a long period, and there is a risk that it is not received in full.

In summary, the comparison of the net proceeds received is not simply about what rate of capital gains tax rate applies.

Employee incentives: growth shares and share schemes

A company that has been looking to build earnings for a future sale may well have provided employees with growth shares and or share options, e.g., Enterprise Management Incentive (EMI) options.
By granting share options or issuing growth shares to employees the intention is that on a future sale of the business, the purchaser will buy the growth shares and EMI shares along with the rest of the company shares and therefore the holders of the growth shares and EMI shares benefit from any uplift in value of the company from when they received their options or shares.

Shareholder agreements or share option agreements may provide the employees the right to exercise their options and sell their growth shares. In the context of a sale to an Employee Ownership Trust, this means that in effect the company will need to fund the purchase by the trust of at least 51% of the ordinary share capital, but also pay out employees for growth shares and EMI shares. The funding issue highlighted above would therefore be exacerbated.

Going forward, to provide equivalent employee incentives to earnings growth, it may be necessary to use bonuses rather than share schemes, in which case there will be significant employer National Insurance contributions (at 13.8%) to pay.

Future sale

Shareholders might think that they could “park” the shares in the EOT to secure favourable capital gains tax, then look for an external purchaser later, for example when profits have recovered from the impact of COVID 19. The aim might be for the trust to realise that gain, and then pay off any remaining outstanding consideration and share out the proceeds with the employees.

However, if the EOT sells a controlling interest in the trading company, its gain will be computed by reference to the base cost of the shareholders who sold it the shares; in effect, the gain of the shareholders, which they did not pay tax on, is then charged on the trust. If the trust bought from founder shareholders with a very low base cost, the trust is paying capital gains tax on the whole of the gain from the company’s commencement.

In short, the legislation is not structured to put the trust in a good position to sell.
Furthermore, any distribution from the EOT to the employees and directors will be taxed as remuneration, with PAYE and National Insurance Contributions applying.

Conclusion

Tax planning should not just focus on headline rates of tax, it should work through the consequences and practicalities of the steps that are proposed.

If you would like to talk through the full breadth of tax implications of your plans, please do contact us.

The follower notice provisions were introduced by FA 2014 and continue to be seen by the government as an important weapon in its fight against tax avoidance.

Follower notices (“FN”) disincentivise users of tax planning arrangements from continuing their disputes with HMRC where the Courts have already made a decision on the same or very similar cases. However, many believe the FN regime to be draconian and that it acts to deny taxpayers a right to justice, by leaving those in dispute little option but to settle with HMRC, irrespective of how strong they believe their cases to be.

The FN provisions

HMRC may serve a taxpayer with a FN provided each of the following four conditions is satisfied:

a)  There is an open enquiry into a person’s tax return or that the person has made a tax appeal which has not been resolved;

b) The relevant tax return was prepared on the basis that a tax advantage results from tax arrangements;

c)  HMRC is of the opinion that there is a judicial ruling which is relevant to those arrangements; and

d)  No previous FN has been issued to the person in respect of the same tax advantage, arrangements, judicial ruling and period.

Recipients of FNs are required to take “corrective action” within 90 days of the issue of the FN. Broadly, that involves recipients who are subject to an HMRC enquiry amending their tax returns by disapplying the tax advantage claimed. Alternatively, where tax appeals have been made, recipients are expected to withdraw their appeals.

Those who do not take corrective action within the statutory timeframe may be subject to a penalty of up to 50% of the additional tax payable “as a result” of counteracting the denied advantage. However, that penalty may be reduced in respect of the quality of the taxpayer’s cooperation. “Cooperation” for these purposes includes assisting HMRC in quantifying the tax, counteracting the tax advantage, providing information for corrective action, providing information to facilitate a settlement and allowing access to records.

Suffice it to say, there is no right of appeal against FNs. Therefore, recipients who wish to have their cases heard before the tax Tribunal (and who, therefore, do not take corrective action), do so knowing that if they are unsuccessful, they face the prospect of having to pay significant financial penalties in addition to the disputed tax.

Raymond Barlow and The Commissioners for HMRC (First-Tier Tribunal 2020)

HMRC levied penalties on Mr Barlow for tax years ended 2005 to 2008 because he did not take corrective action within the time specified by the FNs issued to him. HMRC had agreed to reduce the penalty loadings from the maximum 50% to 29.6% for 2005, and to 37.6% for the other three years, to reflect the quality of his cooperation with HMRC. The validity of the FNs was not in dispute.

