tax plus Welcome to Tax Plus a topical look at tax summer 2014

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1 tax plus summer 2014 Welcome to Tax Plus a topical look at tax Within this edition of Tax Plus, we cover a diverse range of topical issues, aiming to keep you up to date with the latest happenings in tax and how new legislation could impact on you, our reader. We have a couple of areas where UK tax reaches across the borders. Fellow partner, Liz Cuthbertson takes a look at how the proposed changes to capital gains tax will apply on the disposal of UK property by a non-resident. For people working partly in the UK and partly overseas HMRC will now be scrutinising dual contract arrangements. Business Investment Relief was introduced over two years ago to encourage investment into the UK. Despite it enabling non-uk domiciled individuals to bring offshore funds into the UK tax free, it is a little surprising that relatively few have taken advantage of it. Here, we illustrate how the relief works and provide a broad overview of the principles of the initiative. Trust Manager, Daniel Bisby highlights the potential value of Capital Gains Tax Holdover Relief, whilst also advising on some of the pitfalls to avoid. Chartered Financial Planner, Iain Muffitt comments on the outcome of the recent Buckley case and questions how Attorneys will be able to meet their obligations on complying with the resulting practice guidelines whilst being able to act in the best interests of the donor. We always take a keen interest in tax cases which make the news. On our back page, we examine one which challenged the circumstances of whether shares were to be considered of negligible value. It is not always as straight forward as it seems! If any of the topics we have covered capture your interest and you would like to discuss them in relation to your own unique set of circumstances, then please do get in touch. Gill Tallon Partner gilltallon@mercerhole.co.uk IN THIS ISSUE: 02: Business Investment Relief for non-doms 03: Capital Gains Tax Holdover Relief and Trusts 04: International - UK tax reaches beyond the borders 05: Reviewing dual contracts and non-uk domiciliaries 06: Attorneys, beware that relying on an Investment Manager is not enough! 07: Social Investment Tax Relief (SITR) 08: Tax Case Digest mercerhole.co.uk

2 mercer & hole tax plus: summer 2014 Business investment relief for non-doms ALTHOUGH INTRODUCED IN APRIL 2012, THERE SEEMS TO HAVE BEEN LITTLE TAKE UP OF THIS HIGHLY VALUABLE RELIEF. THIS ARTICLE SERVES AS A REMINDER OF THE POTENTIAL TAX SAVINGS THAT CAN BE MADE, BUT AS EVER, THERE ARE TRAPS FOR THE UNWARY AND IT IS IMPORTANT THAT ANY INVESTMENT IS STRUCTURED CAREFULLY TO SECURE THE RELIEF. Business Investment Relief (BIR) was introduced to encourage investment in the UK and has significant benefits for non-uk domiciled individuals who may have built up substantial sums offshore. It enables non-uk domiciled individuals who claim the remittance basis to bring offshore funds into the UK free of tax. It should also not be forgotten that an investment that qualifies for BIR could also qualify for Enterprise Investment Scheme (EIS) or Seed Enterprise Investment Scheme (SEIS) relief providing the investor with potentially substantial tax savings if the investment is structured correctly. For example, if a UK resident but non-uk domiciled individual makes a taxable remittance of foreign income to the UK of 250,000, this would potentially be taxable at the top rate of tax of 45% and tax due of 112,500. However, if the funds are used for an investment where the same remittance can be made free of UK tax, the qualifying conditions are met for BIR. If the investment is also a qualifying EIS or SEIS investment, further Income Tax Relief could be due at either 30% or 50% of the amount invested. So following on from the above example, a qualifying EIS investment would also secure 75,000 of tax relief. The total tax relief would amount to 187,500 ( 112,500 plus 75,000) on the investment of 250,000 75% tax relief! The relief applies to subscriptions for shares in a qualifying company or the making of a loan to a qualifying company. The broad principles of the relief are as follows: The qualifying investment must be made within 45 days of the remittance of the offshore funds to the UK. A claim for relief must be made before the 1st anniversary of the 31 January following the tax year in which the remittance is made. A qualifying company must be a private limited company (i.e. not a partnership or a company whose shares are listed on a recognised stock exchange). The company must be an eligible trading company. It should be noted that for BIR purposes only, investment into a property development or rental company also qualifies for relief. The relief also applies to eligible stakeholder companies or eligible holding companies. No related benefit can be received as a result of the investment, although it is still possible to extract value from the business provided it is on arms length terms in the ordinary course of business. Where there are disqualifying events or the shares are disposed of, there is a 45 day grace period whereby the individual may repatriate or re-invest the amount of the original remitted income or gains (or the disposal proceeds if lower). It is possible to utilise the relief to invest in a company which the investor is already shareholder. On a sale any capital gain is taxable in the normal way, but if the shares purchased were qualifying EIS shares and held for the minimum holding period of three years then the capital gain could also be exempt. Alternatively, the shares could qualify for Entrepreneurs Relief, meaning a rate of capital gains tax of 10%. There are also potential Inheritance Tax (IHT) savings to be made. If the investment is of unquoted trading company shares held for a minimum of two years, business property relief potentially gives 100% relief for IHT purposes. Although the remittance and UK investment needs to be structured properly, BIR really does offer an exciting opportunity for the non-uk domiciled entrepreneur. Suzanne Briggs Senior Manager suzannebriggs@mercerhole.co.uk

