Memorandum by Alex Henderson, advisor
to the City of London Corporation
INTRODUCTION
1. This briefing note will be confined to
the impact of changes to the taxation of residence and domicile.
It will consider broader issues, outline significant points of
detail and highlight areas of continuing concern.
BACKGROUND TO
THE CHANGES
TO THE
TAXATION OF
RESIDENCE AND
DOMICILE
2. The special tax treatment of non-domiciled
individuals and the rules relating to residence go back to the
original introduction of income taxation in the UK at the time
of the Napoleonic wars. The treatment of non-domiciled individuals
has been governed by a mixture of statute, limited case law and
to a very limited extent HMRC practice. The treatment of residence
has been laid down by statute but amplified by substantive case
law (some of which is over a century old) which has been collated
with HMRC practice in their booklet "IR20".
3. In recent years there has been concern
about the extent taxpayers can rely on HMRC practice with regard
to residence. The measures regarding the treatment of non-domiciled
taxpayers worked largely well in practice but mainly because they
limited the attention of the UK tax system to amounts earned or
(mostly income) brought to the United Kingdom.
4. The Government announced a review of
the treatment of residence and domicile in Budget 2002 (there
have been a number of previous reviews, which concluded that no
change was in the best interests of the UK). A background paper
was published in 2003 and Budget 2004 indicated that a consultation
paper would be published setting out possible approaches to reform.
This was long delayed. The Treasury papers accompanying the 2007
Budget simply commented (at paragraph 5.102) "The review
of the residence and domicile rules as they affect the taxation
of individuals is ongoing."
5. The treatment of non-domiciled individuals
is of special concern to the City. Many employees and owners of
financial institutions are themselves non-domiciled. City businesses
are international in outlook and many are international in operation.
They look at the UK as one of a range of potential locations for
providing their services; the rates of tax and stability and certainty
of the tax regime are key factors. Many City businesses provide
services to non-domiciled individuals in managing their wealth
or otherwise advising them. The complexity of international operations
and the international mobility and outlook of both clients and
the people and institutions that serve them has been steadily
increasing.
6. By definition non-domiciled individuals
are not permanently settled in the UK which remains one of a number
of countries where they can be resident and/or do business without
being taxed on their worldwide income and gains. Although often
thought of in shorthand terms as "the super-rich", non-domiciled
status extends to all persons who are not settled permanently
or indefinitely in the UK and encompasses those without significant
wealth who are coming to the UK simply to work. There is no precise
number of non-domiciled individuals currently resident in the
UK. Some estimates suggest there are several millions. Whatever
the figure, it is hugely more than the 100-150,000 range generally
cited by HMT/HMRC, this figure being based on the numbers HMRC
know about as people who complete tax returns. It ignores "ordinary"
employees (many of whom will work for City firms), workers in
such industries as agriculture and hospitality, and students.
7. Changing the tax regime relating to residence
and domicile has effect not only for private individuals but also
but also businesses employing them (particularly if they are "tax
equalised" ie the employer undertakes to ensure neutrality
of the taxation consequences of being posted to the UK) or servicing
them. The changes affect therefore many persons in the City directly
or indirectly.
PRE-BUDGET
REPORT CHANGES
8. Very considerable reforms to the taxation
of non-domiciled individuals were, however, announced in the Pre-Budget
Report on 9 October 2007 to take effect from 6 April 2008. The
Press release announced five main areas of reform (which appear
in one form or another in the current Finance Bill):
(i) Changing the treatment of days of arrival
and departure in computing residence.
(ii) A withdrawal of allowances from persons
claiming non-domiciled reliefs.
(iii) A £30,000 charge where persons
have been resident in seven out of 10 tax years.
(iv) Tightening of the rules regarding remittances
of income.
(v) Tightening of the rules for structures
involving trusts and companies.
9. A Consultative Document was released
in December 2007 but consultation was limited to whether further
changes should be introduced to increase the contribution of non-domiciles
(paragraph 3.3). Draft legislation was promised towards the end
of 2007 but in practice this was not released until 18 January.
Consultation continued via discussion with various interested
bodies and revised draft legislation was released in the Finance
Bill on 27 March together with a summary of responses to the Consultation.
Some of the more complex parts of the legislation were incomplete
and details are awaited by way of Finance Bill amendment.
