February 2018 Tax Services The non-dom newsletter Nineteenth edition 8 February 2018 Introduction Welcome to the latest edition of the non-dom newsletter. In this edition, we consider the recently published HMRC guidance on the 2017/18 non-dom changes. We also consider the actions which trustees may wish to consider ahead of 6 April 2018. If you would like to discuss any of the issues raised in this newsletter, please get in touch for contacts, click here. More of a guidebook than a map The long awaited HMRC guidance on the non-dom changes, which took effect on 6 April 2017, somewhat predictably appeared on 31 January. Welcome as HMRC s insights are, advisors now have over 50 pages of HMRC guidance to read, digest and understand in the lull following tax return deadline day. This newsletter summarises the key points albeit the guidance leaves us with almost as many questions as we have answers and we also set out what we consider to be some of the remaining areas of uncertainty. Read our detailed alert on this subject, here. As well as reading the guidance, we ve also been giving some thought to the actions trustees may wish to consider ahead of the forthcoming legislative changes. See our suggested action list, here. The guidance is a step on the path but doesn t get us home. What is clear is that the true impact of the new legislation and any subtleties within it will take time to emerge. It is only by advisers and trustees sharing views and experiences that a workable solution can be arrived at. This non-dom newsletter is a first step on that road.
HMRC Guidance what it does and doesn t tell us The long awaited HMRC guidance on the changes to the taxation of non-uk domiciled individuals was published on 31 January. Arguably, the guidance leaves us with as many questions as it does answers. From our initial review of the guidance, we set out what we see as being some of the key points the guidance addresses, and also consider some of the remaining uncertainties with regard to the legislation. Cleansing mixed funds The new guidance on the cleansing of mixed funds is perhaps briefer and contains less examples than might have been anticipated. It does confirm one of the initial concerns that an overnomination of income or gains on a transfer will invalidate the nomination, such that the mixed fund cleansing rules will not apply. Instead, the transfer will be treated as an offshore transfer, and therefore a proportion of each type of income, gains and capital in the account. The guidance also contains an example (Example 2) which illustrates the knock-on effect of this on future transfers and nominations out of the same account. The message is clear: if in doubt, err on the side of caution. There are also examples which illustrate the application of the rules to pre-april 2008 transfers out of pre-april 2008 accounts, with each transfer is effectively treated like an offshore transfer (such that a proportion of income and gains is transferred) but without the application to any clean capital in the account. The guidance also confirms that where amounts to be transferred cannot be identified, they should be treated as income. The guidance still leaves a number of unanswered questions, however. It is silent on perhaps one the great outstanding questions: what happens if you transfer clean capital out of an account, which you later remit? For the mixed fund cleansing rules to apply, a transfer must otherwise be within the offshore transfer rules. Technically, if a transfer is made with a view to a future remittance (as might be expected with a transfer of clean capital), the offshore transfer rules cannot apply, and, by extension, neither can the cleansing rules. Instead, the contents of the transfer will be identified using the standard remittance basis rules. This presents a difficulty for taxpayers who may not be able to identify all of the income and gains in their mixed account, but are able to identify the clean capital. Certainly discussions with HMRC at the time the rules were being formulated suggested that such individuals should be able to move clean capital out for their account. The lack of comment in the guidance will nonetheless leave such taxpayers feeling vulnerable. It is also to be noted that there are no examples where there are post-april 2008 transfers out of accounts containing pre-april 2008 income and gains. It is not clear what rules should be applied in these cases, since, for old income and gains the mixed fund rules will not apply, but neither will the new deemed transfer rules. And, as has already been identified, getting the numbers right is essential, in view of the possibility of invalidating the nomination. Another area of uncertainty is how to offset losses when trying to identify the income, gains and clean capital. Should losses reduce the amounts invested pro-rata or reduce the clean capital, or something else? This will be very important, especially given the consequences for tax payers if they over-nominate amounts