Greg Jones looks at the suitable offshore opportunities available to mitigate UK tax and says that a little planning could go a long way
Despite the torrent of anti-avoidance legislation which has rained down upon offshore practitioners in recent years, there are still many opportunities to mitigate tax by conducting your affairs through the use of offshore entities.
Whether it is actually worth it depends on the circumstances of each case: you need to take into account not only the cost and relative inconvenience of placing your assets in the hands of offshore trustees and/or company directors, but the actual tax savings may not be what they once were.
UK Chancellor Gordon Brown recently proposed that taper relief in respect of so-called 'business assets' should now be available after only a two-year holding period. What this means is that if, for example, you have shares in a private company which you then sell at a profit, you will be eligible for a capital gains tax rate of only 10% provided you have held the shares for a minimum of two years. Offshore planning can rarely compete with such official largesse!
However, where the tax rates remain very high, for example, on the sale of straight- forward investments, it is worth considering what an offshore trust or company structure can do for you. Generally, the planning areas fall neatly into three categories: those for individuals who are both resident and domiciled in the UK, those for individuals who are resident but not domiciled in the UK, and those for people who are resident outside the UK. As can be imagined, critical to a proper understanding of these planning opportunities is an ability to recognise and distinguish the key concepts of 'residence' and 'domicile'.
Residence and domicile
Generally speaking, you are resident in the UK for tax purposes if you have always lived there. If, however, you are or have been living outside the UK, then you would still be resident in any tax year (ending 5 April) if you spent more than six months in the UK during that year. If you spend less than six months in the UK but more than three months, and exceed this figure over a period of four years or more, then you would become resident from the beginning of the fifth year. In counting the number of days spent in the UK for both the six month and three month test, you can ignore any day spent travelling. This means that for all practical purposes the real number of days spent in the UK can be even higher. It is theoretically possible to be resident nowhere for tax purposes, by only spending small amounts of time in a large number of countries.
Domicile is a much broader concept. It relates not simply to where you spend your time (as is the case with residence), but which country you regard as your natural homeland. You may be domiciled in a country in which you have not lived for many years. Indeed, whereas residence can be defined as the place where you are living, domicile can equally be defined as the place where you want to die!
Whatever your domicile, however, everybody must have one (whereas, by contrast, it is possible to be resident nowhere). There is a special rule in the UK which operates solely for inheritance tax (IHT). A person who has been living in the UK for 17 out of the previous 20 tax years becomes deemed domiciled in the UK for IHT purposes. A foreign national can, therefore, retain their non-domicile status for general legal and other tax purposes, but will become UK domiciled for IHT. The significance of this is considered below.
People who are both UK resident and domiciled pay tax in the UK on all their worldwide income and capital gains whenever they arise, regardless of whether the funds are paid into the UK. In addition, someone who is UK domiciled will be within the scope of IHT when they die, meaning that 40% tax becomes payable on the value of the estate in excess of the IHT tax-free band (at present, this is £242,000).
Someone who is not domiciled in the UK is only within the scope of IHT on property actually situated in the UK. This will not include, for example, shares in an offshore company, even though that company might own a UK investment property. It is, therefore, sensible strategic planning for a non-domiciliary to use an offshore company to hold UK investments. Additionally, someone who is not UK domiciled, but resident in the UK, only pays UK tax on income and capital gains arising in the UK. Foreign income and capital gains are not taxed until they are 'remitted' (paid into or otherwise enjoyed in the UK). Non-residents do not generally pay UK tax except on rent and trading profits.
For UK-domiciled residents, offshore planning is aimed principally at capital gains tax (CGT) avoidance. The simple use of offshore trustees to hold investments will not work if you create an offshore trust for the benefit of yourself or your spouse, children or grandchildren. If, however, a trust is created for other (non-lineal) family members, or third parties, it can be a useful deferral vehicle, since there is no tax to pay when capital gains are made by the offshore trustees.
However, tax is payable when payments are received by beneficiaries of the trust if they are themselves UK resident and domiciled. The sting in the tail is that the tax could be as high as 64% where there is a long delay between capital gains being made and distributions to beneficiaries. By planning the investment strategy carefully, however, this penalty tax charge can be avoided.
Offshore trusts can also be used for income tax planning by using two or more offshore trusts trading in partnership (land dealing is a particularly suitable activity) and relying on UK double tax treaty protection. This, however, is not for the faint hearted.
Using every option
An underrated and under-utilised offshore planning route is the use of non-resident life insurance contracts. These are essentially life policies issued by a non-UK insurer (typically this would be the offshore subsidiary of a major UK life company). Income and capital gains can generally roll up tax free within a non-resident policy, with no tax charge until maturity of the policy. This tax can be deferred even further by holding the policy in an offshore company. Life policies are most suitable for general portfolio investments, but in certain cases can also be adapted for private company shares or other, more personalised assets.
