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NEW YEAR’S RESOLUTIONS
FOR NON UK-DOMICILIARIES AND THEIR OFFSHORE TRUSTEES
- To keep income or gains nominated in respect of the remittance basis charge, separate from other income or gains to avoid any possibility of remittance. A remittance of any of the nominated amount will result in all the individual’s unremitted income and gains being treated as comprised in one mixed fund ad infinitum. Any remittances to the UK will then be treated as “worst first” (i.e. income before gains and untaxed before taxed etc). It is perhaps safest to nominate only a nominal amount of income and gains in a separate account that will never be remitted.
- To make sure that if the remittance charge is paid from offshore funds it is paid direct to HMRC to avoid the payment being treated as a remittance. This means nominated income and gains can be used for this purpose without triggering the “mixed fund trap”.
- To remember that if foreign income is nominated in respect of the remittance basis charge, the payment will form part of the next tax year’s payment on account. This can be avoided by nominating foreign gains instead.
- Not to overlook foreign currency bank accounts held by offshore trustees as these can give rise to unexpected capital gains tax exposure if capital payments have been made since 5 April 2008. The general exchange gains rules apply to trusts but the exemptions for funds held for personal use and same currency inter-account transfers do not. The latter exemption is also not applicable to non-UK domiciled individuals although HMRC have indicated that this may be reviewed in the future. Gains will not be in point for offshore companies as their gains are calculated in accordance with the corporation tax rules which exempt foreign currency accounts under the loan relationship rules.
- To avoid remittances arising from payments for services by offshore trustees and companies. In order for the exemption in section 809W of Income Taxes Act 2007 to apply, the service must relate “wholly or mainly” to property situated outside the UK. HM Revenue & Customs accept that “wholly or mainly” means at least 51%. If the non-UK element of the service is less than 51% of the total, it would be advisable to contract and pay for this element separately. The view of HMRC is that time spent is the best measure by which to split services.
EMPLOYEE BENEFIT TRUSTS
Inheritance Tax Ten-Year Charges
Offshore employee benefit trusts have been used for a number of years and became particularly popular in the late 1990’s and early 2000’s when full corporation tax relief was available for employer contributions. The Dextra case in late 2002 resulted in a restriction to relief for contributions to the EBT unless the funds were used by the trustees to meet qualifying expenses or to provide qualifying benefits within 9 months of the company’s accounting year end. Initially, there was no requirement for the benefits to be subject to PAYE and NIC and in many cases the benefits were “conferred” by means of a transfer of funds from the main EBT to a sub-trust for a particular individual. The funds could then be loaned to that individual, thus deferring PAYE and NIC but with full corporation tax relief available for the employer contribution. This practice was halted by Finance Act 2003, which specified that a corporation tax deduction would only be available if the amount paid out by the trustees was subject to PAYE and NIC.
The sub-trusts created during this window of opportunity have now reached or are approaching their ten-year anniversary and trustees will need to carefully consider the inheritance tax position.
The exemption from the relevant property regime (i.e. ten-year charges and exit charges) contained in section 86 of Inheritance Tax Act 1984 applies to EBTs under which all or most employees are eligible to benefit. If funds within an EBT cease to be within s.86, a charge will be levied on the trustees at that point and thereafter those funds will be subject to the relevant property regime.
It is understood that HMRC consider funds transferred to a sub-trust for particular employees as not available to benefit all or most employees (even if the sub-trust is revocable) and as such outside s.86 IHTA 1984. If this is the case, the funds held in those sub-trusts could give rise to a ten-year anniversary charge and trustees will need to consider their possible exposure and whether inheritance tax accounts should be submitted to HMRC.
One might assume that in such a situation, section 81 IHTA 1984 would apply such that the date of the ten-year charge is governed by the date on which the main EBT was created. However, HMRC have recently stated that they consider the date of the charge will be by reference to the date on which the sub-trust was created. Whilst this view is difficult to substantiate from the wording of the legislation, it will result in a deferral of the date of the charge and is therefore unlikely to be challenged by taxpayers.
Allocation of Funds to Sub-Trusts
The “Spotlights” section of the HM Revenue & Customs’ website publishes comments on a small number of tax planning schemes which have been notified to HMRC.