transferred. Similar issues arise in respect of currency gains and losses and again the guidance is silent here. The guidance makes clear that nominations must take place between 6 April 2017 and 5 April 2019. However, it gives no suggested wording for a nomination nor any suggestion of how you would evidence the date on which the nomination is made. It would appear that there is no need to notify HMRC of the nomination. Cleansing: what to do The guidance has arrived and the remaining window is 14 months so now is the time to start on cleansing. We have a specific methodology which can assist. Contact your usual EY advisor for details. Protections for trust income Settlor interested trust provisions Part 2 of the new guidance explains the concept of protected foreign income and transitionally protected foreign income for the purpose of the settlor interested trust provisions. It confirms that the transitional protections only apply to income arising since 6 April 2008 and only excludes from charge a remittance by the trustees. This is The non-dom newsletter 2
because the transitional protection operates by excluding trustees from the definition of relevant person in respect of that income. The guidance spells out that, should a loan be made to an underlying company, that company could remit transitionally protected income and that would be a potentially taxable remittance. Similarly a loan to the trustees from the settlor from transitional income would still be a remittance. Transitionally protected income for this purpose is foreign income which would have been protected foreign income if it arose after 6 April 2017. Trustees will need to take care with regard to this income as it could still be remitted to the UK, even where it is not used to provide a benefit. This could be, for example, by loan to an underlying company and then investment in the UK, or even by using those funds to repay a loan from the settlor. The more complex areas of the settlor interested trust provisions will not apply until 6 April 2018 and there is no guidance on these forthcoming changes. Transfer of assets abroad provisions Part 3 of the guidance deals with the new protections for the transfer of asset abroad provisions and gives a number of examples of the way in which s.720 (which deems income to arise to the transferor) will henceforth apply only to UK income and not to foreign income to the extent that it remains in trust and meets the protected foreign income conditions. The conditions for income of a company under a trust are spelled out including the condition that the individual s power to enjoy the income must result from the trustees being participators in the company. However, there is no guidance on how to apply these provisions where both an individual and a trust of which he is settlor are participators in an offshore company. In these circumstances the individual will have power to enjoy the income of the company both in his own right and as a result of the trustees power to enjoy. With regard to transitionally protected income, the guidance makes clear that from 6 April 2017 this income can no longer be remitted to the UK by the company, the trustees or any other relevant person. However, the income can be matched to a benefit, and may still be remitted and become taxable on that basis. The rule here is narrower and therefore more helpful than the corresponding position for trust income (see above). The guidance spells out that both protected and transitionally protected income can be brought to the UK and invested without a tax charge arising to the settlor under s.720. It does, however, state that such income will be relevant income available to be matched to benefits. Such benefits will be treated by the legislation as deriving from the trust income and vice versa and, as such, a remittance of this income may be significant for a non-uk domiciled recipient of a benefit. HMRC example of George touches on this. The guidance suggests that HMRC consider the capital receipt provisions (in s.727) apply as soon as the settlor makes a loan to a trust, presumably on the basis that he will be entitled to repayment of that loan at some point in the future. Many practitioners will have assumed that entitlement to a capital receipt does not arise until such a time as the loan is repayable, or when the settlor demands repayment, where it is a loan repayable on demand. Where the capital receipt conditions apply, the settlor is taxable on the income of the structure as it arises. Prior to 6 April 2017 this would have been subject to the remittance basis. However, from April 2017 non-uk income will not be taxable to the extent that the income is protected foreign income. There are examples in the guidance showing the operation of the benefits charge both in relation to the settlor and in circumstances where benefits paid to close family members will be taxed on the settlor. What to do Where practical, avoid remittances of income at trust level. Think through the consequences of