BROAD IMPACT
OF THE
CHANGES
10. It will be evident given the background
of extremely lengthy and unresolved consultation detailed above
that affected individuals, their employers and their advisers
were extremely surprised and dismayed by the extent of the changes
announced in the Pre-Budget Report and their swift introduction.
11. The affairs of non-domiciled individuals
or those whose residence status changes, whether or not particularly
wealthy, can be complex. This is borne out by the length of time
it is taking to produce legislation to govern the new regime.
12. The measures were introduced with effect
from the current tax year and with no transitional measures, so
very little time was available for individuals to rearrange their
affairs to take account of the new regime and any planning that
was done needed a large element of educated guess work.
13. Because no systematic information is
kept about non-domiciled taxpayers, it is of course impossible
to be definitive about the short or long term effects of the changes.
Some of the effects such as decisions not to come to the UK or
to set up businesses here will not necessarily be visible in the
UK. It is possible to infer however that the sudden truncation
of consultation process, the wider than expected changes and the
delays in producing a finalised regime have undermined confidence
in the certainty of the UK tax regime.
14. The measures apply to specific classes
of individuals but affects them, their spouses and civil and other
personal partners, children and grandchildren. There are also
significant consequent issues for businesses involved with those
individuals. The time pressures, uncertainty and wide-ranging
impact of the changes caused concern therefore to a wide range
of persons.
15. Many taxpayers who found the non-domiciled
regime an attraction of residence or doing business in the UK
have now necessarily looked at their options in other countries.
The Republic of Ireland, for example, similarly has a non-domiciled
regime while Switzerland is well known for its "forfait"
system of lump sum taxation. In the short term it is not straightforward
to move residence of an individual or business, in the medium
to longer term taxpayers and businesses can be expected to continue
to assess the factors drawing them to the UK. If the regime proves
onerous in practice and clients move out of the UK or employees
find their tax burden (including compliance obligations) unacceptable
then businesses can be expected to follow. The City seems particularly
vulnerable to this, given the essentially mobile and international
nature of its business base.
16. It should be noted that HMRC and Treasury
listened to matters raised by interested parties who were concerned
about the impact of the changes and introduced amendments to the
original legislation. In particular they acted to relax or relieve
measures regarding the definition of residence, the creditability
of the £30,000 charge for US purposes, the treatment of trusts,
the requirements for disclosure, the treatment of art on public
display and raised or introduced de minimis levels. Amendments
to deal with services provided in respect of overseas assets are
awaited. Some policy and technical matters remain unresolved or
unexplained however. The more significant of these are detailed
below.
MORE DETAILED
IMPACTS OF
THE CHANGES
17. The definition of residence has been
amended to take account of days when an individual is present
at midnight. While some detailed points remain about the definitions
this is a sensible change. However, this statutory rule only applies
to the 183 day test of residence. Many international workers are
assessed for residence on the basis of the 91 day test of regular
residence for that period—a test dependent on HMRC practice
which has not yet been republished. The UK remains one of the
few OECD countries without a comprehensive statutory code of residence
for modern living and working practices.
18. The loss of personal allowances (and
CGT annual exempt amount) for anyone who elects for the remittance
basis is triggered immediately—there is no seven year period.
This has the potential to affect City employers: many non-domiciled
employees will find that their UK tax bills increase (through
being taxed on worldwide income or through loss of personal allowances).
That will result in the employees expecting their employer to
compensate for any additional tax through tax equalisation agreements,
increasing employment costs or simply adding to administrative
burdens around sorting out tax issues for affected individuals.
It is also not clear how the new regime will interact with some
of the practical measures which HMRC had developed under the old
regime. A particular issue for example is how HMRC Statement of
Practice 5/84 is to be regarded under the new regime. This relieved
the need for expatriates to examine the source of a remittance
to the UK every time a remittance was made to the UK out of an
account containing overseas earnings. It is currently not clear
how or whether this will continue to operate. It appears policy
and legislation in these practical areas is still being developed
as unforeseen complications are brought to HMRC's attention.
19. There is also a subtle point coming
out of the seven year period for the £30,000 charge. The
City has a good track record in hiring very able graduates, a
significant proportion of whom have come to the UK to finish their
education. A student who has done "A" levels and degree
course in the UK will already have logged five out of the potential
seven years and is likely to be less keen to take a UK-based job
if there is a any significant "home" income involved.
