Introducing the UK Requirement to Correct

Transcription

1 Introducing the UK Requirement to Correct Andrew Park The Requirement to Correct legislation included in UK Finance Bill 2017 is designed to capture any loss of UK Income Tax, Capital Gains tax or Inheritance Tax relating to non- UK offshore tax non-compliance. As such, its potential scope to capture the full range of inadvertent oversights is huge from simple failure to understand basic reporting requirements, through to the personal attribution of income and gains arising in overseas structures through anti-avoidance legislation. Even with no deliberate intent, Failure to Correct penalties of 100% to 200% of the potential lost tax revenue combined with 10% asset-based penalties will apply where full disclosure is not made to HMRC by 30 September 2018 where no reasonable excuse can be demonstrated. Family offices dealing with any connections to the United Kingdom must urgently instigate a review of the UK tax implications of non-uk assets and activities to engage with the risks. In turn, professionals providing family office services will need to carefully manage their own professional risks. Introduction Further to the UK government s ongoing drive against all forms of failed tax compliance, matters have taken a draconian new turn. Legislation in the UK Finance Bill 2017 will force full UK tax disclosure with regard to all offshore (ie, non-uk) related matters or relevant offshore transfers assessable to UK tax by 30 September 2018 or else the parties concerned will face hugely increased penalties of up to over double the original amount of omitted tax, even in circumstances where there was never any deliberate intent. The applicability and level of the new penalties will apply irrespective of the original behaviours which gave rise to the omissions. After a concerted UK campaign over many years to shake free the low hanging fruit by detecting or encouraging disclosure of deliberately undisclosed offshore bank accounts, the new measures highlighted in this article are very much intended to capture and penalise inadvertent non-deliberate non-compliance including that related to the sorts of bona-fide overseas investment or trust arrangements routinely set up over the years by family offices. It is the potential consequences in those sorts of inadvertent circumstances which I focus on here. What this means in practice for family offices Where parties have wilfully evaded UK tax they are at least cognisant of the fact. However, what of all of the other parties and their family office and other advisers who are, at present, utterly unaware that they have outstanding liabilities to UK tax with regard to their non-uk assets and non-uk activities? Wealthy families do, of course, tend to be international and to have sophisticated international arrangements to hold and manage their wealth. The risks are very significant. I will explain the measures further below and I will set out some common examples of where unwitting exposure may lie from the mundane, relating to basic reporting errors, through to some of the more complex and esoteric anti-avoidance provisions designed to capture non-uk offshore structures. The new Requirement to Correct (RTC) measures In summary: the statutory correction window applies between 5 April 2017 to 30 September 2018 the end date purposely coincides with the date of the first full mass exchange of financial information between all of the over 100 countries and territories participating in the OECD-led Common Reporting Standard (CRS); per the legislation: the tax non-compliance involves an offshore matter if the potential loss of revenue is charged on or by reference to income arising from a source in a territory outside the United Kingdom, assets situated in a territory outside the United Kingdom, activities 58 June

2 Introducing the UK Requirement to Correct carried on wholly or mainly in a territory outside the United Kingdom, or anything having the effect as if it were income, assets or activities of a kind described above; for the purposes of the legislation, offshore transfers relate to: assessable income received in a territory outside the United Kingdom or transferred on or before 5 April 2017 to a territory outside the United Kingdom; assessable capital gains where any of the disposal proceeds were received in a territory outside the United Kingdom or transferred on or before 5 April 2017 to a territory outside the United Kingdom; Inheritance Tax liabilities where: (a) the disposition that gives rise to the transfer of value by reason of which tax becomes chargeable involves a transfer of assets, and (b) after that disposition but on or before 5 April 2017 the assets, or any part of the assets, are transferred to a territory outside the UK; the measures are aimed primarily at personal tax liabilities and as such apply to all UK Income Tax, Capital Gains Tax and Inheritance Tax still assessable by HMRC as at 5 April 2017 this can be up to 20 previous years depending on factors such as whether no returns were filed or incorrect returns were filed and the relevant behaviours involved in either situation (for Inheritance Tax there is potentially no limit if no return incorrect or otherwise was ever filed); to give HMRC more time to process the information due under the CRS, a special statutory extension will allow any tax years still assessable under existing statute as at 5 April 2017 to remain assessable until at least 5 April 2021; in the event that any person fails to correct any irregularity by 30 September 2018, new civil statutory Failure to Correct (FTC) penalties will apply ie, to any individual or other UK legal personality including trustees, executors and companies with such UK tax liabilities regardless of whether or not they themselves are UK resident or UK