On 18 January 2008 HMRC published draft legislation to implement the changes to the taxation of non-UK domiciliaries announced in the October 2007 Pre-Budget Report.

Although HMRC have stressed that the legislation is not in final form it will form the basis of revised tax rules to take effect from 6 April 2008.

The purpose of this Bulletin is to explain what the draft legislation proposes and what action you should take at this stage. We recommend that you contact us as soon as possible to review your affairs in light of these significant tax changes.

1. Changes to the residence rules

An individual’s tax residence is determined broadly but not entirely on a day count of the number of days spent in the UK. Should an individual spend more than 183 days in the tax year in the UK or more than 91 days on average over a four year period, then he or she will be classified as UK resident.

With effect from 6 April 2008:

1.1 Days of arrival and departure must be included when counting days of residence in the UK (they are currently not counted).

1.2 There is an exception for those in transit as long as they do not come through immigration and remain within the passenger only side of airport terminals.

Action Point

An individual should take care not to offend the new day counting rules if he is seeking to remain non-UK resident. Careful record keeping remains essential.

2. Changes to the remittance basis of taxation

Currently UK residents who are non-UK domiciled can have their non-UK income and capital gains taxed on a remittance basis; this effectively exempts non-UK income and capital gains from UK tax unless and until they are remitted to the UK.

With effect from 6 April 2008:

2.1 Taxpayers will need to claim the remittance basis on their Self Assessment tax returns in respect of employment and investment income and capital gains (not just investment income as is currently the case).

2.2 For those resident in the UK for 7 out of the last 9 tax years excluding the relevant current tax year, a £30,000 annual levy is payable when claiming the remittance basis subject to the individual’s offshore income and gains amounting to more than £1,000 for the relevant year. The remittance basis will automatically apply to this de minimis amount.

2.3 The £30,000 levy will only attract a credit against taxes paid abroad if the provisions of the relevant Double Tax Treaty permit this; currently, US citizens face double taxation under the new regime. Furthermore, funds remitted in order to pay the levy will themselves be taxed on the remittance basis.

2.4 Those claiming the remittance basis will lose their personal allowances for income tax (currently £5,225 in the 2007/08 tax year) and annual exempt amount for capital gains tax (currently £9,200 in the 2007/08 tax year).

2.5 The remittance basis will be claimed annually and it will be possible to opt for the remittance basis to apply in one year and not in the next.

2.6 Those claiming to be taxed on a worldwide basis will pay tax on offshore income and gains that arose in a previous year when the remittance basis was claimed if such income and gains are remitted to the UK.

Action Point

A decision will need to be made on an annual basis about whether to claim the remittance basis of taxation and how to structure your financial affairs to minimise the amount of the levy for your family.

3. Correction of “flaws and anomalies” relating to the remittance basis

A number of current planning possibilities are being restricted for those who continue to be taxed on the remittance basis of taxation.

With effect from 6 April 2008:

3.1 Income can no longer be converted into capital by closing the income source in tax year one and remitting the funds in tax year two. This mechanism, known as “source ceasing” or “source closing”, was often made use of when capital funds had become tainted due to an inadvertent aggregate income payment.

3.2 Offshore assets acquired and subsequently brought into the UK will be subject to income tax if the purchase monies were made up in whole or in part by non-UK income which has not previously been taxed.

3.3 It will no longer be possible to re-categorise income and gains as capital by making gifts offshore to connected parties (e.g. family members) prior to a remittance or re-routing the funds through offshore trusts and companies whilst the donor or settlor still benefits from the assets. This was known as “alienation” of income and gains.

3.4 Less favourable rules have been introduced regarding the order in which remittances are made out of mixed offshore funds. It remains that income is deemed to be remitted first but capital gains will now be subject to a similar regime so that gains are not pro-rated between clean capital but deemed to be remitted in their entirety ahead of clean capital.

Action Point

There may be planning possibilities to utilise the existing rules concerning alienation of income and gains and remittances from mixed funds if action is taken before 6 April 2008.

4. Changes to taxation of offshore trust and company structures

Significant changes are to be introduced to the taxation of offshore trust and company structures established by non-UK domiciled individuals.

With effect from 6 April 2008:

4.1 Non-resident trusts with UK resident, non-domiciled settlors will have to be disclosed to HMRC. This applies to existing trusts: the settlors will have 12 months to inform HMRC, as opposed to 3 months for settlements created after 6 April 2008.

4.2 UK resident, non-domiciled settlors of “settlorinterested” offshore trusts will be taxed on trust gains on an arising basis, unless the remittance basis is claimed in relation to the non-UK situs assets within the trust. A trust will be settlor-interested if the settlor or his close family can benefit from it.

4.3 UK resident, non-domiciled beneficiaries of offshore trusts will be taxed on a receipt of “capital payments” in the UK where there are gains within the trust and where the settlor has not been taxed on the same. Historically, only UK domiciled beneficiaries were taxed on this basis.

4.4 Any gains relating to an underlying non-UK close company (one with 5 or fewer shareholders), that are received by an offshore trust will be attributed to the settlor (if the trust is settlor-interested) or a UK resident beneficiary on receipt of a capital payment and taxed accordingly (i.e. the structure becomes transparent).

4.5 UK resident, non-domiciled shareholders/participators in non-UK close companies will be subject to UK tax on company gains pro-rata on an arising basis for UK assets and on the remittance basis for offshore assets.

4.6 Rules governing attribution of income to UK resident, non-UK domiciled settlors and beneficiaries have been extended so as to dovetail with the new remittance provisions.

4.7 UK residents receiving gains in offshore funds will be taxed on an arising basis, unless the remittance basis is claimed.

4.8 Subject to the proposed changes to the UK capital gains tax regime, the rate of tax when attributing historic gains to UK resident beneficiaries in receipt of capital payments could be either 29% (if the flat rate of 18% is introduced) or as much as 64% (if not).

Action Point

All existing offshore company and trust structures should be reviewed immediately.

In particular, the new rules significantly affect the common trust and company structures used to hold UK property.

There may be planning possibilities to reduce the impact of the new rules if action is taken prior to 6 April 2008. Action may need to be taken by offshore trustees or company administrators and will be time critical.

Going forward, new structures may need to be considered to ensure that the current benefits achieved by offshore trusts and companies are maintained.

There has been no mention of the introduction of a harsher regime for longer-term residents in the UK who have been here for at least 10 years, as was put forward by HM Treasury previously.

HM Treasury’s consultation, “Paying a Fairer Share: a consultation on residence and domicile”, is still ongoing and clients and advisors are invited to submit their comments by 28 February 2008.