The New Remittance Rules (Part 1)
Certain individuals, mainly those who are resident but not domiciled in the UK, are entitled to pay tax on the remittance basis. This article looks at the recent changes to the remittance basis of taxation introduced in Finance Act 2008
Who can pay tax on the remittance basis?
A UK resident client will usually pay UK tax on income as it arises and on capital gains as they accrue, on a worldwide basis. This is known as the ‘arising basis of taxation’.
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There are two cases where a UK resident person may be entitled to pay tax on the ‘remittance basis’. Briefly this means s/he will only pay tax on UK source income and on gains made on the disposal of UK situated assets. Any offshore income and gains will be outside the scope of UK taxation unless remitted to the UK.
The first category of remittance basis applies to taxpayers who are UK resident but not domiciled. Here, the remittance basis can apply for both income tax and capital gains tax purposes.
The second category of remittance basis applies to taxpayers who are resident but not ordinarily resident in the UK. However, this time the remittance basis only applies for income tax purposes, not capital gains tax. It can be useful for sheltering offshore earnings from UK income tax where the individual is working only partially and temporarily in the UK.
The remittance basis: automatic
For some non-domiciled and/or not ordinarily resident taxpayers, the remittance basis of taxation can apply automatically. These taxpayers must fall into one of two categories:
- The taxpayer’s unremitted foreign income/gains amount to less than £2,000 in the year; or
- The taxpayer has no UK source income/gains and makes no remittances of offshore income/gains to the UK.
There are two points to note here. For the first category, you look at the unremitted foreign income/gains not the original amount arising overseas. So, for example, a taxpayer might have £15,000 of offshore income and bring £13,500 into the UK (paying tax on the remittance). The balance of £1,500 unremitted is below the de minimis threshold so the remittance basis will apply automatically.
For the second category, there is a time limit if the taxpayer is over 18. This automatic remittance basis will only apply if the adult taxpayer has been resident in the UK for no more than 6 out of the previous 9 years of assessment. For minor taxpayers, this time limit does not apply.
Where the remittance basis applies automatically, the taxpayer retains his/her annual allowances for income tax and capital gains tax. This is not the case for taxpayers who have to claim the remittance basis, as set out below. However taxpayers who are eligible for the automatic remittance basis can still elect to be taxed on arising basis, should they wish.
The remittance basis: claim
Any individual who wishes to pay tax on the remittance basis, and does not fall into either category set out above, must claim the remittance basis in his/her tax returns. The taxpayer may also need to pay the remittance basis charge or “RBC” for the ‘privilege’ of paying tax on the remittance basis.
There is an additional side effect to claiming the remittance basis. The taxpayer will lose his/her entitlement to personal allowances for income tax and capital gains tax. This will have to be taken into account when calculating if it is worth applying for the remittance basis.
The remittance basis user charge (RBC)
Where the non-domiciled taxpayer has been resident in the UK for at least 7 out of the previous 9 tax years, any claim to pay tax on the remittance basis will lead to payment of the RBC. This is currently set at £30,000 per annum.
It is worth bearing in mind that this charge applies to each individual who wishes to pay tax on the remittance basis (and who does not fall into one of the categories of automatic entitlement). This means both husband and wife may have to pay the RBC, effectively doubling the cost of ensuring the family’s offshore income and gains are not taxed in the UK on the arising basis. If the family also have adult children who own assets overseas, and who wish to be taxed on the remittance basis, this can be even more costly.
For this reason, many families have considered putting all the family’s offshore wealth into the name of one family member. That family member would then pay just one RBC, sheltering the family’s offshore income and gains from being taxed on the arising basis. However there may be other issues to consider, such as the possibility of a future divorce or separation.
If the non-domiciled taxpayer chooses not to pay the RBC, s/he will be taxed on the arising basis, on worldwide income and gains, in just the same way as a UK domiciled and resident person.