domiciled (the exemption being a specific exemption for the UK Capital Gains Tax payable in some circumstances by non-uk resident companies); the FTC penalties will comprise: a new maximum 200% financial penalty applied to the final amount of undisclosed tax still assessable, this can be mitigated to no lower than 100%; a new further 50% uplift to the 100% to 200% financial penalty in the event of any attempt to move assets to a more opaque (ie, non-crs) jurisdiction to prevent discovery and FTC penalties making the effective penalty band in those circumstances 150% to 300% of the final amount of undisclosed tax; an additional financial penalty of 10% applied to the value of the offshore assets in cases where underpaid tax exceeded 25,000 for any tax year; potential naming and shaming where the loss of tax is greater than 25,000 in total or five or more FTC penalties are charged; in the event that a failure to correct occurs the only defence against the FTC penalties will be that the taxpayer had a reasonable excuse. In order to demonstrate that that they had a reasonable excuse post 30 September 2018, taxpayers will inevitably need to be able to demonstrate inter alia that they sought suitably competent independent professional advice to review all of their non-uk assets and activities for any potential UK tax oversights and that they provided such advisers with all relevant information. In the event that those reviews are not performed or the independent professionals involved are not held to be sufficiently expert in the relevant areas, existing case law suggests that any attempt to argue reasonable excuse is unlikely to be upheld before the UK courts. Such demonstrable specialist UK tax expertise will almost certainly not exist in-house within even the larger private single family offices or multi-family boutiques and, even were it to exist, questions might be raised about independent objectivity were a tax dispute to arise. It must be emphasised that the penalties will be applied in addition to HMRC also requiring full payment of the outstanding tax itself and late payment interest levied on the outstanding tax at HMRC s official rate of interest. Deliberate irregularities are not the focus of this article. However, it is also worth noting that in those circumstances HMRC might potentially opt to embark on a criminal investigation and prosecution rather than seek to apply the civil FTC penalties. Examples of inadvertent exposure I set out below some common examples of where exposure may lie: Reporting errors on overseas investment products The UK taxation treatment of such investments is not always straightforward and can even seem counterintuitive to taxpayers or advisers who are not fully au fait. Regularly seen errors include: failing to identify roll-up bonds / nondistributing bonds as offshore income bonds for the purposes of UK tax and the resultant June

3 The International Family Offices Journal The scope for errors or challenge over residence and domicilerelated matters is legion. Often, tax reporting is correct subject to the understood residence and domicile status but that understanding is flawed. failure to report any gains as income assessable to UK Income Tax (ie, rather than as a capital gains) while still needing to treat any losses as capital losses (not available for offset against any gains on those products to be treated as income); failing to report or correctly compute chargeable event gains arising with regard to offshore insurance products for instance, if encashments of offshore portfolio insurance bonds were made in excess of the statutory 5% annual drawdown allowance. Questions over residence and domicile The personal assessability of people to UK tax on UK or overseas interests or activities is determined by the interaction between the specific and separate UK concepts of residence and domicile. These relate to their degree of connection to the United Kingdom. Many people are understood to be tax resident in the United Kingdom but are not UK domiciled ( nondoms ) which requires a longer-term ongoing degree of connection. As such, they are understood to be not necessarily assessable in the United Kingdom on their overseas income or capital gains. However, the rules are complicated and evolve over time. The scope for errors or challenge over residence and domicile-related matters is legion. Often, tax reporting is correct subject to the understood residence and domicile status but that understanding is flawed. At its simplest, appropriate advice is not always sought when people move to the United Kingdom often the individuals concerned and their existing advisers and support network form invalid assumptions of their own based on what they think is logical or make assumptions based on outdated knowledge. It is common, for instance, to encounter UK resident taxpayers who assume that, because they are continuing to return income arising in their overseas country of origin and are paying tax there (the misconception seems particularly common with US citizens), that no reporting obligations might arise on that income in the United Kingdom. On the other-hand, plenty of long-term UKresident non-doms received valid advice on the prevailing UK domicile rules in place upon their arrival pre-6 April 2008 but who did not reorganise their affairs and did not change their reporting to take account of the regime from 6 April 2008, ie, to elect to pay the annual UK Remittance Basis Charge (RBC) or else to be taxed in the United Kingdom on their worldwide income and gains. Sometimes these individuals have substantial non-uk assets and are part of a wider family which has family office support but are, for instance, on the periphery of the family for whatever reason and have not sought or received timely ongoing advice. Many taxpayers have taken