In August last year, there was an announcement from HMRC which came as a nasty shock to certain non-UK domiciled taxpayers. HMRC announced that it was replacing, with immediate effect, its previous guidance on the tax treatment of loans used in the UK and collateralised on assets representing foreign income and gains of remittance basis users. The replacement guidance, released on 4 August 2014, stated that HMRC would treat such loans as involving a remittance of the foreign income and gains comprised in the collateral. Any remittance basis user with an existing loan used in the UK, and collateralised by assets representing foreign income and/or gains, would be treated as having made a taxable remittance, unless the loan was repaid before 6 April 2016 or the security was released. (See our previous briefing, “Collateral damage”).
On 15 October 2015 there was a further surprise announcement by HMRC regarding such loans. Its effect is that most loans that were in existence on 4 August 2014 will be “grandfathered”, avoiding the need for taxpayers to repay them, or find other collateral for them, before 6 April 2016.
This is a major change, and obviously a welcome development for affected taxpayers. However, it is regrettable that it has come so late in the day and that there have been so many changes of mind on the part of HMRC. There are lessons to be learned here by both taxpayers and, especially, the UK tax authority.
HMRC PRACTICE BEFORE 4 AUGUST 2014
As this is quite a complex saga, it is worth briefly setting out HMRC’s stated practice in relation to such loans before the announcement on 4 August 2014.
Where a UK resident, non-UK domiciled individual using the remittance basis took out a loan which was secured on assets representing his foreign income or gains, and any part of the funds borrowed was brought to or used in the UK, and the loan was “commercial”, involving regular interest payments, HMRC’s original published practice was not to treat the income and gains comprised in the security as remitted to the UK. Under the pre-4 August 2014 guidance, there would only be a remittance if foreign income or gains were used to make interest payments or principal repayments. To the extent that interest payments and principal repayments were made out of clean capital or UK taxed income, HMRC took the view that there would be no taxable remittance.
Many UK tax advisers were doubtful about the correctness of this guidance, and nervous about the possibility of its being withdrawn. Nevertheless, it was fairly common before 4 August 2014 for remittance basis users to borrow on the security of investment portfolios representing their foreign income and gains, and use the borrowed funds in the UK, typically for London house purchases. The practice was particularly common for long-term remittance basis users, who may have little or no “clean capital” that can be brought into the UK without triggering tax.
HMRC PRACTICE FROM 4 AUGUST 2014
On 4 August 2014, without warning, the above guidance was replaced. HMRC stated that any loan used in the UK and secured on assets representing foreign income and/or gains would constitute a remittance of the income or gains. For post-4 August 2014 loan arrangements, the remittance would be immediate, whereas for loans already in place on the date of issue of the new guidance, a remittance would be triggered unless the loan was repaid before 6 April 2016, or the security over the foreign income and gains was released by that date.
Oddly, HMRC stated that they would require taxpayers proposing to take either of these courses in relation to a pre-4 August 2014 loan to give an undertaking to HMRC, by the end of December 2015, to repay the loan or replace the security.
This change of position plunged a small group of taxpayers into something of a crisis. Many were faced with the prospect of substantial re-financing costs or, much worse, being taxed at up to 45% on loan balances of (in many cases) many millions of pounds, which they had taken out in reliance on HMRC’s previous guidance.
HMRC’S ANNOUNCEMENT ON 15 OCTOBER 2015
HMRC has apparently realised the impact on taxpayers of the 4 August 2014 announcement, and the unfairness of requiring individuals to unravel arrangements which were put in place in reliance on HMRC’s earlier guidance, or face punitive tax charges if they cannot. It could also be that HMRC is aware of the possibility of affected taxpayers litigating, on the basis that legitimate expectations have been breached, and is rightly concerned that a court would be sympathetic to that argument.
Whether this is the case or not, the tax authority has had a major change of heart. Taxpayers with pre-4 August 2014 loans who have not yet provided written undertakings to HMRC, and who have not yet taken steps to repay loans or replace collateral, can generally breathe a large sigh of relief. Where the borrowed funds were brought into or used in the UK prior to 4 August 2014, there is generally no requirement for action before 6 April 2016 (or at all, until the expiry of their current loan arrangements).
However, any remittance basis user who is proposing to take out a new loan secured by a charge over assets representing his foreign income and gains should be aware that HMRC’s position with respect to any such loan is as stated in the announcement on 4 August 2014. In other words, if the loan is used in the UK, HMRC will treat the income and gains as remitted. This is probably correct, although it is fair to say that the relevant legislation is capable of a number of interpretations, so the legal position is not clear.