moving from s.720 transferor regime to the s.731 benefits regime Capital gains tax and trust protections The guidance is particularly sparse on this subject. It simply sets out that an individual will be taxed under s.86 on capital gains of the trust as they arise where they are deemed dom as returning doms (those born in the UK with a UK domicile of origin) or where the trust has become tainted. For those who are non-uk domiciled and deemed domiciled under the 15 out of 20 rule, gains will continue to be matched to benefits under s.87, provided the trust has not been tainted. Tainting Tainting is a big issue for trustees and so any guidance on this topic is welcome. The guidance confirms that a settlor s failure to exercise a right of recovery in relation to settled property could taint a settlement The non-dom newsletter 3
(for example where a settlor has paid tax in respect of trust income). However, in respect of tax, the settlor need only claim reimbursement within a reasonable time there is no indication of what HMRC might consider to be reasonable or to what lengths a settlor must go. Ordinary fluctuations in currency in respect of loans would not, the guidance suggests, cause a settlement to become tainted, but arrangements involving the use of appreciating or depreciating currency balances designed to add value not surprisingly would. The guidance also gives an example where the release of an option over shares by the settlor leads to the increase in value of those shares and therefore taints the trust. It confirms that where property is added to the trust by someone other than the settlor or the trustees of a relevant settlement, this will not taint the trust. However, it may constitute a separate settlement in its own right, with its own consequences. The guidance considers each of the categories of property or transactions which can be ignored for tainting purposes. For transactions entered into at arms-length, the example given is of a transaction between the settlor and the trustees and notes that a professional valuation has been carried out. In contrast, in the example used for property provided without any intention to provide gratuitous benefit, the settlor has only taken appropriate measures to determine the value of the property being sold to the trustees and believes the value to be correct. It is not clear in this example what HMRC would consider to be appropriate measures. Straightforward examples are given of loans made on arms-length terms to and from trustees of a settlement and such loans being repaid, but there is no consideration of more complex situations where loans are made to or from companies owned by trusts. We understand from HMRC that such loans should be treated as though they were loans to and from the trustees themselves, but it would have been helpful for this to have been spelled out in guidance. For property provided in pursuance of a liability, the guidance gives an example of a commitment by the settlor to settle additional funds for a specific purpose, with an agreed date in this case completion of the purchase of a property. The guidance makes clear that any addition of property in relation to trust expenses must be in relation to the settlements expenses only and expenses of underlying companies may not be taken into account The guidance also confirms that reimbursing trustees for benefits will not taint a trust, where the valuation of benefits rules apply and where the reimbursement is at the value of the benefit under the tax rules (even if that is greater than the commercial or open market benefit). There is no comment on whether payments of insurance or for repairs to trust property which has been leant to the settlor might taint the trust. Though it is assumed that this might be similar to a reimbursement of the benefit. The guidance lays out the circumstances in which an otherwise qualifying loan may taint the settlement, ie, Capitalisation of interest payable under the loan Any other failure to pay interest in accordance with the terms of the loan Variation of the terms of the loan such that they cease to be arm s length terms In respect of failure to pay interest HMRC will apparently not seek to apply the tainting provisions for a minor failure to pay interest on time and give examples of acceptable and unacceptable delays. With regard to loans existing at the time an individual becomes deemed domiciled, the guidance sets out the importance of repaying the capital or putting the loan on commercial terms by the deemed domicile date (or 6 April 2018 for those becoming deemed domiciled on 6 April 2017). However, it also states that a fixed term loan whose provisions cannot be varied, entered into by the settlor before the domicile date of the settlor will not taint the settlement, up to the expiry of the loan. Failure to repay at that point, however, will taint the settlement. The failure of the settlor to exercise a power of revocation in respect of a settlement will not be regarded as an addition of value, nor will a failure of underlying companies to pay dividends in the case of a life interest trust. The guidance does not consider whether the increase in value of carry or of share options as a result of services or employment duties carried out by the settlor could be considered an addition of property. The HMRC guidance is disappointing in its comments on tainting. While it contains examples, it also states..it has not been possible to include herein examples that cover all eventualities and it is intended that more The non-dom newsletter 4
