Others may be on holiday in August, but not HMRC, who chose August 2014 to take taxpayers by surprise and change their stated position, with immediate effect, on the taxation of foreign income and gains used by UK resident, non UK domiciled individuals claiming the remittance basis (Remittance Basis Users - “RBUs”) as security for loans used in the UK.
The most significant advantage of being an RBU is the ability to shelter foreign income and gains from UK income tax and capital gains tax unless and until they are “remitted” to the UK.
Many RBUs segregate their income and gains from capital, which is neither income or gains, for example a gift or inheritance (often referred to as “pure” or “clean” capital). This segregated capital, unlike the foreign income and gains, may be remitted to the UK without triggering any UK tax.
The statutory definition of what constitutes a “remittance” is wide and the interpretation of it can be uncertain. HMRC has therefore published guidance on how it interprets the legislation.
There are specific rules about how the use of foreign income and gains may constitute taxable remittances with regard to debts. In this context, one important clarification of HMRC’s position was in relation to collateral.
HMRC’s original position in relation to collateral
When the legislation in relation to the remittance basis was published in the Finance Act 2008, there was much uncertainty about non UK income and gains used as collateral for a loan in the UK. It was not clear whether such income and gains would be used “in respect of” a debt used in the UK and therefore constituted a taxable remittance to the UK, or if “use” of foreign income and gains “in respect of” only applied to the servicing and repayment of the debt.
On 14 August 2009, HMRC introduced a statement in their guidance on the remittance basis (subsequently incorporated in the Residence, Domicile and Remittance Basis Manual) that, if a loan was made in a “commercial” situation and “serviced” (ie regular interest payments were made to the lender), foreign income and gains used as security would not be treated as remitted and subject to UK tax. Foreign income or gains used to service the debt would still be treated as a taxable remittance.
The thinking behind this view appeared to be that there was otherwise a risk that taxpayers might suffer double tax, being taxed on both the foreign income and gains used to service the debt and the foreign income and gains used as collateral for the debt.
HMRC warned that this treatment would not apply in cases involving tax avoidance. The treatment also did not apply to non-commercial arrangements.
Many advisors had recommended a cautious approach in relation to this guidance. This is because it seemed a generous interpretation of the strict wording of the legislation, was not binding on HMRC and could be withdrawn at any time. However, this published statement has, in practice, been relied upon by some RBUs, particularly if they were not aware of the risks, or if, having been properly advised, they still decided to take the risk. An RBU might have decided to use foreign income or gains for a debt used in the UK if they were struggling to find tax free funds to meet their UK living expenses if, for example, they were unable to separate their foreign income and gains from capital, or their segregated capital pot had run out, for example, because they had stayed in the UK longer than originally planned.
HMRC’s new position
HMRC have taken the industry by surprise by announcing, with no prior warning, that they have changed their approach with immediate effect from 4 August 2014.
HMRC will now treat foreign income/gains used as security for a loan used in the UK as a taxable remittance regardless of whether there was a commercial reason.
HMRC has not changed its original view that foreign income and gains used to pay interest on the debt and/or to repay the borrowed capital will also constitute a taxable remittance.
This means that there are potentially two possible sources of taxable remittance charge in respect of the debt, the foreign income and gains used:
- as collateral; and
- to pay the interest on the loan or repay all or part of the loan capital.
HMRC state that their initial view was a concession, although this was by no means clear from the previous guidance.
Points in practice for existing arrangements and new loans In relation to existing arrangements, HMRC has provided RBUs with some leeway. RBUs will not be taxed on foreign income/gains that they have used as collateral for a loan if they did so in reliance on HMRC’s prior guidance and as a result did not declare a remittance provided that they:
- notify HMRC (by an unspecified deadline) of the loan with full details including the amount of foreign income or gains comprised in the collateral and the amount of the loan remitted (if not the full amount) and either:-
- give a written undertaking by 31 December 2015 (which is subsequently honoured) that the foreign income/gains used as security has been or will be replaced by non-foreign income/gains security by 5 April 2016; or
- repay the loan or part of the loan remitted to the UK before 5 April 2016.
