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Draft legislation on the residence and domicile tax rules

Following the Chancellor of the Exchequor’s announcement of the consultation on changes in the tax rules on residence and domicile in October 2007 and the issue of the Consultation Document in December 2007, the Government has published draft legislation which will introduce changes in the method of counting days in and out of the UK for determining UK residence and profound alterations to the remittance basis of taxation, including introducing the £30,000 charge for long term residents. 

1. CHANGES IN THE RESIDENCE RULES AND PRACTICE

The existing statutory test under which an individual is treated as resident in the UK if they spend 183 days or more in the UK in a tax year will be amended to include days of arrival and departure when counting the 183 days. 

HMRC will also alter its practice so that days of arrival and departure will be taken into account in determining whether the non-statutory 91 day average test has been met. Under this test, if a person spends an average of 91 days in the UK over four years, they are normally treated as resident and ordinarily resident from the beginning of the fifth year unless it was known from the outset that the individual would be spending an average of 91 days or more in the UK, in which case they are treated as resident from the beginning of the tax year in which they make their first visit.  

However, time spent as a transit passenger travelling via the UK will not count for the purpose of the new rules provided that the individual remains in a part of an airport or port that is not accessible to members of the public. 

Accordingly, expats or business people who visit the UK regularly may need to spend fewer days in the UK if they wish to remain non-resident. It is also advisable for those who visit the UK frequently to keep detailed records of their arrival and departure with supporting evidence (e.g. boarding passes) in order to minimise the risk of becoming resident and being exposed to the full measure of UK taxes.

2. CHANGES IN THE REMITTANCE RULES

Currently, an individual who is resident but not domiciled in the UK pays tax on their UK income and gains in the year in which these arise. However, they only have to pay UK tax on foreign income and gains when these are brought into the UK. Any foreign income which is not remitted to the UK is not taxed in the UK (i.e. ‘remittance basis’).

The draft legislation confirms that individuals who are resident but not domiciled in the UK (or who are resident but non-ordinarily resident in the UK) will be liable to tax on the whole of their worldwide income and capital gains in the year in which income is earned or the gain is made (i.e. ‘arising basis’) unless they make a valid claim to be taxed on the remittance basis.

Additional costs for claiming the remittance basis

Individuals who have been resident in the UK for at least seven out of the immediately preceding nine tax years will only be able to claim the ‘remittance basis’ if they pay a £30,000 charge. This charge will be payable for each year for which the ‘remittance basis’ is claimed and will be in addition to any tax liability for the year in question. 

However, an individual who has unremitted foreign income and gains of less than £1,000 in the year of the claim or has been resident in the UK for fewer than seven years will be able to claim the remittance basis without paying the additional charge.

Individuals who choose to be taxed under the ‘remittance basis’ will no longer be entitled to claim the personal allowance for income tax and the annual exemption for capital gains tax. 

The draft legislation confirms that it is possible to opt in and out of the ‘remittance basis’ from one tax year to another. However, where income arises in a year where the ‘remittance basis’ has been claimed but is remitted to the UK in a subsequent year, it will still be chargeable to tax in the year of remittance even if the individual is taxed on the ‘arising basis’ in that year. 

Meaning of ‘Remittance’

The draft legislation will broaden the definition of ‘remittance’ to include ‘any money or other property is brought to or received or used in the UK by or for the benefit of a relevant person; or any service provided in the UK to or for the benefit of a relevant person’ which derives (wholly or partly and directly or indirectly) from the income or chargeable gains.  So, for example, a UK resident who purchased a car in Germany which was paid for out of overseas income would be treated as remitting the amount of that income which was paid for the car if and when he (or a relative of his) imported the car into the UK.

Abolition of source ceasing rules

Currently, under the long standing ‘source ceasing’ rules, no tax liability can apply to remitted income if the source of the income remitted does not exist in the year of remittance. This rule will be overturned by the proposed legislation, under which such income will be taxed in the year of remittance irrespective of whether the source exists in that year.

Sums remitted

At present, the remittance of assets and chattels is not taxable as it is necessary for a sum of money to be received in the UK for it to be taxable. The new definition of ‘remittance’ makes it clear that if an individual brings an asset into the UK which has been purchased with ‘Relevant Foreign Income’ (broadly, non-UK trading or investment income) (‘RFI’) this will now be treated as a taxable remittance of the RFI used to purchase the asset.

