17 Jan 2017

CAPITAL letters - Issue 21

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Non-dom reforms – the nasty sting in the tail

You may think that you already know what you need to know about the non-dom rules and how they affect trusts – but the chances are that you are mistaken. True, the reforms are based on some fairly straight-forward ideas – such as the new 15/10 year rule and the concept of the 'protected trust' – but most of the changes proposed by HMRC are apparently unrelated to these 'simple' ideas. Indeed, it seems that HMRC is attempting to smuggle in a whole host of provisions which have long been on its 'to-do' list.

There are seven proposed changes to the CGT taxation of offshore trusts and only one of those is directly relevant to the concept of a protected trust. The rest are of peripheral relevance and, if I were to be cynical, looks very opportunistic on the part of HMRC.

I warn you that this edition is highly technical and you may be tempted to do something more pleasurable instead (which, if I'm honest, would be anything short of stabbing yourself in the face with a fork) but you really need to read this – these changes will have some monumental effects in the coming years.

I will look solely at the CGT changes in this edition as HMRC has not yet blessed us with the detailed income tax provisions. I might (if you ask nicely) tackle the income tax changes in a future issue -  if HMRC can get its act together and publish the rules at some point before they come into effect. We live in hope.

Offshore trust reforms

  1. Section 86 – the new protection

    A new para 5A to Schedule 5 TCGA will provide the s.86 'switch-off' for settlors who are UK domiciled only by virtue of the new 15/20 year rule (remember that returning UK doms are not protected). This protection is lost if the settlement is 'tainted' by way of the additions of new property. There are exemptions for arm's length transactions and contributions to cover the shortfall in trust expenses (which will be a relief to trustees everywhere!).
     
  2. New settlor charge on payments to close family members

    A new s.87G imposes a settlor charge where capital payments are made to a close family member (spouse/minor child) who is non-resident or UK resident but claiming the remittance basis. This provision, like the following five below, is not dependent upon the settlor becoming deemed domiciled under the new rules. To be clear, this will apply to all offshore trusts.
     
  3. Capital payments to temporary non-residents

    This is a technical amendment which makes sure that the new disregard of capital payments to NR beneficiaries (see below) does not affect the existing rule that temporarily non-resident beneficiaries (that is those NR for less than 5 years) are taxed on their return under s.87.  This sentence will probably make no sense to you until you read 5 below.
     
  4. Termination of settlements – treatment of capital payments

    A new s.87F will attribute gains to NR beneficiaries on the termination of a trust. This is the only exception to the new rule (see below) which disregards payments to NR persons.
     
  5. Disregard of capital payments to NR beneficiaries

    This is the real sting in the tail to these reforms and it will really hurt. HMRC is proposing that in allocating trust gains to capital payments (the so-called 'matching' process) after April 2017 all previous payments to NR beneficiaries are to be disregarded.

    The extent of this change is breath-taking as it will affect all trusts (not just those that are so-called 'protected') and all capital payments made to NR beneficiaries, even those made many years ago. You need to take a deep breath at this point and ponder the consequences. You may, as a trustee, have carefully maintained your gains pool over the years, painstakingly calculating the trust gains and netting off against all distributions made to beneficiaries, whether resident or not. You may think that you have an accurate record of the taxable gains pool available for matching to any distributions to UK resident beneficiaries going forward.  Well, post April 2017, you can throw that calculation away and, thanks to the new s.87D, you will have to start again.

    Putting this simply – all gains that you thought had previously been washed out to NR beneficiaries will magically re-appear. Given that many trusts will have used washing-out techniques in the past, this reform will be a major complicating factor.  This may mean that you will have to accelerate payments to UK resident beneficiaries before 5th April 2017 or bring the trust to an end, to take advantage of the one exception to this new rule. Either way, it's a huge headache. It's also hugely retrospective/retroactive* (*delete as appropriate, according to your political taste). I have more to say in this below in my comment section.

  6. Migrating beneficiaries

    In another technical amendment, a new s.87J makes sure that payments made to beneficiaries whilst UK resident which do not match to trust gains (because there are none at that time) are disregarded for future gains pool calculations if the beneficiary later leaves the UK. I appreciate that you may be feeling a bit confused by this stage (I know I was on the first, second and third reading of this provision) so perhaps it is best to think of it in this way – this amendment is required in order to respect the new principle that gains do not match to payments unless they trigger a UK tax charge. Does that help?

  7. Onward gifts

    The new s.87I is effectively a legislative enactment of the rule in Furniss v Dawson, the case which introduced the judicial anti-avoidance concept of 'inserted steps'.

    The concept here is quite simple – if you make a payment to a NR beneficiary or a resident beneficiary on the remittance basis and that beneficiary makes an onward gift to a close family member resident in the UK within 3 years or if that beneficiary makes an onward gift before the distribution from the trust "in anticipation of receiving it" then that gift recipient will be taxed under s.87. If the arrangement is actually part of some tax avoidance arrangement (which I should imagine most are) then the 3 years requirement is removed and HMRC can go back indefinitely.

    This last provision is staggering in its scope and leaves the possibility that you could be caught by Section 87 if your non-resident brother gives you a Christmas gift 20 years after he received a distribution from the family trust.

 

Re-basing

Do you want some good news? I think we could do with some right now. Here's some – HMRC has relaxed and extended the scope of the re-basing rules. It's looking quite generous, particularly when you compare it to the horrors above.

Re-basing will occur on 6/4/17 for anyone who becomes deemed domiciled on that date and who holds a foreign asset on that date. The earlier (inexplicable) suggestion that it will only apply to assets held as at 8th July 2015 has been dropped. It covers any assets, except UK assets and those inside trusts, companies, life insurance bonds or roll-up funds. You need to have paid the remittance basis charge (RBC) at some point in order to qualify.

Remember that this will only re-base the base cost of the asset for CGT proposes – it does not mean that you can ignore the remittance rules if that asset was funded from unremitted foreign income or gains. You need to 'cleanse' the funds to achieve that.

 

Cleansing

You can make a one-off election (per account) to dis-apply s.809R ITA 2004, which will enable you to separate income and gains from your clean capital. You have two years to do this from 5/4/17 and it will only apply to the movement of money from one account to another during that period. That means you need to liquidate assets in order to achieve the cleansing.

Unlike the re-basing, this will apply to all non-doms resident in the UK, provided you have claimed the remittance basis at some point (although you do not need to have paid the RBC). It will not apply to returning non-doms.

 

Comment

I think we have all got used to the idea of the new deemed domicile rules and, broadly speaking, they seem quite fair. The proposed rules to 'protect' offshore trust were also good, at least in theory, as it means that long term residents in the UK can remain here and still largely escape IHT, income tax and CGT on their foreign assets. Whilst we expected some pay-back for these new protections, we did not expect wholesale revisions to the CGT code for all offshore trusts, especially ones with such punishing retrospective/retroactive* effect.

I have written before about the alarming new tendency for retrospective legislation and would like to remind our lawmakers (someone please tell them) that such measures not only offend against the natural rules of justice but also our obligations under the European Convention of Human Rights.

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