Mr Barlow’s appeals were made on two grounds, (i) that he had acted reasonably, despite not having undertaken corrective action within the time allowed, and (ii) that in any event the penalty loadings were excessive. He said the reason for the delay was because he had relied on the advice of his adviser at the time, Montpelier.

In his judgment, Judge Charles Hellier said that in order to set aside the penalties, it must have been “reasonable in all the circumstances for Mr Barlow not to have taken corrective action” sooner than he did. Mr Barlow’s counsel argued that his client was a layman who relied on the advice of his professional adviser. Evidence provided at the hearing supported Montpelier’s credentials and that Mr Barlow had acted on its advice not to take corrective action. In short, he had not simply buried his head in the sand. However, there were certain inaccuracies in Montpelier’s correspondence which, according to HMRC’s counsel, should have caused Mr Barlow to query the position. The inaccuracy concerned the Huitson case, i.e. the judicial ruling cited in the FN issued to Mr Barlow.

Montpelier had referred to the Huitson case as ongoing, but the time for making an application for permission to appeal had passed, as correspondence available to Mr Barlow from HMRC confirmed. HMRC argued that it would have been the action of a reasonable taxpayer, in Mr Barlow’s position, to seek clarification on the point and question Montpelier why it believed litigation would be more successful second time around. There was no evidence that he had done so.

Judge Hellier decided the case in favour of HMRC in relation to first part of the appeal, namely that penalties were justified. He commented:

“It seems to me that if a taxpayer is not reasonably well informed and does not take steps to make himself such, his action or inaction may not be reasonable.”

“Overall I conclude that it was not shown in all the circumstances that Mr Barlow acted reasonably in acting on the basis that he had a good or reasonable case that the scheme worked.”

In respect of the second part of the appeal and the quantum of the penalties, it was decided that further quality reductions were due in light of Mr Barlow’s cooperation. Interestingly, whilst penalties were reduced to 25% of the denied advantage for all years, Judge Hellier commented:

“In setting the penalty reduction I do not consider that the reasons for a taxpayer’s behaviour should generally play any part …. I do not consider that the fact that he delayed because he had been advised that the scheme worked is relevant.”

Summary

What is to be taken from the judgment in the Barlow case is that the bar protecting taxpayers from FN penalties is very high indeed. Regardless of an adviser’s credentials, recipients of FNs cannot simply rely on advice received without seeking to properly understand it.

The government has already rejected the House of Lords committee’s recommendation to abolish FN penalties claiming that it would render the regime ineffective. However, perhaps to appease critics, it has been proposed that the penalty regime be amended. The consultation (which ended on 27 January) proposes replacing the 50% penalty with a 30% penalty, with an additional 20% should a tax tribunal strike out the taxpayer’s appeal on certain grounds, e.g. where the taxpayer has no reasonable prospect of success. Some might say such a change offers little relaxation to the regime and that it continues to restrict access to justice.

If you would like to discuss the FN regime or HMRC’s pursuit of tax geared penalties, please contact us.

HMRC’s access to information on taxpayers’ assets, income, and gains, including overseas, is greater than ever due to international agreements and increased use of technology.

Facing constrained resources for formal enquiries, HMRC’s has expanded its use of “one-to-many” or “nudge” letters. Rather than open a formal enquiry, HMRC prompts large numbers of recipients to identify and correct omissions or errors themselves. Other letters prompt taxpayers to consider the entries that are required on forthcoming returns to ensure that they are complete and correct.

The targets of the latest nudge campaigns include two specific categories of individuals: those whom HMRC consider to be deemed domiciled and those who consider they are non-UK tax residents.

Deemed domicile

From 6 April 2017, non-UK domiciled individuals may be “deemed domiciled” if they have resided in the UK for 15 or more of the previous 20 tax years.

HMRC has sent letters to individuals who it believes may be deemed UK domiciled and, as such, required to include their worldwide income and gains on their self-assessment tax returns. There are two versions of the letter, one issued in advance of recipient’s filing their 2019/20 tax returns, the other nudging them to review their already submitted 2017/18 and 2018/19 tax returns.

Both versions outline the new deemed domicile rules that apply from 6 April 2017 including the potential implications of deemed domicile status for “protected trusts”, such as the requirement to pay tax on any UK source trust income as well as offshore income gains which are not considered protected foreign source income.

The tax implications of deemed domicile status are far-reaching and resolving the question may require detailed examination of the person’s tax residence status over previous years to determine whether the threshold of 15 years of UK residence is actually met.