20. The new regime more consistently taxes
non-domiciled individuals on a remittance basis. It is unclear
what the overall policy objective behind this measure is since
money is brought to the UK either to fund expenditure or make
investments. These contribute to the economy and its fiscal base;
a remittance to fund expenditure may produce more tax in respect
of VAT and income tax/NIC/corporation tax than the tax levied
on the remittance itself (which ranges from 18% to 40%).
21. The revised legislation published on
27 March 2008 relating to the treatment of offshore trusts introduced
some significant and welcome relaxations to the regime governing
non-domiciled individuals who own assets via trusts. In particular
they will not be chargeable on gains on UK assets unless this
money is brought to the UK and all assets owned at 6 April 2008
are rebased for the purposes of the tax charge on capital payments
made to them. A similar change has not been introduced however
where assets are held via companies. It is not clear why there
is felt to be a need to discriminate in favour of taxpayers who
use trusts over those who use companies or in favour of those
who were present in the UK/had trusts at 6 April 2008.
22. It is similarly unclear from the legislation
whether remittances by trustees or companies they control will
be treated as remittances by the settlor of trusts and it remains
the case in the current draft legislation that for example investment
by a privately owned offshore company into the UK could be treated
as a taxable remittance to the UK by a non-domiciled individual
who owns as little as 10% of that company.
23. The (in fact quite narrowly drawn) measure
requiring disclosure of trusts was withdrawn and statements from
HMRC showed sensitivity to the concerns of non-domiciled individuals
about disclosing their affairs in constructing the rebasing election.
Wealthy non-domiciled individuals often have very significant
concerns about security in disclosing information about their
wealth to any party and most non-domiciled individuals see it
as fair to disclose details of income and assets in the UK to
HMRC but question why assets held and used overseas should be
within this. Despite the particular sensitivities noted above
HMRC will retain powers to make enquiries into worldwide assets
under their general enquiry powers and to an extent taxpayers
are taking it on trust that HMRC will use those powers responsibly.
24. The new s832(3) ITTOIA 2005 in paragraph
49 of Schedule 7 reverses the longstanding case law rule that
income tax cannot be charged when the source of that income is
no longer owned. This was a widely known and adopted planning
technique amongst non-domiciled individuals. There is no time
limitation on this change with the result that records may not
be available to identify whether a remittance post 5 April 2008
falls within this measure. This is perhaps the most widely applicable
of numerous detailed measures which are requiring non-domiciled
individuals to incur time and cost in reviewing their affairs
in detail.
25. Given the obvious complexity of some
of the changes required for more complex offshore structures involving
trusts and companies and the difficulty of drafting these it would
be highly desirable for the measures relating to those areas to
be postponed till the tax year beginning on 6 April 2009.
26. While the £2,000 de minimis
amounts in new section 809C and s809T of ITA 2007 are welcome,
they still appear too low. Small gains or small amounts of income
eg from letting out a property in the home country or employment
overseas can cause the measure to be exceeded with the result
that the individual will need to file a tax return and assess
their liability to tax under two bases. This will create a significant
burden for taxpayers and also HMRC. In the first year of operation
there will be significant changes required to PAYE codes. The
extension of this legislation across large numbers of migrant
and temporary workers in the UK will at best create a diversion
of resources for HMRC and at worst could foster a culture of non-compliance
in a sector of the economy. Fixing the de minimis at the
same level as the personal allowance and allowing all or half
of the capital gains annual exempt amount would be a logical way
to remove much complication from the system relieving individuals,
businesses and also HMRC from drains on their resources.
GOING FORWARD
27. The commitment in the Chancellor's Budget
speech not to amend the provisions further for the remainder of
this Parliament and the next is reassuring to the City, although
a little double-edged. As noted above, this legislation remains
work in progress and it will be necessary to monitor its effects
in practice and its practical implementation over this period.
A number of points remain unresolved at the time of writing and
it would be remarkable if legislation of this technical complexity
did not contain some anomalies and require further revision in
the future to ensure it operates as intended.
28. There is a real need to rebuild confidence
in the UK's tax system for individuals and businesses affected
by these changes (which are many in one way or another in the
City). Although we are not likely to see a sudden exodus, thanks
in part to the changes made to the draft rules, the image of the
UK as a place that welcomes international skills and wealth and
wants to attract them has been significantly affected. Some will
leave; more will not come in the first place; some employers will
redirect expatriates away from the UK: it will be interesting
to see how much net tax is actually raised by these changes in
the long run.
29 April 2008
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