Where UK trustees hold portfolio investments it may be possible to export the trust offshore by bed and breakfasting within the same 30-day period. Once offshore, the trust can be further exported to a country with which the UK has a double tax treaty ' preferably one that does not levy capital gains taxes: Mauritius is often used for this purpose.
Offshore companies can also still be used by UK resident domiciliaries, but only if they are resident in a suitable treaty country, such as Belgium. Where investments are held in an offshore company, the usual route is for that company to form a subsidiary in Belgium to which the investments can be sold; this transaction will not produce a tax charge, and a subsequent sale by the Belgian company will not be taxed in either Belgium or in the UK. This device no longer works, however, where the offshore company is held by offshore trustees, rather than directly by a UK person.
Inheritance tax planning for UK domiciliaries does not rely on an offshore element. Generally, IHT planning at its simplest involves giving away assets before you die. However, a gift of investments standing at a large capital gain might trigger an unwelcome capital gains tax (CGT) charge. To avoid this, consider first gifting the investments into a discretionary trust, which will enable a CGT 'holdover' election to be made, to enable the CGT to be deferred. While this will be a gift for IHT purposes, by making the discretionary trust a short one, the value of this gift ' and thus the tax payable ' can be restricted to a negligible amount, if not avoided altogether.
Other IHT solutions which are currently very popular include the use of trusts to create a family fund which will not fall foul of the IHT 'gifts with reservation' provisions: often these are linked with a suitable life policy, allowing a 5% annual withdrawal of the original capital. Selling the family home in exchange for a promissory note which is gifted to a children's trust is also a way of removing property from your estate without restricting your ability to continue to enjoy use of the property.
Planning for non-domiciled UK residents is easier, since the UK tax rules still regard foreign domiciliaries as a favoured species, who need only pay tax on income and capital gains which either arise in or are brought into the UK. Some simple strategies arising from this, therefore, include:
• Minimising the levels of UK sourced income/capital gains.
• If it is necessary to bring in funds from overseas, making sure this is pure capital rather than income or capital gains.
• Making sure interest on offshore deposits is paid into a separate account, thereby allowing remittance of pure capital.
Where it comes to capital gains, non-domiciliaries are in an even more favoured position. Whereas a foreign domiciliary who makes a capital gain on the sale of non-UK assets will only pay tax when the proceeds are 'remitted' to the UK, such an individual who holds assets in an offshore trust pays no tax on distributions of proceeds of capital gains made by the trustees. This rule even extends to UK assets! On the face of it, therefore, there is no reason why a non-domiciliary should pay CGT. Even the general exception, which is that everyone pays CGT on the sale of assets used in the course of a UK trade, can be avoided by a non-domiciliary (or by a non-resident) by the simple expedient of first transferring the assets to a company incorporated outside the UK (the gain is allowed to be 'held over' at this point) and by the subsequent sale of the non-UK company shares. As seen earlier, by putting these shares into an offshore trust prior to sale, the proceeds could then be remitted to the UK tax-free.
A non-UK domiciled person who in is danger of becoming deemed domiciled in the UK through the 17-year rule should consider putting all their assets into a trust before this happens. Of course, it will first be necessary to make sure that no UK assets are directly held, by putting any UK property into an offshore company. Even if you then become a deemed UK domiciliary, the property which is already in trust will remain completely outside the scope of IHT. A word of warning here: the Inland Revenue recently announced it may be reconsidering its position on this point, but only in respect of new trusts. The moral, therefore, is buy now save later!
Finally, for non-residents the UK is generally a tax-efficient place in which to invest. Not only is there no CGT on the sale of investments, but both dividends and interest are generally tax free for a non-resident. Non-residents still pay tax on rents from UK property, but the higher rate of 40% can be avoided by making the investment through an offshore company, which also helps to keep the property out of the IHT net. Moreover, it makes good sense to keep taxable rents down to a minimum by maximising interest relief and other outgoings. This can often be achieved by the use of 'back-to-back loans', whereby a cash deposit lodged offshore is used as collateral for a 100% mortgage, effectively replacing taxable rents with tax-free deposit interests.
As can be seen, therefore, planning opportunities still abound, and there is still much mileage to be had from a suitable offshore structure. However, one should not overlook the simple things, which often involve little more than properly utilising tax breaks which the government has made available. Above all, it usually pays to take advice ' and not just for the adviser!
• Someone who is UK domiciled will be within the scope of IHT when they die.
• Non-residents do not generally pay UK tax except on rents and trading profits.
• The UK is generally a tax-efficient place in which to invest for non-residents.
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