Statutory residence test

UK residents (unless they are eligible for, and elect for, the remittance basis) are liable to tax on their worldwide income and gains. Tax residence is therefore fundamental to individuals’ liability to UK taxation. UK tax residence is determined by the statutory residence test (“SRT”).

HMRC’s letters remind recipients of the factors that impact their UK tax residence under the SRT including working in the UK, the number of days spent in the UK in the tax year, and the number of ties that the individual has to the UK, and the importance of the taxpayer retaining relevant records to support their self-assessed residence status for the year ended 5 April 2020.

While these letters prompt recipients to review their position prior to filing their 2019/20 tax return, it may be prudent for recipients who have filed their returns on the basis that they were non-UK resident in previous tax years, to review their position for those years too.

The end of the 2019/20 tax year corresponds to the coronavirus pandemic and any taxpayer who claims that any of the days that he or she spent in the UK were due to exceptional circumstances arising from the pandemic should take particular care to ensure that they retain evidence.

The SRT involves a detailed set of rules which are heavily fact-based and HMRC routinely asks for evidence of travel and other activity to determine whether or not a person is UK tax resident in particular years.

Responding to nudge letters

Taxpayers receiving a “nudge” letter should review their filed returns to confirm that their filed returns include all relevant income and gains.

In some cases, HMRC may send a “certificate of tax position” with the nudge letter asking the taxpayer to certify that his or her tax affairs are correct. We advise recipients against completing such a certificate without taking appropriate professional advice. There is no statutory requirement to complete such forms and they exclude important taxpayer safeguards. Rather than ignore the letter however, whether a certificate is provided or not, we recommend responding to HMRC by letter. If no response to the nudge letter is provided, there is a risk that HMRC might open an enquiry to check the taxpayer’s position.

If a review uncovers undisclosed income or gains, the taxpayer will need to consider his or her position carefully to understand the number of years that are open for HMRC to raise assessments and the best disclosure route. For omissions relating to the 2018/19 tax year, the individual may still be in time to amend his or her self-assessment tax return. Otherwise, the Digital Disclosure Service, and Worldwide Disclosure Facility may be suitable. However, where there have been deliberate omissions, the Contractual Disclosure Facility might be preferable to secure immunity from potential criminal prosecution.

For those letters which are educational, and issued in advance of a due tax return, particular care should be taken to ensure that the subject of the nudge letter is addressed and that the return is complete and correct.

Trident Tax has extensive experience of tax domicile, tax residence, HMRC investigations and voluntary disclosures. If you or your clients wish to discuss how to respond to a nudge letter, please contact us.

In this article we take a look at the growing number of domicile enquiries by HMRC, which looks set to increase further following their recent success in the Henkes case, more of which later.

A particularly challenging aspect of domicile enquiries is the fact they look back over the life of the individual – and often of their parents –  to establish their likely domicile status if it is unclear – which means there can be great difficulty in providing documentary evidence to help prove what may be well known family history. However, domicile enquiries can also look into the future, seeking evidence of an individual’s stated objective of leaving the UK; this too can present evidential difficulties.

If documentary evidence can’t be found to prove the facts of the past and the plans for the future, HMRC and tax tribunals are entitled to draw inferences about what is the most likely state of affairs based on the civil standard of proof; the balance of probabilities. Over the years, courts and tribunals have wrestled with the difficulties a lack of clear evidence can create and in particular, how much weight should be given to declarations of an intention to leave the UK. In Henkes the judgment noted that “those declarations need to be examined critically in view of the fact it is clearly in the interests of the Appellant to say that his intentions are not to remain in the UK indefinitely. This means that the Appellant’s intentions (quoting an earlier case) “have to be ascertained by the court as a fact by a process of inference from all the available evidence about the life of the Appellant”.”

Awareness of the standard of proof and the tribunal’s approach to critically examining statements of intention against the facts should help taxpayers to ensure they gather and retain evidence of their family history, major life decisions, connections with their country of domicile versus the UK and, perhaps most critically, their plans to leave the UK.

The Henkes case provided a number of avenues for HMRC to challenge the past and future actions of the taxpayer and demonstrates that decisions on domicile rarely turn on a single aspect of a person’s life, but rather are more likely to result from an accumulation of evidence across various aspects. It is also worth noting that HMRC take a forensic approach to gathering evidence in minute detail, which is consistent with this view that it isn’t only the major decisions that are taken into account.

