Following conclusion of the consultation in summer 2011, the Government has released details of the proposed changes to the non UK domicile rules. The new rules will take effect from 6 April 2012.
The changes included a major new relief which is intended to provide non UK domiciles (non-doms), and potentially their trusts and companies, with an important opportunity to invest foreign income and gains into qualifying businesses, without UK tax arising.
Under current rules a non-dom is subject to tax on foreign income and gains if they remit these to the UK.
They may also be taxed on remittances of foreign income and gains that are made by certain other connected persons known as “relevant persons”. A non-dom may be taxed for example where a trust that they had created, uses its foreign income to invest in the UK.
The Government’s clear intention with the relief is to assist the UK economy by providing the opportunity, but they also clearly do not want to start a new round of ‘remittance planning’. Consequently, they have sought to prevent a mechanism which non-doms might exploit to enjoy funds in the UK that might otherwise be unavailable.
The warning for this is clear; there is an immediate disallowance of relief where an investment is part of a scheme or arrangement with a main purpose of avoiding tax.
Overview of the relief
Not every qualifying business investment may be an immediate remittance.
However, where funds are brought to or received in the UK in order to make a qualifying investment, the relief will apply if, within 45 days of the remittance being otherwise taxable, the remitted funds are used by a non-dom or a ‘relevant person’ to make an investment into ‘target companies’.
The investment needs to be in the form of a loan to a company (secured or unsecured) or acquisition by way of an issue of shares or securities in a company.
Investments must be in private companies that have limited liability. No shares may be listed on a recognised stock exchange. Thus:
- shares listed on AIM can qualify;
- shares eligible for VCT and EIS relief could qualify; and
- investment in non UK incorporated companies can qualify; but
- investments into limited liability partnerships will not qualify.
- Investing in target companies- eligible trading companies
A trading company may be a target company if:
- it carries on a trade on a commercial basis with a view to realising a profit;
- it is preparing within two years to carry on a trade on a commercial basis;
- it is undertaking research and development intended to lead to an eventual commercial trade for the company or benefit to the company; or
- the trading activity is substantially all that the company does or was reasonably expected to do when the company started trading (broadly the company will have substantial non trading activities if this is more than 20% of the overall business).
- any activity which is treated as if it were a trade for the purposes of Corporation Tax; and
- a ‘business carried on for generating income from land’.
- Investing in target companies – ‘stakeholder’ companies
- A private limited company which exists wholly for the purpose of making investments into eligible trading companies may also qualify as a target company.
Investments into eligible trading companies must be held or there must be an intention to hold such investments within two years.
The Government has been keen to ensure that an investor or someone linked to them such as a relevant person has not directly or indirectly received or become entitled to receive a benefit related to the making of the investment.
A benefit will be related if it is directly or indirectly attributable to the making of the investment whether it is received before or after the investment is made, or if it is reasonable to assume that the benefit is only available because of the making of the investment.
If a benefit is in point, relief for the investment is not available.
The Government has indicated that it intends to introduce a form of advance clearance so that an investor can be aware whether an investment will qualify for relief prior to investment. This will ensure that a non-dom does not remit funds and then find that the investment is inappropriate.
This was not included in the draft legislation but is intended to be inserted in early 2012.
Withdrawal of relief
A remittance may initially be subject to the relief but may subsequently cease to be eligible for relief if certain events occur. A number of events are specified in the legislation as giving rise to a potential withdrawal of relief as follows:
- the target company failed to qualify, (eg. the commercial trade did not commence within the permitted 2 year period);
- the target company ceased to qualify,(eg. the company lists);
- the investment is disposed of;
- value is extracted in breach of the rules detailed below;
- the person making the investment ceases to be a relevant person; or
- the company goes into administration, receivership, is wound up or dissolved for genuine commercial reasons and value is received.
If relief is to be withdrawn, there are a number of options open to the non-dom depending on the reason for the withdrawal of relief. Two examples are detailed below:
Disposal of the investment
A non-dom may take mitigating steps:
Within the ‘grace period’ take the proceeds (in the form in which they are received) outside the UK so they are no longer available to be used or enjoyed in the UK. (Where the consideration is received in instalments each instalment is treated as a separate disposal).
Within the ‘grace period’ the proceeds may be reinvested in another qualifying investment.
Accept that the original remittance becomes a chargeable remittance arising at the end of the grace period.
The grace period is normally 45 days beginning with the day on which the proceeds are received by the non-dom. However, in certain exceptional cases HMRC may extend the grace period.
Making a capital gain
If the disposal gives rise to a gain to the non-dom, the withdrawal of relief applies only to such element of the proceeds as represents the funds originally remitted (thus the non-dom will need to take mitigation steps only in respect of the amount relating to the original relief).
Any UK capital gain arising to the individual would be subject to UK tax in the usual way, and it is envisaged that the funds would be available for the individual to meet any UK tax on the gain without the need to remit further funds.
An issue has yet to be resolved where there is only a partial disposal as the non-dom may be taxed on a gain without funds available to meet any UK capital gains tax- this is currently being considered.