3 03 Capital gains tax holdover relief and trusts LEGISLATIVE CHANGES IN RECENT YEARS HAVE MEANT THAT AN INCREASING NUMBER OF TRUSTS ARE WITHIN THE RELEVANT PROPERTY REGIME FOR INHERITANCE TAX PURPOSES (IHT). AS SUCH GIFTS INTO MOST TRUSTS ARE CHARGEABLE LIFETIME TRANSFERS FOR IHT AND DISTRIBUTIONS FROM MANY TRUSTS GENERATE AN IHT CHARGE. IF THE TRANSFER IS WITHIN THE IHT NIL RATE BAND, THERE MAY NOT BE ANY IHT PAYABLE. HOWEVER, IT IS IMPORTANT TO BE AWARE OF THE OPPORTUNITY TO DEFER ANY CAPITAL GAINS TAX (CGT) CHARGEABLE THAT ARISES AS A CONSEQUENCE. TECHNICALLY, WHERE A DISPOSAL MADE BY AN INDIVIDUAL OR TRUSTEES IS A CHARGEABLE TRANSFER FOR IHT, THEN CGT HOLDOVER RELIEF IS AVAILABLE ON THE GAIN. Holdover Relief is a deferral of CGT and it is very valuable in its own right according to the old adage that tax deferred is tax saved. However, through sensible planning there are also opportunities for direct CGT savings. For example, if Holdover Relief is obtained when assets are distributed from a trust and the beneficiaries receiving those assets later sell them within their own CGT annual exemption, then no CGT will be payable. If there are multiple beneficiaries and this process is spread over a number of years then there is potential for a substantial CGT saving. Holdover Relief is not automatically applied and is subject to a claim. There are some pitfalls to be aware of, two of which are covered briefly here. The first point to note is that Holdover Relief is not available on an appointment of capital in the first three months after a ten year anniversary. This would otherwise be a tempting option because there is no IHT upon a capital appointment in these circumstances. It may be advisable in the first three months following a ten year anniversary to distribute an exempt asset such as cash from the trust but not assets chargeable to CGT. A second factor to consider is that where a gain has been heldover and the recipient then becomes non-resident within six years, the Revenue may claw back the tax on that gain. If the Revenue cannot recover the tax from the transferee then the trustees become liable to pay the CGT. This can cause problems if the trustees have distributed all the assets. If the trustees are concerned about such a scenario it may be advisable to hold back sufficient funds to pay the tax on any gain. The trustees should of course also consider how much CGT is at stake were they simply not to make a holdover election but to pay the CGT instead. After allowing for any capital losses that may be available this may not be as much as feared. Daniel Bisby Trust Manager danielbisby@mercerhole.co.uk

4 mercer & hole tax plus: summer 2014 International UK tax reaches beyond the borders Highlighting changes and a practical explanation to Capital Gains Tax on disposal of UK property IT HAS LONG BEEN THE CASE THAT MOST COUNTRIES TAX CAPITAL GAINS REALISED ON DISPOSALS OF PROPERTY IN THEIR COUNTRY REGARDLESS OF THE OWNER S RESIDENCE STATUS. BY CONTRAST, THE UK DOES NOT TAX NON-RESIDENTS ON THE DISPOSAL OF UK PROPERTY ON THE BASIS THEY ARE SIMPLY OUTSIDE THE SCOPE OF CAPITAL GAINS TAX (CGT). The Budget 2014 announced changes to this position, the details of which have been the subject of a consultation which has only recently concluded. The proposed changes, outlined below, extend the CGT regime to UK residential property owned by non-uk residents and will bring a significant number of people into the UK tax regime. Who will be caught by the new rules? The new rules will apply to non-uk resident owners of UK residential properties. The term owner applies not just to individuals but to companies and trusts also. A type of close company test will be applied to ensure institutional corporate investors are not caught. Partnerships themselves are not included but this is because the CGT transparency rules place the charge on the partners themselves. What property types will be caught? The charge aims to target all UK residential property which includes a place that is currently, or has the potential to be used as a residence as well as property that is being constructed or converted for such use. This includes rental properties but specifically excludes a residence which is the taxpayer s only or main residence. However the test for what qualifies as a main residence for a non-uk resident is likely to be revisited. When will the new charge be implemented? The rate of tax for individuals appears to mirror the rules for UK residents. If the non-uk resident s UK income is less than the basic rate band, tax will be initially charged at 18%. Otherwise