Mr Henkes was born in Venezuela to a Dutch father, he was educated in the USA and was a Dutch passport holder, although he appears never to have lived there. Mr Henkes arrived in the UK in 1967 at the age of 23 and had remained UK resident since then. His wife, children and grandchildren all lived in the UK and although he owned a large property in Spain, it was noted that he used the property typically for holidays.

The other key factors that indicated Mr Henkes had acquired a UK domicile were as follows:

  • His wife appeared to be reluctant to leave the UK; this statement was made in a letter to HMRC and although it was retracted, the tribunal still considered it was significant
  • Mr Henkes stated he would leave the UK when he retired but there was a lack of clarity over if and when he would actually retire
  • He travelled to his home in Spain for holidays and then returned to the UK rather than spending extended time in Spain
  • Most of his non-executive work was outside the UK, he did not have to remain in the UK to obtain work or to carry out his work
  • Mr Henkes’ domicile or origin was unclear (Venezuela or Netherlands) and the tribunal decided he had no meaningful links in either country
  • The tribunal decided his intention to retire was no more than a vague aspiration

 
But what will prompt HMRC to enquire into a person’s domicile status?

The change of law in 2017 to introduce the concept of deemed domicile for income tax and capital gains tax purposes after 15 out of 20 preceding years of UK residence has been a major trigger for domicile enquiries. Taxpayers who are deemed domiciled cannot elect for the remittance basis of taxation and their overseas income and gains must be included in their tax returns.  However, settling a protected trust prior to acquiring deemed domiciled status or acquiring a UK domicile of choice can achieve many of the benefits of the remittance basis, depending on client circumstances.     Settling a trust may pique the interest of HMRC with a view to questioning whether a UK domicile of choice has been acquired at some point before the date of deemed domicile.

Those who are not yet deemed domiciled and continue to elect for the remittance basis can also attract enquiries, particularly older taxpayers whom HMRC might judge to have settled here permanently.

New arrivals in the UK are not immune from HMRC’s attentions; we have had to explain to a number of people in their 70’s and 80’s that it is simply not realistic to expect that HMRC will agree they are not settling here permanently or indefinitely unless they can demonstrate very clearly why their stay is only temporary.

There are of course many other triggers to prompt a domicile enquiry (including, perhaps most notably, the death of the taxpayer with a view to considering their Inheritance Tax position) which will be specific to the particular circumstances of an individual and the enquiry is likely to be lengthy and onerous in terms of the questions and information requested. Therefore, we recommend that rather than being reactive when a domicile enquiry is made, non-doms should take a proactive stance and continually maintain and add to a “domicile file” to safely record evidence of their origins, past actions and future plans to ensure that domicile status can be adequately evidenced to HMRC and the tribunal if required.

If you would like to discuss any issues in relation to domicile please contact us

As we all know by now, most EBT/EFRBS type arrangements don’t “work” in the sense they are not accepted to deliver the hoped for tax result. Cases such as Oco/Toughglaze and Rangers saw to that, with the result that many taxpayers who entered into such schemes admitted defeat and have settled the tax liabilities arising with HMRC, particularly with the threat of the 2019 loan charge hanging over them instead (more on that below).

The arrangement considered by the GAAR panel on this occasion presented a twist on such planning arrangements. The twist was that the beneficiaries of the trust are not the employees of the business but rather (for all intents and purposes) providers of finance to the Trust. In this particular case, the provider of finance happened to be the director of the company that established the trust. The director in question lent £100 per month to the trust (which was repaid a month later so no more than £100 was ever outstanding). In return, the trust lent the director approximately £125,000, which was essentially the sum contributed to the trust less promoters fees. The company claimed a Corporation Tax deduction for the sum contributed to the trust, and it was claimed that the loan to the director was not taxable and, in particular, was not taxable under the Disguised Remuneration legislation as the loan was not connected to his employment.

In April this year the GAAR advisory panel – a body of independent tax specialists which opines on the “reasonableness” of certain tax planning considered to be abusive by HMRC – reported that the arrangements were in its view contrived and served no purpose other than to avoid tax, and therefore concluded that the taxpayer entering into the arrangements was not a reasonable course of action in relation to the relevant tax provisions. That is the same conclusion they had reached on various EBT “fettered payment” schemes previously.