detailed guidance, including further examples, will follow in due course. The promise of later examples at some future unspecified date is little comfort given that tainting has been troubling trustees since April last year. There is, for example, nothing in the guidance on whether the provision of a guarantee by the settlor on behalf of his trustee is the provision of property. The better view, we believe, is that it is not (or not until the guarantee is called) but given the consequences the cautious view in practice will be not to take the risk. But if the trustees choose to pay for the settlor s guarantee, valuation will be an interesting challenge. What to do Study the examples of tainting to get a flavour of the issues and review structures in a wide context to ensure no value added at any level. Valuation of benefits The guidance sets out the new rules in relation to the valuation of benefits for the purpose of the capital gains and income tax charges which came into effect on 6 April 2017 With regard to moveable property, the guidance states that when considering whether something is made available this should be interpreted widely, regardless of whether the beneficiary chooses to use the property. Although it does acknowledge that a benefit can be pro-rated where moveable property is made available to more than one person at the same time. An example is given where a yacht is available throughout the year, but only used for a very short period. In the example the beneficiary is charged on the value of a full year s benefit. There is no discussion of the circumstances in which a yacht might not be considered available for example if it is regularly chartered to third parties or under repair. With regard to land made available to a beneficiary there is also no discussion of what made available might mean. So for example, a property let as a holiday home which is used by the beneficiary for part of the year but otherwise let in the market would presumably not be available for the full tax year for this purpose, but this is not considered. What to do Review all existing benefits to compute the level of the tax charge and if they can be restructured to be more tax efficient. Ensure a benefit does not taint a trust (eg, by payment of more than market value). Rebasing for Capital Gains Tax The guidance sets out the rules with regard to rebasing of assets by individuals and gives some examples of their application. One example is of an inter-spouse transfer shortly before the 5 April 2017 deadline by which the asset must have been owned and the recipient spouse has an entitlement to claim rebasing. The guidance also makes clear that rebasing is not available for trust assets. There seems to be no consideration of the interaction between the rebasing rules and mixed fund cleansing, despite the fact that this raises many questions. In particular, where the ultimate disposal of the asset gives rise to a loss, or where the funds invested in the asset themselves consist of a mixed fund and there have been previous capital losses from the disposal of previous assets. Carry The guidance explains that carry gains have been retrospectively removed from s.13, s.86 and s.87 (the sections which tax participators on the gains of close companies and which tax settlors and beneficiaries on the gains of offshore trusts). However, it is silent on the complexities involved in making payments out of trust to enable the settlor to pay tax in respect of trust carry gains which have been deemed to arise to him personally. It would have been helpful if HMRC had the opportunity to spell out its view of how the double tax relieving provisions might operate in these circumstances. Other guidance On 31 January HMRC also published an updated version of RDR1 the residence, domicile and remittance guide, some basic guidance on the meaning of deemed domicile and guidance on the changes to business investment relief. Our conclusions The guidance leaves many uncertainties and unanswered question, particularly in the areas of the mixed fund cleansing and tainting of trusts. Given the high stakes in both these areas, some clients and advisors may wish to consider a non-statutory clearance application before taking action. BACK The non-dom newsletter 5
