Accidental remittances

Accidental remittances

Key points

What is the issue?

Loans are a prevalent mechanism for transferring wealth, particularly for remittance basis taxpayers. This article looks at some of the dangers of lenders assuming they have powers to make loans to borrowers without first checking their governing documents.

What does it mean for me?

This is a highly relevant issue for practitioners advising resident, non‑UK‑domiciled individuals as well as those advising offshore trustees and directors.

What can I take away?

The importance of ensuring that a lender has sufficient powers to make loans to borrowers before any loans are made.

 

The use of loans is perhaps the most common form of fund extraction from non‑UK‑resident structures. There are myriad issues that should be considered when making or reviewing loans, including interest, security and repayment provisions, but the first question a potential lender should ask itself is whether it has the power to make a loan in the first place.

This may seem an obvious point and, in most cases, the ability to make the loan to the borrower will be clear. However, there are a small number of cases where the lender does not have the power to make a loan, and the consequences can be significant. An ‘ultra vires’ loan can arise, inter alia, where the recipient is not a beneficiary of the trust and the loan is not on commercial terms, or where a company makes a loan without the power to do so in its governing articles.

This article considers a ‘simple’ structure with a non‑UK‑resident trust (the Trust) established by a UK‑resident but not domiciled, or deemed domiciled, settlor (the Settlor). The Settlor is excluded from the class of beneficiaries but, notwithstanding this, the Trust makes an interest‑free loan of GBP10 million of relevant foreign income to the Settlor (the Loan). The Loan is paid and retained in a Swiss bank account.

This article will not consider whether the payment by the Trust to the Settlor is, in fact, a loan or whether it constitutes some other form of payment. However, this is something that will need to be considered in light of the powers and restrictions that may apply to the Trust under its governing documents and local laws. On this, it is worth noting the recent case of Sofer v SwissIndependent Trustees SA,[1] which showed that the courts are willing to look beyond what a transaction is reported to be by the trustee to the substance of the loan itself.

Making an ultra vires loan has a number of consequences, but importantly, for UK tax purposes, it creates a series of claims between the lender and the borrower. These claims include a potential claim in personam against the borrower, as well as a claim for a constructive trust over the lent assets. So, why does the creation of these claims cause a potential remittance of a loan?

Situs of a chose in action

When a lender makes an ultra vires loan, a chose in action arises the moment the loan is made. As already considered, this chose in action may comprise multiple claims that the lender can bring against the borrower, but there is only one asset: a chose in action.

In the above example, the claim in personam will be regarded as situate where the borrower is resident, i.e., the UK. The claim for a constructive trust would be situate where the assets were located; Switzerland in this example. So, where is the chose in action situate? Perhaps unsurprisingly, there is no clear answer to this question, so it is necessary to look at analogous examples to draw reasonable conclusions.

If we consider mortgages, the position has several similarities. A mortgage debt also confers a variety of remedies on the mortgagee; it is an interest in land, conferring (at least when the debt is due and unpaid) a right to possession, power of sale and right to foreclose; and it is also a debt, conferring a right of action against the debtor/mortgagor (like an unsecured debt). The cases discussing the situs of a mortgage debt are not consistent, but Her Majesty’s Revenue and Customs (HMRC) generally adopts the view that the location of the land prevails over the residence of the mortgagor.[2]

However, HMRC also gives weight to the legal system governing, or likely to govern, the relevant asset.[3] This emphasis on the appropriate legal system may be more relevant where a reasonable person may conclude that the lender would be far more likely to bring a claim in the UK than in the country where the received assets were currently being held. For example, if, instead of Switzerland, the Loan was paid and held in an account in the proverbial Timbuktu, it is likely that any reasonable person would first seek to enforce the chose in action in the UK. As such, the UK may well regard the chose in action as being UK‑situs, the UK being the most likely place of enforcement of the claim by the lender.

UK tax analysis

If we accept that the Trust acquires a UK‑situs asset when making the Loan, the question then arises as to whether there has been a remittance.

Section 809L(2)(a) of the Income Tax Act 2007 (the Act) provides that an asset can be remitted to the UK if it is ‘brought to, or received or used in, the United Kingdom by or for the benefit of a relevant person’. The mere ‘acquisition’ of a UK‑situs asset does not necessarily mean a remittance has been made.

If a claim is ever made by the borrower through the UK courts, it is fairly clear that the asset has been ‘used’ in the UK. However, even if no claim is made, it could be argued that the claim has been received in the UK as it is a UK‑situs asset. As the Trust is a relevant person to the Settlor,[4] it is immaterial that it is the Trust that acquires the asset and not the Settlor.

A UK tax liability may arise to the Settlor by virtue of s.720 and s.731 of the Act. Before 6 April 2017 and the introduction of the protected foreign‑source income rules,[5] s.720 generally treated all relevant foreign‑source income as arising to the Settlor. However, for settlors who paid UK tax on the remittance basis, a UK tax liability only arose on that income if there was a remittance.[6] On the basis of the above, at the moment the Loan is made, the Trust (which is a relevant person to the Settlor) receives a UK‑situs asset and that asset is derived from its income. Thus, a remittance is made by the Settlor and UK tax may fall due on the entire value of the Loan.

Since 6 April 2017, it may be necessary to consider whether a liability arises to the Settlor under s.731 of the Act. A tax liability under s.731 can only arise to the extent that a person has received a benefit from a relevant transaction. The amount of income deemed to arise to such an individual is capped at the value of the benefit received.[7]

While it appears that the Settlor has received a benefit (i.e., the use of the monies received), the fact that a court could order them to repay these monies should be factored in when calculating the net value of the benefit to the Settlor. On the assumption that the Settlor’s benefit is likely to have a value greater than zero, then it is necessary to consider whether a remittance has occurred and the same considerations as set out above apply.

Conclusion

Those advising clients considering whether to make a loan to a third party should first consider what powers it has to make such a loan and whether any loan should be subject to certain conditions, such as charging interest, in order to make the loan ‘commercial’. A failure to make a loan in accordance with the lender’s powers can make a loan ultra vires, which gives rise to a number of claims against the borrower, including a claim in personam for the return of those funds. The situs of such a claim is unclear, but there are strong arguments that HMRC could suggest that such a claim should be situate in the UK where the borrower resides in the UK. If the claim is regarded as a UK asset, there may be unexpected and severe UK tax consequences for the borrower. In a situation where such a loan already exists, care will need to be taken to ensure that any subsequent action does not give rise to further complications or UK tax liabilities.


[1] [2020] EWCA Civ 699

[2] HMRC’s Inheritance Tax Manual, IHTM27079 – Foreign Property: Specialty debts: bonds and debentures under seal

[3] HMRC’s Residence Domicile and Remittance Manual, RDRM33050 – Remittance Basis: Practical examples of remittances to the UK

[4] s.809M(2)(g), Income Tax Act 2007

[5] s.721A, Income Tax Act 2007

[6] s.726, Income Tax Act 2007

[7] s.733, Income Tax Act 2007