Many RBUs will be unhappy about the arduous task of having to provide details of all such existing loans to HMRC.
Some RBUs may be unable to reorganise their loan arrangements in time or may find it difficult, if not impossible, to calculate accurately the value of foreign income/gains comprised in the collateral.
There is also a potential problem for RBUs who do not have sufficient clean capital or UK assets to replace the original foreign income/gains security or the loan. In such situations, and for all new arrangements from 8 August 2014, HMRC will treat the RBU as having made a taxable remittance equal to the lesser of the amount of foreign income/gains used as collateral and the amount of the loan brought to the UK.
There are a number of scenarios where RBUs may be disproportionately impacted by this change. An obvious example of this is an individual who completed a property purchase shortly prior to 4 August and who took out a mortgage secured on non UK income or gains to pay part of the purchase price. Such an individual might not have proceeded with the purchase had they known that they might incur an additional large tax expense, that they might not have budgeted for or be able to afford.
In respect of both existing and new arrangements, there may be no alternative to paying tax on the remittance of foreign income or gains to the UK. Some may even find themselves in the difficult position of having to remit further foreign income and gains just so that they can pay the tax on the original remittance. However, there may be other structuring options that would result in no tax charge, such as identifying a source of capital or UK assets that can be used as collateral. Other options may result in a low tax charge, such as the availability of business investment relief, the wide exemptions for pre 2008 income and double tax treaty relief.
In terms of identifying a different source of collateral, some RBUs may consider offering offshore bonds as security. Whilst it is true that offshore bonds are taxed under the chargeable events regime and so fall outside the remittance basis rules in general, care should be taken in analysing how the premium was funded. If the bond was not funded with pure capital but with foreign income or gains then the use of the offshore bond as collateral for a debt used in the UK (or indeed a simple withdrawal and use of the funds in the UK) would constitute a taxable remittance. Whilst not in the chargeable events regime, similar funding and additional concerns apply with regard to the use of shares in offshore companies as security. Careful advice should therefore be taken with respect to the choice of collateral.
Further thoughts and implications
HMRC’s announcement is controversial, not least because of the way that they have ambushed taxpayers, because it is a sudden and complete about turn from their previously stated position and because the change is retrospective in that it will catch pre-existing arrangements. The change marks a new stage of HMRC’s ongoing attack on tax avoidance techniques and is one of an increasingly long string of examples, including, for example, the case of Gaines-Cooper and his reliance on IR20, which highlights the risk that taxpayers take in relying upon non-binding HMRC guidance in their tax planning.
Within their announcement, HMRC have given an indication into the thought process behind this volte face. It seems that their previous guidance was issued on an erroneous assumption that if HMRC agreed that the use of foreign income and gains as collateral was not a remittance then taxpayers would play fair and repay their loans out of foreign income and gains, thereby making a taxable remittance. Unsurprisingly, many taxpayers chose not to do this and repaid their loans from non-foreign income or gains that would not be charged as a remittance, despite foreign income or gains collateral having been used for the debt. HMRC could therefore not collect any tax. HMRC are now hurriedly attempting to cover up their mistake.
HMRC’s statement also indicates their willingness to unilaterally change their mind about something they previously permitted without needing to resort to a change in legislation to alter the rules or give them new powers. Their ability to do this partly stems from the ambiguities in the original drafting, which should serve as a reminder to all those involved in commenting on draft legislation of the need for precision. The absence of a clear definition of what is meant by “use in relation to” in the remittance basis code remains and will continue to be unclear unless and until the legislation is amended or the point is litigated. As the litigation is so uncertain, it would be a brave (and possibly foolish) taxpayer who would now act contrary to HMRC’s new guidance, use foreign income or gains as collateral for a relevant debt, not declare a remittance and challenge HMRC in the courts on this point.
Clearly, each taxpayer’s circumstances will be different and, in light of the above, all RBUs with existing loan arrangements should contact their tax advisors for a “tax health check” and all RBUs putting such arrangements in place from 4 August 2014 should take careful structuring advice.