On 1 September HMRC issued Spotlight 56, warning that taxpayers who entered into such arrangements on or after 17 July 2013 (when the GAAR legislation was introduced) may now receive a “GAAR counteraction notice” – essentially allowing HMRC to adjust any relevant tax returns to reflect the correct position, which is likely to include a PAYE and NIC charges on the company in respect of the amounts “loaned” to the Director). Although the taxpayer has the right to appeal any such adjustments to the Tribunal, the chance of success would appear to be slim in view of the GAAR panel’s view on the arrangements. Furthermore, the issuance of a GAAR counteraction notice also allows HMRC (if it couldn’t do so before) to issue an Accelerated Payment Notice – forcing collection of the tax now, even if the taxpayer appeals to the Tribunal. HMRC suggest that if taxpayers want to avoid this, they should contact HMRC to settle the tax that is due instead, to avoid any ongoing costs of investigation and litigation. HMRC have said that “no special terms” will apply to taxpayers who settle after 30 September 2020, although it may be noted the settlement terms HMRC have offered previously appear to offer little in the way of an incentive in any event.

For those affected, the timing of the publication of the GAAR Panel’s opinion is unfortunate, perhaps due to COVID 19 delays. The GAAR panel opinion is dated 7 April, it appears to have been published by HMRC on 28 August and followed by the issue of the Spotlight on 1 September. It means employers were given only a month to decide whether to reach settlement with HMRC, which will simply not be practical in some cases.

If that doesn’t give clients (and their advisors) enough to think about, HMRC also make the point in the spotlight that the 2019 loan charge may apply to outstanding loans in this and similar cases. This was discussed in more detail in previous newsletters and is, broadly, a charge to PAYE/NIC on loans made to employees through tax avoidance arrangements such as EBTs, that were not otherwise be charged to tax as income in the past. The liability arises on 5 April 2019, but (following much controversy regarding the loan charge) now only applies, again broadly, to loans made between 9 December 2010 and 5 April 2016, and only then if they were not fully disclosed to HMRC. Settling the historic liabilities associated with the planning arrangements with HMRC is an effective (if costly) way to avoid the loan charge.

The timing of this announcement also means that in cases where the employer does not settle with HMRC, the individuals with loans outstanding at 5 April 2019 need to decide whether to amend their 2018/19 returns by 30 September to include the Loan Charge. Our understanding is that some users of schemes that rely on them not being able to benefit from the trust as a result of their employment may have been advised that the loan charge will not apply to their loans, so this may come as a considerable surprise to them. If the employer does not meet the liability, it will fall to them instead.

As already explained, this may also require some immediate action to be taken. Taxpayers within the loan charge are required to report the loan charge on their 2018/19 tax return, and in such cases HMRC have extended the date for submission of the relevant tax return to 30 September 2020, less than two weeks from now. If the individual taxpayer wants to spread the loan charge over 3 years, they also have to submit a loan charge reporting form by the same date.

Affected taxpayers will therefore need to consider the position carefully, but quickly. Do they settle with HMRC now to avoid the loan charge, or do they continue the fight to the Tribunal (despite the GAAR panel decision) and suffer the loan charge instead, should it be in point? As a further complication, HMRC have made it known that a penalty of up to 60% could be levied if the arrangement was used after 15 September 2016.

If you would like to discuss this matter further, please contact us.

We have previously discussed the planned extension of the Off Payroll Working rules to medium and large size employers in the private sector from 6 April 2021. This involves shifting the responsibility that currently exists under IR35 for a supplier company to operate PAYE to the engager that pays the intermediary supplier company. Medium sized and large employers will be required to consider arrangements involving contracts granted to suppliers who provide their services through a personal service company or similar entity and decide whether PAYE should be operated. There will be difficult decisions to make for the engagers.

An engager must issue a Status Determination Statement to a worker and any third party it contracts with. This is no small undertaking. The new rules will require an engager to take reasonable care and HMRC has issued guidance on what constitutes reasonable behaviour. The range of criteria for reasonable and unreasonable is almost as complicated as determining a worker’s status. We will look at this process more closely in an upcoming newsletter.

Engagers could decide in all cases of doubt to determine a worker as having an employment status , thereby increasing the commercial risk of losing access to an important skills base or risking further complications when determinations are challenged. Alternatively, they may continue to operate the rules appropriately and comprehensively so that the service providers stay on existing terms where that is the correct basis for an engagement. However, utilising that second approach will come with the knowledge that the primary financial risk for any failure to operate PAYE correctly rests with them as the engager, notwithstanding the fact that most contracts for services include tax indemnity clauses.

Beware HMRC enquiries

But what if HMRC challenges a status decision where an engager decides there is not a requirement to operate PAYE? To recap the new rules briefly, an engager must make a decision on the status of any contractor and ask themselves whether the individual delivering the services would be considered to be an employee of the engager but for the existence of a personal service company or similar entity through which the services are provided (the IR35 rules). HMRC can review and challenge a decision not to operate PAYE under the new Off Payroll Working rules.