the rate will be 28%. The good news is that the annual CGT exemption will be available to non-uk resident individuals and trusts. How will the charge be collected? It is anticipated that CGT will be collected by way of a withholding tax at the point of the property transaction. This would be similar to the collection of stamp duty land tax and is the way in which many other jurisdictions operate. However the consultation also considered a payment on account system although this could get complicated where there is no self assestment record. Will double taxation apply? Where there is a double taxation treaty between the UK and the taxpayer s country of residence a tax credit will usually be available for the UK CGT paid. This means if the CGT rate in the country of residence is higher than in the UK, full credit will be available for the UK tax paid leaving the taxpayer no worse off. What happens next? The government will now consider the responses with a view to publishing draft legislation in the Autumn. Further consultation will then take place before the legislation is published in The charge will apply to gains arising from April 2015 onwards. How will the charge be implemented? The specifics of the charge are still unclear. Many are hopeful that there will be a rebasing of the property at April 2015, to set the acquisition cost. Alternatively the gain may simply be time apportioned. Given that a rebasing option applied for the Annual Tax for Envelope Dwelling (ATED) tax charge this would seem the most likely option. Liz Cuthbertson Partner lizcuthbertson@mercerhole.co.uk

5 05 Reviewing dual contracts and non UK domiciliaries HMRC has announced that it will scrutinise arrangements involving dual contracts for employees as they believe many of these arrangements are artificially constructed to obtain a tax advantage. New rules from 6 april 2014 Where the foreign contract is with an associated employer in a low tax jurisdiction, the remittance basis will not apply and the whole of the individual s earnings will be taxable in the UK. Four conditions will need to apply: 1. The individual must hold both a UK and an overseas employment in the same tax year. 2. The individual s UK and overseas employer must either be the same or associated (e.g. by being part of the same group of companies). 3. The individual s UK and overseas employments must be related to each other. Examples of employments which would be related include situations where: It is reasonable to suppose that the individual s UK employment would cease if his overseas employment ended; The individual has two employments and undertakes client meetings, entertainment or marketing in his overseas employment and manages investments for the same clients in his UK employment; The individual is employed in the UK and his contract specifies that he cannot work outside the UK but he is also employed in another country under a similar contract doing the same type of work; The individual provides financial advice to someone under both his UK and his overseas employment contracts. 4. The rate of Foreign Tax Credit Relief which the individual would receive if his overseas income were taxed on the arising basis would be less than 29.25% (65% x 45%). If the duties of a UK employment could not lawfully be performed in the overseas territory for regulatory reasons then the above anti avoidance rules do not apply. The issue in brief Where an individual, who is resident in the UK, works partly in the UK and partly overseas, 100% of his earnings are potentially taxable in the UK. However, if he is not UK domiciled, earnings from a separate contract with a foreign employer where the relevant duties are performed wholly overseas have until now only been taxed on a remittance basis. This means the individual has been able to avoid UK tax on those earnings by receiving payment for his overseas duties outside the UK and then not bringing them to the UK or receiving a benefit from them in the UK either directly or indirectly. This arrangement has long offered scope for appropriate planning for non-domiciliaries where the relevant circumstances have supported effective dual contracts in the UK and overseas. It has always been the case that nongenuine arrangements were not valid. This would normally be apparent, for example, if the amount attributed to the overseas contract was disproportionate to the actual work carried out under that contract. What does this all mean in practice? If you are not domiciled in the UK and you have contracts of employment both in and outside the UK you now need to review those arrangements carefully as soon as possible to ensure you are not caught by this new anti-avoidance legislation. OVERSEAS WORKDAY RELIEF (OWD) OWD Relief may well be a valuable relief for a taxpayer meeting the required conditions. It works by exempting earnings from UK income tax where they are attributable to work carried out overseas for a limited time period. This is provided that the overseas earnings are not remitted to the UK. OWD Relief can be claimed by non-uk domiciled individuals who have been UK resident for less than three UK tax years. OWD Relief can exempt overseas earnings for the UK tax year in which the individual becomes UK resident and the following two tax years. This at least gives a non-dom individual a bit of breathing space in the early years of becoming UK resident.