Trustees: what to do between now and 6 April Further changes to the taxation of offshore trusts come into effect from 6 April 2018. In addition, the transitional provisions allowing trustees to put loans on a commercial footing come to an end on the same date. Below are some actions trustees may wish to consider ahead of these two deadlines. Loans and tainting Consider reviewing all trustee lending and borrowing to ensure it is on a commercial basis, in accordance with the legislation ie, at or above official interest rates where loan is from settlor to trustees; at or below official interest rate where loan is from trustees to settlor. Consider reviewing any loans from or to companies below trusts or from trust to company or vice versa. Where loans are inter-trust or from or to the settlor, the loan will need to be put onto the official interest rate to avoid tainting. Where the terms of loans are changed to avoid tainting it will also be necessary to ensure that interest for the period 6 April 2017-5 April 2018 is paid on the new commercial terms. Rolling up interest = tainting. As an alternative to putting loans on a commercial basis, trustees may wish to consider repaying the capital on loans ahead of the 5 April deadline, to prevent tainting. Where loans are already on commercial terms, trustees will want to ensure that interest payments are and have been made on a timely basis, to prevent tainting. Other actions to consider Where trustees are considering making payments to non-uk resident beneficiaries, they may wish to consider advancing those payments to ensure they fall before 5 April 2018, to allow such payments to be matched to capital gains in the trust. Where trusts have non-resident beneficiaries with unmatched capital payments, they may wish to consider advancing the disposal of assets to realise capital gains to be matched to those payments, where this fits with investment objectives. Any unmatched payments to non-resident beneficiaries will drop out of account. Trustees may wish to review bank accounts and consider whether income which would be taxable on the settlor under the settlor interested trust provisions is easily identifiable, so as not to be accidentally remitted by being paid out to beneficiaries or other relevant persons. They could consider the mixed fund cleansing rules here. Where settlors will become deemed domiciled on 6 April 2018, trustees may wish to consider paying some of the foreign income out to them so as to allow them to benefit from the remittance basis, as such a payment in future would be matched and taxed wherever the payment is received even if the income arose before the settlor became deemed domiciled. BACK The non-dom newsletter 6
EY Assurance Tax Transactions Advisory About EY s Private Client Services Contact details For further information, please contact one of the following or your usual EY contact: London David Kilshaw 020 7783 0763 dkilshaw@uk.ey.com John Mackay 020 7951 2779 jmackay@uk.ey.com Neil Morgan 020 7951 1878 nmorgan@uk.ey.com North Katherine Bullock 0113 236 4303 kbullock@uk.ey.com Martin Portnoy 0161 333 3275 mportnoy@uk.ey.com Andrew Shepherd 0161 333 2726 ashepherd@uk.ey.com Trevor Sherlock 0191 247 2527 tsherlock@uk.ey.com Scotland Peter Ames 0131 777 2262 pames@uk.ey.com South Paul Cooper 0117 981 2076 pcooper3@uk.ey.com EY s Private Client Services offers tax-related domestic and cross-border planning and compliance assistance to business-connected individuals and their associated entities. In addition, in today s global environment, crossborder services can help meet the evergrowing needs of internationally positioned clients. Our dedicated resources in major markets around the world serve individual clients needing a wide range of tax services, including tax compliance, tax planning and tax advice relating to their business interests, investments and other financial-related assets. We have experience working with individuals and companies of all sizes across many aspects of the tax life cycle planning, provision, compliance and controversy. The UK firm Ernst & Young LLP is a limited liability partnership registered in England and Wales with registered number OC300001 and is a member firm of Ernst & Young Global Limited. Ernst & Young LLP, 1 More London Place, London, SE1 2AF. 2018 Ernst & Young LLP. Published in the UK. All Rights Reserved. ED None In line with EY s commitment to minimise its impact on the environment, this document has been printed on paper with a high recycled content. Information in this publication is intended to provide only a general outline of the subjects covered. It should neither be regarded as comprehensive nor sufficient for making decisions, nor should it be used in place of professional advice. Ernst & Young LLP accepts no responsibility for any loss arising from any action taken or not taken by anyone using this material. ey.com/uk Elsa Littlewood 011 7981 2267 elsa.littlewood@uk.ey.com Ireland Sherena Deveney 028 9044 1460 sdeveney@uk.ey.com Channel Islands Daniel Collins 01481 717 598 DCollins@uk.ey.com Elaine Connor 01534 288 275 econnor2@uk.ey.com Emma Hosking- Williams 01534 288 780 EHosking-Williams@uk.ey.com BACK The non-dom newsletter 7