appropriate advice to determine their residence and domicile at all relevant times but then errors have been made by them and their representatives in taking account of their status such that taxable remittances may have arisen. For instance, the parties managing an overseas portfolio investment account on the taxpayer s behalf may have inadvertently purchased UK-sited investments because they were unaware that those purchases could give rise to taxable UK remittances for their clients. It is also not unheard of, for instance, for a person to have used a credit card paid for from an overseas account for overseas expenses further to sound initial advice but to then have lapsed into also using that credit card in the United Kingdom all such UK expenditure then potentially giving rise to taxable remittances for someone in their particular circumstances. Potential mischaracterisation of trusts and foundations Frequently, the characterisation of overseas trusts for UK tax purposes is not clear-cut the legal documentation can be ambiguous or there can be questions over whether it truly reflects the substance of the arrangements. Although parties may have filed UK tax returns based on the apparent legal form of the arrangements, that treatment may not be consistent with a full current analysis of the position by a specialist UK tax adviser or with the position HMRC would itself adopt upon a full review of the facts. For instance, many trusts regarded at face value as discretionary trusts were at one time created overseas for UK residents at the instigation of overseas advisers in order to circumvent foreign withholding tax that would 60 June

4 Introducing the UK Requirement to Correct otherwise have been deducted under the provisions of the European Savings Directive. Although clients were often ill-advised and never intended any illegal subterfuge, there was also often no conscious intention on the part of the so-called client settlor to settle a proper trust and the named trustees were later wholly subservient to the settlor and exercised no independent discretion. In those circumstances, one would expect HMRC to characterise the position as that of a nominee arrangement for UK tax purposes. Indeed, I have seen many such situations where HMRC has taken that view not necessarily to the ultimate disadvantage of the taxpayer in light of the transfer of assets points that might otherwise apply as below. Additionally, many UK residents have interests in overseas foundations established in countries which have a Civil Law legal framework. These are alien legal constructs in the United Kingdom which have no direct UK equivalent prescribed to them in UK statute. Accordingly, the UK tax treatment of interests in these constructs requires full consideration of the facts to determine the closest equivalent under UK Common Law. In practice, there can be no absolute certainty as to the appropriate characterisation and UK tax treatment in any given instance without entering into a dialogue with HMRC and confirming its agreement to any treatment adopted. Potential personal attribution of the income and gains arising in overseas structure under UK Transfer of Assets Abroad legislation Under longstanding UK statutory anti-avoidance provisions, the income and gains arising within overseas structures could be attributed to and personally assessed on UK resident individuals in the past tax years in question. I refer to: Section 720 of the ITA 2007 itself evolved from Section 739 of the ICTA 1988 with regard to the potential attribution of income arising in trust and corporate structures to UK resident individuals who created those structures and who retained the power to enjoy income arising in them; Section 86 of the TCGA 1992 with regard to the potential attribution of capital gains arising in trusts to the settlors of those trusts; Section 13 of the TCGA 1992 with regard to the potential attribution to UK resident participators of capital gains arising in overseas companies with five or fewer controlling participators (or any number of participators who are directors). Although these provisions are now familiar to many more UK tax advisers, in practice, overseas advisers and trustees in particular frequently had limited past awareness of them and UK advisers unfamiliar with the overseas aspects of UK taxation were also not always sufficiently aware of them to identify the risk that their clients were potentially or certainly assessable in such a way. Upon reviewing the full facts relating to any overseas structure one can now confidently expect HMRC to consider any transfer of assets abroad implications as a matter of course. HMRC is aware that many structures, particularly older ones created at the instigation of overseas intermediaries, were created without any thought as to whether UK resident individuals could be personally assessable under the transfer of assets legislation. Furthermore, parties often became inadvertently assessable by: moving to the United Kingdom and becoming personally resident in the United Kingdom after creating the structures; getting incomplete advice at creation for instance, acting on advice to irrevocably exclude themselves from benefiting from a trust in the attempt to prevent possible assessment under Section 720 but failing as part of that to irrevocably exclude their spouse; not getting appropriate advice on the routine operation of a structure for instance, non-uk domiciled individuals who were still potentially assessable under Section 720 in the event that UK source income of a UK subsidiary was paid up to the overseas part of the structure as a dividend. Other trust-related oversights Other common reporting errors that occur in relation to overseas trusts include: internationally mobile beneficiaries becoming UK tax resident after the structure was implemented and their representatives failing to take appropriate UK tax advice or to notify the trustees of their change of status resulting in them and the trustees failing to identify taxable distributions or benefits; the settlement of overseas discretionary trusts by long-term UK-resident settlors who were not identified as being deemed domiciled for UK Inheritance Tax purposes at the time of settlement (even before the latest changes applying to future tax years, the United Kingdom already had a longstanding 17 years resident out of 20 deemed domicile rule for Inheritance Tax) and were therefore subject to a lifetime Inheritance Tax charge upon settlement and the trustees were therefore also subject to UK Inheritance Tax 10-year charges as well as potential Inheritance Tax exit charges on distributions; the inadvertent mixing of the overseas funds June