Remittances from mixed funds

The legislation confirms the existing practice that remittances from mixed funds should be treated as taxable income in the first instance.  It now provides for a statutory priority of attributing funds to different types of income. However, where any proceeds from the sale of a non-UK asset is remitted, it is treated as the remittance of capital gains before any capital originally invested. This is less favourable than the current practice of treating the remittance on a pro-rata basis. 

Overseas gifts

It will no longer be possible for a UK resident, non-domiciled individual to gift to a relative funds outside the UK arising from foreign income or gains and for the relative to bring the funds into the UK without incurring a tax charge. From 6 April 2008, a tax charge will arise to the donor if the donee (being a ‘connected person’) remits any part of the gift to the UK. The definition of ‘connected person’ is very wide and will include a man and woman living together as if they were husband and wife, or two persons of the same sex living together as if they were civil partners. 

Offshore Companies (extension of CGT Anti-Avoidance Provisions)

Broadly, gains realised by non-UK companies with five or fewer shareholders will now be attributed to the UK resident, non-domiciled (as well as UK domiciled) shareholders whose interest (taken together with the interest of any connected persons) exceeds 10% of the company. If the asset giving rise to such a gain is a UK asset, the gain will be taxed on an arising basis; however, if the asset is a non-UK asset the gain will be taxed on the remittance basis in the hands of the non-domiciled individual shareholders.  

Where the ultimate ‘owner’ of a non-UK company is a trust then the gain will be attributed to the settlor or matched with capital payments made to beneficiaries and taxed on the remittance basis as explained below. 

Offshore Trusts 

Capital gains realised by non-UK trusts will from 6 April 2008 be either attributed to the settlor or matched with capital payments made to beneficiaries. 

Non-UK domiciled settlors of offshore trusts who retain an interest under the settlement will now be taxable on the remittance basis in respect of gains accruing to the trustees. Gains realised on UK assets will be attributed to the settlors on an arising basis whilst gains on non-UK assets will become chargeable when they are distributed from the offshore structure. Any gains made before 5 April 2008 will not be subject to the new rules affecting non-UK domiciled settlors even if they are remitted after that date. However, such gains could be or become taxable under the rules affecting beneficiaries (as to which see below).

Previously a non-domiciled beneficiary could receive a capital payment from an offshore trust in the UK without incurring a tax charge. They will now be subject to a full UK tax irrespective of their domicile or the location of the asset on which the gain was made regardless of whether they remit the funds to the UK or not. All gains realised in an offshore trust since 17 March 1998 which have not been paid out to beneficiaries will now be available to match against capital payments.

3. EXTENSION TO NOTIFICATION REQUIREMENTS

The obligation on settlors who create settlements with non-UK resident trustees to notify details of such settlements to HMRC will be extended to settlors who are resident or ordinarily resident, but not domiciled, in the UK.  These obligations will cover settlements created before, as well as on or after, 6 April 2008, unless the settlor became UK resident and domiciled before that date (in which case they are required to notify details under the current rules).

4. WHO WILL THE CHANGES AFFECT?

The proposed changes will affect individuals who are UK resident and who, because they are not UK domiciled or non-ordinarily resident in the UK, are currently taxed on a remittance basis in different ways, depending on their particular circumstances.

For example:

Long-term residents:  Individuals who have offshore trusts and companies should have these structures reviewed as early as possible.  Depending on the circumstances, it may be desirable for these structures to be dismantled or amended before 6 April 2008.  Individuals who have been UK resident for more than 7 years will need to consider whether it is worthwhile paying the additional charge in order to claim the remittance bonus.

Short-term residents:  These individuals should also have their overseas structures reviewed as soon as possible, even if they will be eligible to continue claiming the remittance basis without paying the additional charge.

Short-term non-ordinarily resident expatriates:  The new rules are likely to affect these individuals, who are usually resident in the UK for less than three  years, to a lesser extent than longer-term residents. Interestingly, the new rules will not amend the existing legislation which taxes gains and benefits arising from employment related securities and securities options acquired by UK resident but non-ordinarily resident managers and employees which, generally, are subject to more favourable tax treatment than those acquired by UK resident and ordinarily resident managers and employees.

It is considered that the proposed changes are unlikely to be subject to substantial amendments before they come into force on 6 April 2008. Please contact Laytons for any further information on the above or to discuss any opportunities to structure the tax affairs to minimise the impact of these changes.

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