Beware any such enquiries; the House of Lords Select Committee that reviewed Off Payroll Working heard evidence of unsatisfactory attitudes and approaches by HMRC officers that echo our own experiences in some cases.

HMRC has an agenda

HMRC will not make enquiries into the status of individuals who are deemed by engagers to be within the scope of the new rules and subject to PAYE. As with the current rules and IR35, HMRC’s objective is to identify individuals whom they consider should be within the scope of PAYE and to collect additional tax and duties. The pitfalls listed below reflect an approach that is intended to increase the scope of PAYE. It would be naïve to assume HMRC is simply carrying out routine health checks when it looks to test how the new rules are being operated. The conclusion of such an enquiry can involve assessments to tax, interest and penalties and so engagers should pay close attention to any interaction with HMRC from the very beginning.

Don’t let HMRC’s views or opinions become facts

Where a Revenue Officer is tasked with finding evidence of an employment, it is possible that they will interpret answers to questions or information that supports a case for employment status. In our experience, there can be a further risk that officers will listen for certain answers, assume a certain emphasis or attempt to “fill in blanks” that are consistent with an anticipated or desired pattern. The danger is that information gathered at meetings can be skewed or moulded by asking leading questions or by repeating answers for clarity which are not precise or have a different emphasis. The accumulated effect will alter the overall balance of the explanations given of a particular engagement. An officer’s preconceptions or opinions can begin to contaminate what should be a straightforward process of establishing the facts.

Everything you say or do is potential evidence

The answers to questions given at a meeting will be written down and used to produce meeting notes. You may think that this would be a collaborative process where both parties look to agree the facts but that is not necessarily the case. We have encountered situations where meeting notes contain errors because an officer has misheard, misunderstood or misconstrued answers given at a meeting. When brought to the officer’s attention we have been told not only will the notes not be changed but, if necessary, the officer’s handwritten notes will be produced as evidence at a Tribunal Hearing. Regrettably, in a particular case and after going through the complaints procedure in HMRC, this approach was supported by senior managers within HMRC. This confirms the need to manage any meetings with HMRC closely to prevent the risk of any such behaviour.

HMRC may cherry pick its evidence

Having described a process where answers given at a meeting are written down, converted into notes and put forward as evidence, that does not necessarily follow where answers to questions do not support HMRC’s aim of finding that an employment status exists. The notes may record answers to questions that indicate there is no employment status, but these answers will not be regarded as concrete evidence in the same way that answers supportive of an employment are treated by HMRC. In fact the reverse is likely to happen, whereby answers and explanations supplied to HMRC are often dismissed unless contemporaneous documentary evidence is supplied to back up the answers; this reflects the view that “if it isn’t written down it didn’t happen”. Evidence given to the House of Lords Select Committee records complaints of HMRC simply leaving out crucial evidence from status reviews such as unfettered substitution rights. HMRC officers fully understand the significance of such rights and, unfortunately some will try, if possible, not to recognise them.

Don’t allow HMRC officers to introduce their own definitions and criteria

The right to substitution, where present in an engagement, presents a difficulty for HMRC. It is a key indicator of self-employed status. HMRC officers may seek to blunt the effect of substitution rights by redefining them as not being “true” rights because the right has not been invoked or the officer presumes it will never happen. In one case, we were able to show circumstances in which substitution took place, but this was dismissed because it was in the year prior to the period that was under review despite the same terms and conditions existing throughout the engagement.

Don’t assume HMRC officers always know what they are doing

HMRC officers may speak with confidence and authority when presenting decisions, putting forward computations and threatening litigation. The reality is that some officers do not have an adequate knowledge of the legislation and relevant caselaw but instead base their approach on HMRC’s own guidance and policies, both formal and informal. In one case, the HMRC officer conducting an enquiry did not understand the IR35 rules, did not understand that HMRC had no discovery position, was out of time to make assessments and was incorrectly grossing up income for PAYE purposes and simply got some things wrong. The same individual was still prepared to use the threat of a contentious appeal hearing before the Tribunal to try and persuade an engager to settle on HMRC’s terms. We strongly recommend that everything that an HMRC officer puts forward as a recoverable liability at the conclusion of an enquiry should be checked via the relevant legislation.