5 The International Family Offices Journal from which beneficiary distributions were made by overseas trustees and investment managers and the unwitting remittance of taxable income or gains to the United Kingdom in place of untaxable clean capital. Errors of implementation or administration Sometimes, despite the best intentions and despite generally sound planning advice, potential tax exposure arises as a result of implementation or administrative errors or as a result of a minor flaw in an otherwise sound structure. The larger, the more complex and/or the more commercial the structure, the more likelihood that such errors will arise if only because of the number of tax relevant factors involved and the scale of activity. Depending on the nature of the error, that could have personal tax consequences for individuals in the United Kingdom that are not immediately obvious. For instance, to use a somewhat obscure real-life example to illustrate the point, the inadvertent use of an opaque offshore corporate vehicle to hold a private equity fund in place of a limited liability partnership might have rendered all personal receipts derived from that fund to be income distributions in nature rather than capital as confidently and erroneously set out on the personal tax returns of the UK-resident parties getting the receipts. Conclusion As illustrated above, the potential for inadvertent UK reporting errors with regard to non-uk interests and non-uk activities is very wide. The RTC is a sea change in placing an even heavier burden of responsibility on any parties with overseas interests in any way connected to the United Kingdom to review their arrangements carefully and in detail to ensure they are fully UK tax compliant now and that they were fully compliant with all the relevant legislation applicable to all previous UK tax years which are still assessable. In the event that unintentional irregularities are overlooked which later come to HMRC s attention through the CRS or by any other means, the RTC regime will enable HMRC to seek the penalties summarised above a level of financial penalties far beyond what was once seen even for wilful tax evasion. The 30 September 2018 deadline to make full detailed disclosure will come all too quickly so it is vital that all overseas interests are reviewed as a matter of urgency. Thorough reviews will often be time consuming and involve significant professional costs. Reviews will have to demonstrably involve independent professional advisers who were given all relevant information and were appropriately skilled for the level of complexity. Challenging conversations may be required with the family members concerned to explain the process and to ensure their buy-in. However, that discomfort must be weighed against the need to best protect those parties from the risks involved, as well, of course, as to manage any professional indemnity risks where family office advisory boutiques and service providers are concerned. Any clear oversights giving rise to additional UK tax should be fully disclosed through professional advisers to HMRC at the earliest opportunity whether through HMRC s new Worldwide Disclosure Facility (a disclosure regime rather than an amnesty) or by alternative means. Inevitably, advisers will also often identify areas of risk grey areas where HMRC could feasibly seek to assess further tax upon awareness of the full facts but where the advisers may feel that technical arguments exist why no tax is payable. In such circumstances, careful thought must be given to whether a full voluntary nil tax disclosure of all the facts should be made to HMRC. If appropriate, that should be done well before 30 September 2018 in order to initiate a dialogue and to obtain agreed certainty that the existing tax treatment is correct. Without such a full disclosure, the risk of potential FTC penalties will remain. The good news is that voluntary disclosure of any inadvertent UK tax exposure by the deadline will ensure that not only will the FTC penalties not apply but that the more favourable current statutory penalty regime will apply instead a regime where the potential penalty levels are much lower and substantial mitigation reductions even down to nil penalties in some circumstances are applicable for unprompted voluntary disclosures. Uncomfortable reading, perhaps. The measures are designed to cause that discomfort and to compel action. Inaction is not an option Andrew Park is a Director in BDO LLP s UK Tax Dispute Resolution team. He is a Chartered Accountant and Trust and Estate Practitioner specialising in assisting wealthy private individuals and their advisers with complex enquiries conducted by HMRC into their United Kingdom and overseas interests and activities and family trust arrangements. Introducing the UK Requirement to Correct by Andrew Park is taken from the fourth issue of The International Family Offices Journal, published by Globe Law and Business, 62 June