The relief is to be withdrawn if a non-dom extracts value without, for example, a disposal of the investment.
The legislation is drafted widely to reflect the possibility that value might be received from a number of different sources. Value received from target companies (eligible trading companies or, if the investment is in a stakeholder company, any underlying eligible trading companies), companies connected with the above and anyone else in circumstances where that extraction of value is directly or indirectly attributable to the investment being made (either by the non-dom or a relevant person).
The non-dom may:
- Dispose of the investment and take the proceeds (in the form in which they are received) outside the UK so they are no longer available to be used or enjoyed in the UK.
- Reinvest the proceeds in another qualifying investment.
- Take no mitigation steps and accept that the original remittance (or part of it as appropriate) is taxed at the end of the grace period. (The grace period is the same as above.)
The value rule is not breached in every circumstance. The non-dom may work for a target company and be paid a market wage for example.
The rules, though complicated, provide far reaching opportunities for non UK domiciles wishing to utilise the relief in the spirit in which the Government has legislated.
The relief is not only beneficial to non-doms, but also and probably more importantly to family trusts who may wish to invest in the UK.
For those seeking inward investment, non-doms, who may previously have been ignored because of their inability to remit funds to the UK, will suddenly become ‘fair game’.
It is important to realise that each of the rules needs to be considered, but there are nonetheless a number of particularly interesting aspects. This list is by no means intended to be comprehensive.
The legislation does not specifically seek to exclude any specific business activity. So in addition to normal trading companies, commercial property letting can also qualify. Whilst the letting of residential properties may fall outside the provisions, and furnished holiday lettings should not qualify, a business may still do so where the activity is undertaken on a commercial basis. For example, the letting of private hospitals, hotels, nursing homes and halls of residence could qualify.
Many non-doms and family trusts have sought to invest into collective investment schemes but have found it problematic where either the investing platform is UK based, or where the ultimate investment is in UK assets.
The changes may make such investments less problematic where the investment vehicle meets the conditions to be a target company.
A family trust might wish to consider the possibility of investing in the UK by using this relief. They may seek professional advice on the application of the rules. Where the trust meets those costs from trust income, that payment could still amount to a remittance for the non-dom, despite it being in connection with a UK scheme of relief.
A non-dom may wish to invest into an entity that might otherwise qualify for EIS relief. This could lead to the position that a remittance of say £100,000 to the UK could generate a repayment of UK tax to the individual of £30,000. Whilst the Treasury clearly recognises the possibility of investing into such entities, it is not clear as to whether the receipt of the £30,000 could still be a remittance. More importantly is it a value extraction? Hopefully the answer will be that neither apply.
Will those promoting EIS schemes going forward seek clearance that the proposed activities of the company qualify for both EIS and non domicile investor relief?
An investor ceasing to be a relevant person may result in relief withdrawal. For example if non remittable funds had been provided to a spouse to make a qualifying investment, a subsequent divorce could mean that a tax charge arises to the non-dom. This is because on divorce the spouse will cease to be a relevant person. If mitigation steps need to be taken, it is important that these are negotiated into the process rather than after it is completed.
Ensuring that everyone is on the same page
A family trust set up by a non-dom might invest into a qualifying investment directly. As it is only the non-dom who might otherwise be taxed on the remittance of funds by the trust, it will be important for the non-dom to ensure that there have been no events which might lead to a withdrawal of relief. Thus the non-dom really needs to be fully aware of the trust activities.
Moreover, even if there has been an event such as a disposal by the trust, it is unclear how the non-dom can ensure that either the trust removes the funds from the UK or reinvests.
Who should apply for an extended grace period in such circumstances?
Clearly all such relevant persons need to be communicating and ‘singing from the same hymn sheet’.
There are invariably going to be situations in which the non-dom does not have the kind of control over the investing vehicle, as thought to be the case under the legislation. If there are events leading to withdrawal of relief, the individual may simply have no way to stop it. Moreover, if an event occurs they may not be able to take the appropriate mitigation steps required.
For example, a company moves from AIM to a full listing. An event is triggered, requiring the non-dom to sell the shares. They may be a board member and as such prohibited from selling the shares in a closed period.
Whilst it is hoped that the latitude given to HMRC officers over the grace period would be used in such eventualities, it is important that there is both consistency over time and between officers. Guidance is therefore important.
Negotiating the making of an investment
In view of the potential clawback of relief it will be important to ensure that where a non-dom or relevant person invests utilising this relief, there is an ability to take mitigating steps in the event of a withdrawal of relief. This needs to be dealt with before the investment is made.
The relief is generous, but currently there are some gaps in the draft legislation still to be finalised. It will be very interesting to see how the relief operates in practice and, in particular, how HMRC deal with matters over which they have discretion.
This legislation is clearly being introduced with the intention of making ‘UK PLC’ a territory of choice for non-doms and their trusts as business investors. If the legislation and discretions are operated in practice with that primary intention in mind then this relief could prove to be valuable to not only non-dom and trust investors, but those seeking inward investment as well.