The announcement made on 15 October 2015, called “Revenue and Customs Brief 16 (2015)”, is very short. It leaves many questions unanswered regarding the treatment of loans used in the UK, where such loans are collateralised on assets representing foreign income and gains.
The most fundamental of these is the meaning of “collateral” for these purposes; or, to use the language used in the legislation, in what circumstances foreign income and gains will be considered to be “used in respect of” such a loan. A long-standing unanswered question is whether the concept of “use in respect of” a loan extends beyond situations where assets are subject to a charge or pledge, to situations where there is no such security but the lender has a set-off right. In the absence of any guidance on this point, it is suggested that it may be reasonable for taxpayers to take the position that such situations do not involve “use” of the foreign income and gains in respect of the loan, provided that this position is flagged through the inclusion of a “white space” statement in their tax returns. However, where possible, the issue should be avoided by ensuring that there are no rights of set-off.
Brief 16 also fails to clarify the position of taxpayers with loan facilities used in the UK where the facility was in place before 4 August 2014 but the amount drawn down has increased after that date. The wording of the announcement suggests that, on the basis that the loan was first used in the UK before the key date, HMRC would accept that the facility is covered by the “grandfathering”. However, any individuals in this position would be well-advised to seek an assurance from HMRC that their loans will indeed be “grandfathered” (as a matter of urgency, so that there is time to unwind the arrangement before 6 April 2016, if necessary). Brief 16 includes contact details for HMRC staff, although it is unclear whether the named individuals will have authority to give binding statements as to HMRC’s practice on this point.
THE DANGERS OF “GUIDANCE”
In recent years there have been a number of cases which have exposed the problems with HMRC “guidance” which does not necessarily reflect the law, but which taxpayers may rely on, in the reasonable belief that HMRC will follow its own published practice. A previous case of particular notoriety was that of Robert Gains-Cooper, which drew attention to serious defects in HMRC’s “guidance” concerning tax residence.
The saga in relation to loans used in the UK and collateralised by assets representing foreign income and gains has drawn the spotlight back onto this issue. HMRC must be – or at least should be – embarrassed by how it has dealt with these loans. Two major mistakes have been made.
The first was to issue “guidance” in 2008 which a significant number of professional advisers considered not to be an accurate interpretation of the law. The second was the U-turn in August 2014, whereby HMRC changed its position on the treatment of such loans, seemingly without regard for the fact that individuals had put arrangements in place in reliance on the previous “guidance”, which in many cases could not be unwound without significant tax costs.
It was also unhelpful that HMRC's announcement in August 2014 included an assertion, that its previous practice on such loans was concessionary. That was not apparent from the pre-4 August 2014 “guidance”, and an unrepresented taxpayer would have had no inkling that the “guidance” was anything other than an explanation of the law. Many people might feel that it was disingenuous of HMRC to try to justify its own position by only stating six years after publication of the guidance that the guidance was concessionary.
HMRC is to be applauded now for recognising that the 4 August 2014 announcement was unfair and needed correction, and for doing the right thing. It is hoped that some lessons will be learned by HMRC about the need to get guidance right at the outset, and to avoid changes of practice which breach taxpayer’s legitimate expectations that published statements of practice will be followed. But in case they have not, taxpayers would do well to be cautious in following any HMRC guidance, particularly where they are aware that it may not be in line with the law.
New loan arrangements
- If borrowed funds are to be used in the UK, care should be taken to avoid collateralising the funds on foreign income and gains, which would result in a taxable remittance of the collateral.
- Advice should be sought on the measures needed to avoid inadvertent “use” of foreign income and gains “in respect of” a loan used in the UK, e.g. due to the existence of set-off rights in standard banking documents.
Loan arrangements in place before 4 August 2014
- Individuals with arrangements that were put in place prior to 4 August 2014, where the borrowed funds had already been used in the UK by that date, are no longer obliged to take steps to repay the loan/replace the collateral or provide undertakings to HMRC.
- Care should be taken not to replace loans with new financing arrangements, which might trigger a remittance under the treatment in place since 4 August 2014. Advice should be sought before making any changes to an existing loan, e.g. an increase in the amount of the loan.
- The requirements re commerciality and regular servicing of loans will, as far as we are aware, remain in place. If a loan is renegotiated and ceases to be “commercial” as a result, this may trigger a remittance of the foreign income and/or gains used as collateral.