6 mercer & hole tax plus: summer 2014 Attorneys, beware that relying on an investment manager is not enough THE RECENT BUCKLEY CASE SERVED AS A REMINDER FOR ALL ATTORNEYS WHEN DEALING WITH THE FINANCIAL AFFAIRS OF DONORS. THE COURT S GUIDANCE SUGGESTS A WIDER APPLICATION OF ATTORNEY S FIDUCIARY DUTIES AND ALL SHOULD BE ALERT TO HOW THEY COMPLY WITH THESE RESPONSIBILITIES. The judgement from the Public Guardian was handed down last year and reconfirmed Attorney s responsibilities when dealing with a donor s financial assets and investments. Whilst Attorneys investment powers and responsibilities have always been subject to strict guidelines, the judgement re-emphasised the fiduciary duties of Attorneys. The Buckley case is extreme and Judge Lush referred to the implied responsibilities under the Trustee Act 2000 and the standard criteria of suitability and diversification for investments. These guiding principles should not be lost on Attorneys. Making investments relevant to the donors position should be forefront in the Attorney s mind. Many of us will remember that before the Mental Capacity Act 2005 came into force both the Court of Protection and the Office of the Public Guardian were involved in the investment of funds and used short term ST and long term LT codes to define the type of investment and risk. ST1 and ST2 codes are relevant for smaller funds where suitable investments were cash and National Savings. Even though this historical basis provides a one size fits all solution the process still makes some sense; although what happens in today s low interest rate environment? The return on cash assets have been plummeting in recent years and Attorneys either accept low rates of return or higher investment risk with the aim of increasing returns. With elderly clients, capital preservation is normally the key driver for their investments and there are only a small number that can afford the luxury of living off cash assets. In recent years many academic studies have suggested that life expectancy continues to increase and the fee inflation for care home fees remains significantly higher than the Government s headline inflation rate. How do Attorneys ensure that they comply with the recent guidance and still provide for the best interests of the donor against this economic backdrop? Professional advice in this area is a must and many Attorneys are turning to financial planners rather than pure investment managers to ensure they can meet the long term requirements of those they are responsible for. Financial Planners are able to help Attorneys understand risk in its many guises, which range from too long to the effects of cash and low risk returns. Using a range of cash flow models to help Attorneys find the right fit between these risks will be key in ensuring their assets can support the expected expenditure. Obtaining professional advice on whether investments will last against the ravages of living too long and long term inflation allows Attorneys to fully discharge their fiduciary responsibilities. Starting with this type of professional financial planning will ensure that any investments made will be relevant and suitable. Iain Muffitt Chartered Financial Planner iainmuffitt@mercerhole.co.uk

7 07 Social Investment Tax Relief (SITR) OVER THE YEARS WE HAVE SEEN A NUMBER OF TAX BREAKS FOR INVESTORS IN BUSINESS START UP SCHEMES. WITH EFFECT FROM 6 APRIL 2014, THE GOVERNMENT HAS NOW INTRODUCED A SCHEME TO SPECIFICALLY ENCOURAGE INVESTMENT IN SOCIAL ENTERPRISES. THERE ARE TAX BENEFITS FOR THE INVESTOR AND THESE ARE COLLECTIVELY KNOWN AS SOCIAL INVESTMENT TAX RELIEF (SITR). Social enterprises are businesses which have principally social objectives. They can trade in a variety of sectors, such as healthcare, employment and sport and leisure. Such businesses may come in the form of community interest companies, community benefit societies, charities or other entities approved by the Treasury. In order to qualify as a social enterprise for SITR, the entity must have been approved by HMRC. There are a number of criteria for the social enterprise and the investor to meet before SITR is given. While individual investors can invest a maximum of 1,000,000 each year, the social enterprise can at present only receive roughly 286,000 in a three-year period. If full advantage of the annual SITR limit is to be taken, the investment must therefore be spread across a number of enterprises. The SITR consists of three elements; Income Tax Relief, Capital Gains Tax (CGT) Holdover Relief and CGT Disposal Relief. The income tax relief comes in the form of a tax