Finally, many public sector employers avoided difficult decisions when operating the Off Payroll Working rules by simply treating all contractors as employees and operating PAYE. Evidence of this was put before the House of Lords Select Committee. This has caused serious difficulties for some agencies that can no longer recruit key service suppliers. Unless the private sector goes down the same route, there will inevitably be occasions where engagers receive enquires from HMRC into the operation of the new rules.

If you need help or advice on any HMRC enquiries or IR35 matters generally, please call one of our team.

Following the Finance Act 2020 receiving Royal Assent, and HMRC publishing updated guidance on its settlement terms, users of EBTs, EFRBS and other disguised remuneration arrangements should note that urgent action may be required by 30 September 2020.

Background

Disguised remuneration legislation introduced in March 2016 aimed to tackle disguised remuneration arrangements including EBTs and EFRBSs where remuneration was provided by way of loans rather than salary or bonus by imposing a “loan charge” on the balance of such loans outstanding on 5 April 2019. As originally introduced, the legislation applied to any loans taken out from April 1999 onwards that had not been repaid by 5 April 2019 and attracted widespread criticism for its retrospective effects.

Following the publication of Sir Amyas Morse’s independent review in December 2019, the Government agreed that:

  • the loan charge would only apply to outstanding balances of disguised remuneration loans made between 9 December 2010 and 5 April 2019 inclusive;

 

  • the loan charge would not apply to loans made between 9 December 2010 and 5 April 2016 if those loans were fully disclosed to HMRC and HMRC had failed to take any action such as opening an enquiry;

 

  • those impacted by the loan charge would be able to elect to spread the loan balance over the three consecutive tax years ended 5 April 2019, 2020 and 2021;

 

  • late payment interest would not be payable for the period 1 February 2020 to 30 September 2020 on any 2018/19 self-assessment income tax liability provided the tax return is filed, and the tax paid, or an arrangement to pay the tax agreed with HMRC, by 30 September 2020.

 

The required changes to the original legislation were made in Finance Act 2020 which received Royal Assent on 22 July 2020 and HMRC recently published updated guidance to its settlement terms.

The updated legislation and HMRC guidance have important implications and actions may be required by 30 September 2020 depending on individual taxpayers’ circumstances.

HMRC has made clear that taxpayers should not hold out hope that special terms will be available for calculating or paying the loan charge and that settlements must be consistent with the legislation. It is therefore important that all those impacted review their position and take action if required.

 

Actions required by 30 September 2020

Taxpayers seeking settlement under the original terms

Taxpayers who commenced settlement discussions with HMRC by 5 April 2019, will still be able to settle under the original terms published in November 2017. However, they will need to engage with HMRC and reply to HMRC by any dates specified in HMRC correspondence to enable settlement agreements, and any extended payment arrangements, to be agreed by 30 September 2020.

If such taxpayers have non-disguised remuneration charge income for the year ended 5 April 2019 to report, they will need to submit a self-assessment tax return for that tax year by 30 September 2020 if they have not done so already.

 

Other disguised remuneration scheme users impacted by the loan charge

Those who have outstanding disguised remuneration loans at 5 April 2019, where those loans were taken out after 9 December 2010, and not fully disclosed to HMRC, will also need to take action by 30 September 2020. In particular, they will need to:

  • report the loan balances outstanding at 5 April 2019, if they have not done so already;

 

  • decide whether to elect to spread the loan balances over the three tax years ended 5 April 2019, 2020 and 2021 and if they decide to spread the loan amounts over these three tax years, to complete and submit an election by 30 September 2020;

 

  • if they have not done so already, submit their self-assessment tax return for the year ended 5 April 2019 and report the disguised remuneration income for that year in the relevant section;

 

  • pay the loan charge, together with any other tax due, unless they have agreed an extended payment plan with HMRC.

 

Taxpayers who have already settled

Taxpayers who have settled with HMRC and are not due a refund do not need to take any further action.

Taxpayers who have already settled with HMRC for those years that were otherwise “unprotected” because HMRC was out of time to raise assessments, and the payments were therefore voluntary restitution, will be able to reclaim the refund of any element of their settlement where the loan charge would not apply as a result of the post-December 2019 amendments.

HMRC should contact them automatically by 30 September 2020 with details of how to claim the refund and they will have until 30 September 2021 to submit their claim. However, if you think you are entitled to a refund and have not heard from HMRC by 30 November 2020, you should contact HMRC directly.

 

Other disguised remuneration scheme users

HMRC has also published new settlement terms applicable to loans not subject to the loan charge, essentially, those relating to periods before 9 December 2010 where HMRC has open enquiries.

