with careful management, the uk can be a tax planner's dream for foreign expatriates
The UK's tax system uses the connecting factors of domicile, residence and ordinary residence to determine an individual's liability to income tax, capital gains tax and inheritance tax (IHT). An individual who is domiciled, resident and ordinarily resident in the UK is 'fully connected' with the UK and will be liable to income tax on their world-wide income, capital gains tax on their world-wide gains, and IHT on their world-wide estate.
Both UK and foreign income and gains are liable to tax in the year of assessment in which they arise, regardless of whether they are remitted into the UK.
However, a non-UK domiciled individual who becomes resident and ordinarily resident in the UK is assessed on the following modified bases:
• To income tax on UK source income as it arises, but only on foreign income when it is remitted into the UK.
• To capital gains tax on UK gains as they arise, but only on foreign gains when they are remitted into the UK.
• To inheritance tax only on UK situated assets, but not on foreign situated assets.
In practice an individual who has a foreign domicile of origin can become permanently resident in the UK without acquiring a UK domicile of choice if the individual can show that their stay in the UK, albeit protracted, has a defined break-point in the future for example, on their retirement from working in the UK, or when the political situation in their estranged home country has normalised, or when their children have completed their education in the UK and so on.
If the individual can manage to break their tax connection with their home country, for example, because they are no longer resident there, then they will be able to use the UK as a tax haven by taking advantage of the restricted, privileged bases of assessment that apply to non-UK domiciliaries.
The non-UK domiciliary living in the UK could arrange their affairs such that they totally avoid UK taxation by only receiving foreign income, only realising foreign gains and retaining their funds and assets offshore. However, in practice this will not be feasible since the individual clearly needs money in the UK to live on, and will therefore have to make remittances from abroad, and may well want to put assets in the UK investment and property markets, and therefore have UK situated assets. In addition, if their stay in the UK is protracted, then they may become domiciled or deemed domiciled in the UK and therefore expose their world-wide estate to IHT.
One possible solution to their UK funding requirements is to remit only 'clean capital' into the UK. Clean capital is cash held offshore which can be remitted into the UK without incurring a charge to income tax or capital gains tax. Examples of possible sources of clean capital can include:
• Funds that have been received by way of gift or inheritance. Gifts between husband and wife are considered to work, but the donor spouse must not in any way benefit from remittances made out of the gift. This may be difficult in practice, and so great care must be taken if using this arrangement of the recent case of Grimm vs Newman , which can be found at http://www.bailii.org/ew/cases/EWCA/Civ/2002/1621.html and will be discussed in next month's article.
• Funds that have already been taxed for example, income or gains already subject to UK or foreign tax accumulated offshore.
• Funds including income or gains which arose when the individual was not resident or ordinarily resident in the UK.
• Funds including income (not gains) where the source has ceased in a previous tax year.
• Funds deriving from assets sold at a loss.
Bringing an asset into the UK such as a motor car does not constitute a remittance, so that funds 'tainted' with income and gains can be used to acquire assets abroad which are then brought into the UK without attracting a tax liability. However, if the asset is subsequently sold in the UK the proceeds would represent a remittance. The asset should therefore be exported before sale to avoid a remittance.
The problems in practice with the solution of only remitting clean capital are first establishing the provenance of funds held offshore at the time of becoming resident and second, ring-fencing and segregating funds during the period of residence, which may extend to decades. It is therefore extremely important that careful pre-residence planning is undertaken to identify and create clean capital pools offshore and that funds are carefully managed post-residence. Once established these pools can be used to make tax-free remittances using the 'two bank account trick.'
The 'two bank accounts' trick works because it is a principle of UK tax law that there can be no liability to taxation in a year of assessment in respect of income unless the source of that income exists in that year of assessment. If, therefore, a source of income such as an offshore bank account is closed at the end of year one and the interest earned on the account during year two is remitted in year two, then that interest will not be assessable to UK income tax. It has magically become 'clean capital.'
For this solution to work two bank accounts are operated such that the interest earned on the original deposit is credited to a separate income account, rather than the deposit account itself, so as to avoid mixing the interest and the original deposit. The capital in the deposit account can also be remitted into the UK tax-free so long as it is also clean capital.
A trap for the unwary is that bank accounts in foreign currency represent chargeable assets for UK capital gains tax purposes and a remittance out of the account can generate a gain in itself which would be caught even though the funds in the account constitute clean capital.
One possible solution for investing in UK investments and property is to hold them in an offshore company and/or trust. An offshore company can be used to shift the location of UK assets offshore thereby taking these assets outside of the scope of inheritance tax. The capital gains tax anti-avoidance legislation, which has attacked the use of such structures by UK fully connected individuals, has generally not been extended to non-UK domiciled, resident individuals.
However, great care must be taken in running these structures since the Revenue is increasingly bringing criminal actions or attacking the structures as shams, usually as the result of ineffective administration.
Under the UK's IHT rules the status of a trust is determined by the domicile position of the settlor when the trust is created. This rule traps trusts created by UK-domiciled individuals within the UK IHT net despite the fact that the settlors may have subsequently become domiciled outside the UK and frustrates a lot of tax planning for individuals permanently leaving the UK.
However, the rule works in favour of a non-domiciled individual moving to the UK since a trust created by a non-UK domiciled individual is treated as being an excluded property trust for its entire existence regardless of any subsequent changes in that individual's domicile. As a result the assets in such a trust would remain permanently outside the scope of UK IHT , regardless of the fact that the individual could still benefit from the trust during their lifetime.
This means that if an individual comes to the UK with the prospect of a 'wobbly' domicile then they can use a trust to keep their foreign assets (which would include UK assets held by an offshore company) outside the scope of UK IHT for several generations despite that fact that they eventually become domiciled or deemed domiciled in the UK. The trust would also protect them from capital gains tax so long as his foreign domicile was retained
Offshore service companies in conjunction with dual employment contracts can also be used to protect the non-UK domiciliary's non-UK employment income.
This article has touched on only a small part of the tax planning available to non-UK domiciliaries who come to live in the UK, but should have indicated the extent to which the UK can be used as a tax haven.
However, what should have also been made clear is that this tax planning must be properly run to be effective. Non-domiciliaries are a favourite target of the Inland Revenue and it is essential if an enquiry is started that the individual can quickly demonstrate that their tax returns are correct and their offshore arrangements robust.
It used to be possible as an alternative to such planning for an individual to negotiate pre-residence their annual tax liability with the Revenue based on a statement of their world-wide assets, therfore avoiding these complicated, and expensive, planning arrangements. The Inland Revenue, however, has put this arrangement on hold, which means the no-domiciliary has no alternative to planning.
Whenever an individual is moving between countries both mitigation opportunities and liability risks arise. By taking professional advice, planning in good time and using offshore tax and estate planning solutions, the risks can be minimised and the opportunities maximised.
The UK has clarity of law and offers unique tax-planning opportunities for non-domiciliaries who wish to move there. For such individuals the UK can, indeed, be a tax haven.
The 'guidance' in this article does not constitute professional advice and is intended only as an informal introduction. The views expressed are entirely the author's own and should not be relied or acted upon in any way. Professional advice should always be sought before undertaking tax or estate planning.
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