Mandy Connolly Tax Manager, Praxis Fiduciaries Limited
 

These uncertainties were addressed in George Osborne’s first Budget speech on 22nd June with the announcement that the 18% capital gains tax rate will remain in force for basic rate tax payers but a new rate of 28% will apply for higher and additional rate payers with effect from 23rd June 2010. The rate increase is significantly less than anticipated and has not therefore fully addressed the disparity between the income tax and capital gains tax rates. However, on a cautionary note, it has been stated that the Chancellor will decide the rates for capital gains tax for 2011/12 in his next Budget (probably in March 2011), thus leaving scope for rates to be increased further at that time.

The annual exemption will remain at £10,100 for the 2010/11 tax year and the Chancellor noted in his Budget speech that it would continue to rise with inflation in future years, thus allaying fears that it might be cut dramatically in accordance with the wishes of the Liberal Democrats.

Amongst those professionals involved with offshore trusts and non-UK domiciled individuals, it was generally considered that a mid-tax year rate change would be fraught with difficulties and would be best avoided. However, the Chancellor clearly felt that immediate action was necessary and as a result he will now be faced with the task of amending the existing legislation and drafting transitional provisions to deal with the issues.

Capital Gains Tax for Individuals
It has been confirmed that the new 28% rate will apply to gains realised after 22nd June 2010 to the extent that an individual’s total taxable income and gains (i.e. after deduction of personal allowances and annual exemptions) exceeds the basic rate band of £37,400. However, for the current tax year any gains realised on or before 22nd June will be ignored for the purpose of this calculation and will be taxed at the previous flat rate of 18%. The position is therefore fairly straightforward where an individual realises a personal gain.

The position is different for non-UK domiciled individuals who are claiming the remittance basis of taxation for a particular year. Such individuals will be taxed on their UK gains of that year at a flat rate of 28%, regardless of their income. It would appear that their foreign gains of that year will also be taxed at 28% when remitted, even if remitted in a year when the individual is not a remittance basis user. The Budget documentation refers to the payment of the “remittance basis charge” and it would therefore appear that an individual remitting a pre 6th April 2008 personal gain would be eligible for the 18% tax rate if his taxable income and remitted gains for the year of remittance do not exceed the basic rate threshold.

Notwithstanding the increase in the rate of capital gains tax, offshore trusts remain an attractive option for non-UK domiciled individuals. Gains on both UK and foreign assets can be realised by trustees with no immediate tax charge, and so will not necessitate payment of the £30,000 remittance charge on an annual basis. Although the effective rate of capital gains tax on extraction will be up to 48.8%, this can be avoided by leaving funds in trust until such time as the individual leaves the UK. Further options, such as bond wrapping and inserting an underlying offshore company can be used to bypass the income tax and inheritance tax issues arising from income producing assets and UK property respectively.

Gains attributed from Offshore Trusts and Companies
The main difficulties with a mid-tax year rate rise are in point where gains realised by offshore trustees are taxed on the beneficiaries under the “capital payment” regime (i.e. where gains realised by the trustees are only subject to tax when trust capital is distributed to the beneficiaries). In many cases, capital distributions will have been made to beneficiaries ahead of the Emergency Budget with the aim of securing the 18% tax rate. It is not yet entirely clear whether capital distributions made before the Budget will fully succeed in achieving this aim as the current legislation looks at gains “for the year” in question. However, it is assumed that the transitional measures will look to achieve the same effect as for individuals, thus a pre-Budget capital distribution which has matched to an existing trust gain should attain the 18% tax rate, although the position is less certain where capital payments made pre-Budget match to trust gains made after 22nd June.

The maximum effective tax rate for gains falling within the “capital payment” regime will be 48.8%. This is due to the Supplementary Charge which aims to compensate the Exchequer for the deferral of tax (i.e. where gains are realised by the trustees but not distributed until several years later) and is levied at up to 60% of the tax due. The divide between income tax and capital gains tax rates where offshore trusts are concerned is no longer clear cut and any further increases in the capital gains tax rate could mean that realising income rather than gains appears outwardly beneficial, although the advantage of tax deferral under the capital gains tax rules would need to be taken into account alongside individual circumstances.

As things now stand, post-Budget, the personal tax position of beneficiaries will need to be considered when extracting capital from offshore trusts and distributions could perhaps be spread among family members so as to achieve a lower overall rate of tax. Equally distributions of capital could be deferred to coincide with a “low income” year where possible.

Where the gains of an offshore trust are treated as attributed to the settlor by virtue of him having a “defined interest” in the settlement, or where the gains of an offshore “close” company are attributed to the participators, the position is more straightforward and the tax rate for the current year will be determined by the date on which the gain is realised.

Entrepreneurs’ Relief
In addition to a lower than expected rise in the rate of capital gains tax, the Government also decided to extend the lifetime limit for Entrepreneurs’ Relief from £2 million to £5 million with effect from 23rd June 2010.

Where the relief applies, the effective capital gains tax rate is reduced to 10%.

Where relevant assets (e.g. family company shares) are held within a life interest trust, the relief can be applied in respect of gains realised by the trustees, providing the life tenant personally owns at least 5% of the shares and has at least 5% of the voting rights, in addition to being an officer or employee of the company concerned (or has satisfied these conditions for a qualifying period).

OTHER RELEVANT ISSUES

Non-UK Domicile Review
Following the Coalition Agreement, the Government has reiterated its intention to review the taxation of non-domiciled individuals to assess whether further changes should be made. Despite the significant amount of new legislation introduced by Finance Act 2008, further changes may well be looming although no indication of timescale has yet been given.

Inheritance Tax
The Conservatives’ original proposal to raise the inheritance tax threshold to £1 million was not aired during the Budget. The only reference to inheritance tax was in the context of possibly extending the scope of the Disclosure of Tax Avoidance Scheme rules to encompass inheritance tax planning using trusts. It is not known how widely these rules might be drawn but clearly H M Revenue & Customs are looking to monitor possible inheritance tax avoidance more closely.

The £325,000 nil rate band remains frozen until 5 April 2015.

Settlor-Interested Trusts – Tax Refunds
Currently, a settlor who has retained an interest in a trust is taxed on the income arising to the trustees as if it was his own. However, that notwithstanding, trustees of discretionary-type trusts will first pay tax on the income (UK source income only for offshore trusts) at the trust rate of (currently) 50%. The tax paid by the trustees is then available to the settlor as a credit against his personal liability.

It was announced in Labour’s March 2010 Budget that where this arrangement gives rise to a tax repayment in the hands of the settlor, he will be required to pass that repayment back to the trustees. Although this measure was not taken forward earlier in the year, the new Government have announced that it will take effect from 6th April 2010. It was also announced by the new Government that the repayment of tax rebates to the trustees will not be treated as a chargeable transfer and will therefore have no inheritance tax implications for the settlor or the trustees.

Employee Trusts and Employer Financed Retirement Benefit Schemes (EFRBS)
The March 2010 Budget announced the implementation of legislation from 6th April 2011 to tackle arrangements using trusts and other vehicles to reward employees that seek to avoid, defer or reduce liabilities of employees and directors to income tax and NIC or to avoid restrictions on pensions tax relief. The new Government’s Budget press notice, “Tackling Tax Avoidance”, confirms that EFRBS will be within the scope of this legislation. However, EFRBS should remain extremely attractive vehicles when used correctly and in the right circumstances. It should be possible to manage any risks by ensuring that tailored tax advice is taken.
 

FOR MORE INFORMATION CONTACT:

Mandy Connolly
Email mandy.connolly@praxisgroup.com
Tel +44 (0) 1481 737696