HMRC intends to pursue such open enquiries to conclusion. HMRC has said that where taxpayers choose not to settle under its updated terms, it will continue its enquiries until it can issue conclusions and assessments which can be appealed before the tribunals. It notes that reaching finality in such cases might still take many years with legal costs and late payment interest continuing to accrue in addition to any tax that payable should HMRC succeed.

 

If you require assistance in respect of any of the above, please get in touch.

The latest Finance Bill extended the “Off payroll working” rules (originally IR35) as they apply to public sector bodies to medium and large companies in the private sector. The start date has been put back to 6 April 2021, which is to be welcomed, but will those affected be ready for the change?

Who is affected?

Only small companies are exempt. The definition of a small company is one with no more than:
• £10.2 million of turnover (£12.2 million gross)
• £5.1 million Balance Sheet assets (£6.1 million gross)
• 50 employees
It is thought that 60,000 engagers will be affected.

What does it mean?

The IR35 rules were introduced 20 years ago. They were intended to address the situation where an individual provided services to an engager through a personal service company (PSC) but, except for the presence the PSC, would have be regarded as an employee of the engager. The PSC allowed the individual to achieve certain tax efficiencies by timing when they were paid, taking dividends, etc and the engager was not required to pay employer NIC. The IR35 rules apply to individuals that would otherwise be considered employees of the engager and require any intermediary body, such as a PSC, to operate PAYE on the income it receives from the engager for the services delivered by the individual.

A private sector company within the new rules will need to determine whether an individual who is engaged via one or more intermediaries should be regarded as an employee under the IR35 rules. The engaging company will be required to prepare a Status Determination Statement and provide a copy to both the worker and the person or organisation with which the contract for services is held. It must state the conclusion and the reasons for coming to it. A determination of employment status will have consequences:

• The fee payer will be treated as an employer for income tax and NIC
• Any fees paid will be treated as employment income
• The fee payer must operate PAYE and pay employer NIC
• PAYE must be reported and paid through HMRC’s Real Time Information system

What approach to take?

The extension of off payroll working rules to the private sector follows a roll out of the same rules for public sector bodies from 6 April 2017. A House of Lords select committee has reviewed the off payroll working rules and heard evidence from representatives of public sector bodies that have been affected. The committee’s report is uncompromising in setting out the shortcomings of IR35 and the generally negative public sector experience.

Line of least resistance?

The committee heard evidence that many public sector agencies had simply issued blanket status determinations and treated all service providers as employees in the belief that they were less likely to be challenged by HMRC. Undoubtedly, their logic is sound; HMRC will be very happy to receive IR35 PAYE even if this is the result of an incorrect or over-prudent decision, but that decision comes at a cost:
• The fee payer will need to pay 13.8% Employer NIC in addition to any fee paid to a supplier as well as deducting PAYE and employer NIC
• The fee payer must take on additional administration costs and risk around the required PAYE reporting
• Some engagers giving evidence to the committee said that they lost key contractors because of the decision to treat them as employees, which jeopardised major projects
• Other contractors demanded higher fees to compensate for the amount now lost in payroll taxes.

Embrace the challenge and apply the rules as intended?

But will you get it right? The House of Lords select committee heard evidence that pointed to the failings of HMRC to help fee payers to get it right. For many years, HMRC has made available on-line software called Check Employment Status for Tax tool (CEST). Unfortunately, the committee heard that it may only be able to provide an indicated status for a little over 80% of the engagements tested. That aside, the committee heard evidence that the software was fundamentally flawed owing to the absence of key tests applied to employment status. It was widely perceived to produce disproportionately more employment status decisions; the answer that best suits HMRC. Evidence was given that CEST results were often overturned at Tribunal and examples were given where the results were skewed because HMRC did not agree to key factors being inputted.

Clearly, anyone looking to operate the off payroll working rules rigorously will need to have an organised process for reviewing and determining the status of those service suppliers that could be within the IR35 rules and arm themselves with the appropriate tax advice. A strategic approach should reduce the uncertainty and burden of the new rules. It may be possible to apply suitable filters to arrive at clear groupings of those who are definitely outside or inside the rules and then focus effort to consider the more difficult cases. These too may be grouped and sampled to reduce the level of intervention before applying resources carefully to make the difficult decisions as reliable as possible.

The important message is to make sure you have adequate records to support the decisions you make. In our next article we will look at what it means to be on the receiving end of a challenge from HMRC and to go through a difficult enquiry into the employment status of service suppliers engaged by a company.