HMRC have now included comments regarding the use of EBTs to allocate funds to specific employees, often with the contributions to the EBT being structured in such a way as to achieve a corporation tax deduction. HMRC’s published view is that at the time the funds are allocated to the employee, those funds become earnings on which PAYE and NICs are due and should be accounted for by the employer.
This argument was rejected in the Dextra case on the basis that such allocations (e.g. to sub-trusts for particular employees and their families) could not constitute earnings as the funds were still subject to the trustee’s discretion. In addition, many sub-trusts are revocable such that the funds could ultimately be used for the benefit of any of the class of beneficiaries. It would therefore be arguable that the funds have not been definitively allocated at the point they are transferred to such a sub-trust. The provision of loans to employees was also held not to constitute earnings in the Dextra case although this related primarily to interest-bearing loans and it is perhaps interest-free loans that are more likely to attract HMRC scrutiny in the future.
Whilst there is currently no statutory back-up to HMRC’s views they are clearly putting “customers” on notice that this is an area which they will be looking at closely in the future.
UK TAX CREDITS ON FOREIGN DIVIDENDS
2008/09
If a UK-resident individual received a dividend from a foreign company in the 2008/09 tax year, he was entitled to a notional UK tax credit equal to one-ninth of the foreign dividend (or gross foreign dividend if foreign withholding tax has been deducted) providing that his shareholding was less than 10% and the foreign company was not an offshore fund.
2009/10 Onwards
The scope of the entitlement was extended by Finance Bill 2009 (with effect from 22 April 2009) in relation to foreign dividends where any one of the following applies:
(a) Minority shareholding (less than 10%); or
(b) Company is an offshore fund: or
(c) Company is a resident of a qualifying territory (i.e. one with a double tax treaty with the UK with a non-discrimination article. It should be noted that Guernsey is not a qualifying territory for this purpose).
Earlier Years
Prior to 2008/09, the notional UK tax credit was not available. However, a number of taxpayers have claimed the tax credit for earlier years on the basis that judgements of the European Court of Justice indicate that the UK system was unlawful under the EC Treaty because it discriminated between UK and foreign dividends. HMRC has stated that it does not accept this point on a general basis but following legal advice it will accept claims dating back to 2003/04 in relation to dividends from companies resident in Finland, Greece and Ireland (excluding Irish investment funds).
Application to Trusts, Beneficiaries and Settlors
UK-Resident Trusts
The legislation contained in section 397A of ITTOIA 2005 refers to a “person” rather than an “individual” and this is therefore taken to include UK-resident trustees. Following some confusion over the wording of the guidance notes to the Trust tax return SA900 for 2008/09, HMRC have now confirmed that the tax credit will be passed through to UK-resident life tenants and settlors, where the trust is settlor-interested.
Non UK-Resident Life Interest and Settlor-Interested Trusts
Where the trust is non UK-resident, the tax credit will still be available to the life tenant or settlor (if he is taxed on the trust income under the settlement code) by virtue of section 397A(5) of ITTOIA 2005, which treats that individual as having received the income for the purpose of this legislation.
If the life tenant or settlor is UK-resident but non UK-domiciled and claims the remittance basis for the year in which the dividend arises, that income will not become taxable until such time as it is remitted. Remitted dividend income does not benefit from the dividend rate of 32.5% (42.5% from 6 April 2010), however all remittance basis users can benefit from the one-ninth tax credit providing they are eligible to receive it as outlined above.
Non UK-Resident Discretionary Trusts (excluding settlor-interested trusts)
If an offshore discretionary trust receives a foreign dividend it will not be liable to UK tax on that income so the question of entitlement to the notional tax credit is not directly relevant. If the trust income is distributed to UK-resident beneficiaries, they would normally be entitled to a credit for any tax suffered under Extra Statutory Concession B18.
However, ESC B18 specifically states that no credit will be given for UK tax treated as paid by the trustees which is not repayable and this would include the notional UK tax credit. However, conversely, the notional tax credit is not taken into account in calculating the gross taxable income of the beneficiary so only the amount of the foreign dividend received would be brought into charge in the beneficiary’s hands.
FOR MORE INFORMATION CONTACT:
Mandy Connolly
Email mandy.connolly@praxisgroup.com
Tel +44 (0) 1481 737696
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