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Surprise move against UK non-doms' loans

Thursday, 7 August, 2014

HM Revenue & Customs has announced that non-domiciled UK residents must now pay UK tax on offshore income used as security for a loan.

The announcement represents an overnight change of a policy established in 2009, soon after the UK introduced the remittance basis of taxation for non-doms. The remittance basis rule allows non-doms to pay HMRC a fixed annual fee to keep their overseas income and capital gains outside the UK tax system; only money that they remit to the UK is subject to UK tax. Some, however, use the existence of these overseas funds as collateral to borrow money to finance their UK activities, for example buying a house or investing in a business.

At that time, HMRC accepted that it would not be fair to regard overseas income used in this way as having been remitted to the UK and thus subject to tax. This is because foreign funds brought to the UK by a non-dom used to repay or service the debt are taxed, and so taxing both sets of foreign funds might lead to taxing double the actual amount of the loan.

Now, however, HMRC believes this concession (as it calls it) is being abused. It says it is seeing large numbers of arrangements which are not considered to be commercial and not within the intended scope of the concession. These include loans repaid from non-foreign income or gains that are not charged as a remittance, despite foreign income or gains collateral having been used in the UK.

Accordingly it is scrapping the 'concession'. From 4 August (i.e. last Friday), money brought to or used in the UK under a loan facility secured by foreign income or gains will be treated as a taxable remittance of that amount of foreign income or gains. Foreign income that is used to service or repay the loan, either capital or interest, will continue to be regarded as remittances and taxed as well.

The change is effective immediately, although non-doms are being given a grace period to re-finance their existing borrowings. They must notify HMRC of any such arrangements, including disclosing the amount of foreign income used as collateral and the amount of the loan that has been brought into the UK. This foreign income will remain outside the UK tax net if the non-dom gives an undertaking that the loan will be repaid or the collateral replaced by 'clean'1 capital before 5 April 2016.

The announcement has been greeted with widespread disapproval. The Institute of Chartered Accountants in England & Wales called it a 'double tax charge'.

'When the remittance basis rules were being discussed with HMRC in 2008, this particular point was raised and HMRC said its view that there was no double tax charge was based on an interpretation of the law and was not concessionary', says the ICAEW. 'To now call it a concession making it simple to change the position seems disingenuous.'

Tina Riches of accountancy and investment management group Smith & Williamson points out that the proposed rules are unclear and could give rise to uncertainty for many non-doms, especially in the transitional period. 'We are concerned that the rules will apply retrospectively to catch loans on property or invested in businesses some time ago. HMRC need to resolve this as swiftly as possible.'

Law firm Farrer notes that the change of policy removes a valuable method by which non-doms could create 'clean' capital, by taking out a loan secured on their foreign income and gains and servicing the loan repayments using existing clean capital and thus avoid both potential remittances. This practice may be what HMRC is trying to stop.

'The change is unexpected because HMRC had not given any indication that they were reviewing it, but in the current anti-avoidance climate it is perhaps not surprising', say Russell Cohen TEP and Holly Jones of Farrer.

'Taxpayers with loans secured on foreign income and gains will need to review their current arrangements and take advice on the appropriate steps to take', says law firm Withers. 'Any arrangements, whether or not formal security is in place, that envisage foreign income and gains being used in support of borrowing should be reviewed. Taxpayers contemplating putting such arrangements in place would be advised to refrain from doing so until matters are clarified.'

John Barnett of the Chartered Institute of Taxation predicted the announcement would cause significant practical difficulties for banks and their customers, and generates serious uncertainty for them.

'The proposals leave a number of questions unanswered', he said. 'For example, it is common for banks to have a right of set-off against all assets owned by a customer taking out a loan, so even if the primary collateral is in the UK the bank could also have offshore assets as secondary security. What would happen in this situation?'

Barnett criticised HMRC for springing the announcement on practitioners without warning rather than giving them the opportunity to comment in advance. He noted that non-doms were told in 2010 that there would be no further changes to their tax regime in this parliament. 'Making changes without consultation in this way does not enhance the UK's reputation as a place to do business with certainty', he said.

 Sources

  • 1. 'Clean' capital is money arising before the non-dom became UK resident and kept separate from UK assets