Eligible taxpayers can choose each year whether to claim the remittance basis and pay the RBC (if relevant). This means the taxpayer can choose one year to be taxed on the remittance basis and the following year to be taxed on the arising basis.
This can be a useful planning opportunity. For example, an individual is selling an offshore asset that will produce a large gain. The individual wants to ensure the capital gain is not taxed in the UK, but doesn’t like the idea of paying the RBC each year.
The taxpayer applies for the remittance basis, paying the RBC, for the year the offshore gain arises. The gain is therefore outside the scope of UK taxation unless remitted to the UK. The sale proceeds are then deposited offshore.
In the following year the taxpayer decides not to pay the RBC, so that the income produced from the cash deposits will be taxed on the arising basis. The original offshore gain will not become taxable, however, unless actually remitted to the UK. For the price of one RBC and tax on the future income, the taxpayer has sheltered the offshore gain from UK taxation unless actually remitted. If the offshore income is less than £2,000 per annum, the taxpayer may also qualify for the automatic remittance basis.
Nomination of offshore income/gains
The new remittance rules attempt to ensure that the RBC is treated as a tax, rather than a penalty. The rationale is that this would enable taxpayers who pay the RBC to get credit against any overseas tax payable on the same offshore assets.
In order to achieve this, the taxpayer has to nominate the offshore income or gains to which the RBC applies. The RBC is then treated as being a tax on those nominated income/gains, even though the funds are not remitted to the UK. This means the taxpayer needs to nominate sufficient income or gains that would produce a £30,000 tax charge, calculated as if the tax were payable on the arising basis at either 18% for gains or up to 40% for income (50% from 6/4/2010). Details of the nominated funds have to be included in the taxpayer’s claim for the remittance basis.
However, if the taxpayer prefers, s/he can nominate funds that produce a lower tax charge. This does not mean the RBC is lowered accordingly. Instead, a fiction applies to pretend that the tax charge on those nominated funds would be £30,000.
It is not yet certain whether the RBC can be set against offshore taxes. US citizens in particular, who are liable to US tax on a worldwide basis, are uncertain whether the RBC will be creditable against their US tax liability. They may be better served by paying UK tax on the arising basis. They can then hopefully use the US-UK tax treaty to avoid double taxation (although there can be instances where the treaty does not fully help).
In addition, many clients are reluctant to nominate sufficient offshore funds that actually would produce a £30,000 tax charge. This may be because they would prefer not to disclose the existence of those funds to HMRC, fearing increased scrutiny into their offshore affairs. A nomination will be invalid unless it shows the precise amounts of income and gains that are being nominated, including the country of origin and the type and source of income. Many clients are reluctant to give this type of information to HMRC.
Taxation of remittances after nomination
Taxpayers might presume that once they have nominated their offshore income or gains, and paid the RBC, they can then remit those nominated funds without any further tax charge arising. This is correct but only if the taxpayer has no other offshore income or gains.
Where the taxpayer does have offshore assets, in addition to the nominated funds, then special ordering provisions apply whenever the taxpayer remits funds from the nominated account.
These complex rules treat remittances as being from the most highly taxable source first, irrespective of the actual source of the remittance. The aim is to ensure that nominated income/gains cannot be remitted in priority to unremitted (and untaxed) income and gains.
Most taxpayers are therefore setting up separate bank accounts, to produce a small amount of income each year, which can then be nominated. Those funds remain outside the UK at all times, to ensure these new special ordering rules do not apply. That way hopefully there will be no unexpected taxable remittances.
The new remittance rules are complicated. The first step is to determine whether the client is eligible for the remittance basis and whether s/he has to pay the £30,000 RBC. The next step is to discuss which funds to nominate, bearing in mind the special ordering rules if nominated funds are remitted, and whether the remittance basis needs to be claimed each year.
The next article will examine the concept of remittance in more detail, under the new rules introduced in Finance Act 2008.
This article is for general guidance only. You should take advice before acting on any material covered in this article.
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