deduction of 30% of the invested amount (up to annual maximum of 1,000,000). This deduction can be used to reduce an income tax liability to nil, but it cannot generate a repayment. The deduction can also be carried back to the previous tax year, but the carry-back is not available for 2013/14 tax year. If the investment is not held for a minimum of three years, or if it ceases to be a qualifying investment, some or all of the income tax relief may be clawed back. The CGT holdover relief allows the deferral of paying CGT on chargeable gains up to the qualifying amount invested in the year. The qualifying investment must be made between one year before up to three years after the gain was realised. The deferred gain will become chargeable when the social enterprise investment is disposed of or when it ceases to meet the relevant requirements. Provided that the social enterprise investment is owned for more than three years and the Income Tax Relief given has not been clawed back, any gain realised will not be subject to CGT. If the investment is sold at a loss, income tax relief may be available, although this will be reduced by the income tax relief already given. The investment can be in the form of both shares or debt. Any dividends and interest received from the investments are, however subject to income tax as normal. It is anticipated that this relief will appeal to business investors in this sector. Jack Reyland Senior Tax Manager jackreyland@mercerhole.co.uk

8 TAX CASE DIGEST It is sometimes helpful to consider how the legislation works in a practical tax case. In this issue, the case is brown v hmrc is it necessary for a company to have ceased to trade or have been put in liquidation in order for its shares to be of negligible value? Where an individual owns an asset which has become worthless, it is possible to make a negligible value claim to be treated as though they had sold and immediately reacquired that asset for consideration equal to its market value (at the date of the claim or earlier date specified in the claim). For Capital Gains Tax (CGT) purposes, this crystallises a capital loss which can be used against other gains. Where the asset is unquoted shares in a trading company and provided the other conditions are met, the taxpayer may further claim to relieve the loss against income rather than capital gains. Due to another individual having put further monies into the company in the hope that everything would come good at the end, the company was not on the verge of ceasing to trade and it was possible (although probably a remote prospect) that it might at some stage become profitable. The First Tier Tribunal (FTT) considered this point and concluded that it was not necessary for the company to have ceased trading or to have been put into liquidation for the shares to have become of negligible value. It was sufficient that the shares were worth next to nothing at the date of the claim. In the First Tier Tribunal case of Brown v HMRC 2013, the taxpayer, Mr Brown had invested significant sums in an unquoted research and development company at a time when it had some real value. A few years later, Mr Brown submitted a claim for loss relief against income on the basis the shares had become of negligible value. In negligible value cases, it is for the taxpayer to demonstrate that the shares have become of negligible value. In the above case, the FTT also highlighted the importance of valuing assets according to the information available to a prospective purchaser and not the value put on the shares by the taxpayer or an investor who may not be motivated entirely by commercial considerations. St Albans t +44 (0) e stalbans@mercerhole.co.uk London t +44 (0) e london@mercerhole.co.uk Milton Keynes t +44 (0) e miltonkeynes@mercerhole.co.uk Newsletter Disclaimer: This newsletter is a short selection of items extracted from complex legislation. Further specific advice on any matters referred to must be taken at all times. The information is given for general guidance only and publication is without responsibility for loss occasioned to any person acting or refraining from acting as a result of the information given. No part of this publication may be reproduced without the prior permission of Mercer & Hole. Firm Disclaimer: Mercer & Hole is registered by the Institute of Chartered Accountants In England & Wales to carry out company audit work. M&H Financial Planning is the trading name of M&H LLP which is authorised and regulated by the Financial Conduct Authority. M&H LLP is a Limited Liability Partnership registered in England No. OC