The Finance Bill, Capital Allowances, Capital Gains Tax
FINANCE BILL 2008
The Finance Bill has now been published and we can rejoice that the details are available to resolve the finer points on residence, the £30,000 domicile charge, the remittance basis, offshore trusts, offshore companies, capital gains tax, rebasing, entrepreneur relief, etc, etc. We can rejoice even more that the Finance Bill is so comprehensive, covering 500 pages—and we have the benefit of the explanatory notes. They run to a further 1,148 pages. I do not want to sound ungenerous but given what we are trying to find, the last thing we wanted was a haystack.
Alienation
There has been an extremely significant change here. It will be remembered that if a non-dom makes a gift out of their foreign income to another person outside the , that third party can remit the money to the without any charge to tax. It is not their income, nor is it a remittance by the donor. Obviously this falls down if the gift is not genuine, or if there is any reciprocity, but this has been a valuable technique. From 6 April 2008 if the donee is the spouse (or equivalent) or minor child or minor grandchild of the donor, or an appropriate company or trust, the donor will be taxed on the income if it is remitted to the by the donee. The original proposals were much more restrictive and the continued ability to make gifts out of foreign income to adult children is extremely helpful.
A question arises whether or not income given to a spouse or other relevant person before 5 April can be remitted to the UK tax free after 6 April—and the answer clearly seems to be no. A remittance after 6 April will have the disqualifying characteristics and will be taxable. However, this will not be the case if the income had been alienated before 12 March 2008. That money can be remitted by the donee at any time without any charge to tax. For gifts made on or after Budget Day but before 6 April, the Finance Bill allows the funds to be protected from tax provided they were brought to the before 6 April 2008.
Offshore mortgages
Where a foreign domiciled individual has taken out a foreign mortgage to acquire a property, the interest on that mortgage (but not repayments of principal) can be paid out of foreign income without it representing a constructive remittance. That has been the rule for many years but such interest paid after 5 April will now represent a taxable remittance. However, where the loan was in existence before Budget Day and is secured on the property, the continued payment of the interest out of foreign income will not be treated as a remittance until 2028. This protection will be lost if the loan ceases to be secured on the property, for example if the house is sold. It will also be lost if any further loan is taken out which is secured on the property or if the terms of the loan are varied or waived. One can see the clear anti-avoidance thinking here, but what about a switch from fixed rate to variable rate during the existing term of the mortgage? Would this represent a variation in the terms of the loan? Not perhaps if there is an existing right to switch—but it would be a variation if a new right were to be offered by the bank.
The legislation is specific that the interest must be paid out of relevant foreign income so the discharge of the interest out of foreign earnings or capital gains after 5 April would be regarded as a remittance.
Rebasing election
The trustees of a non resident trust will be able to make an irrevocable election for the purposes of capital gains tax to rebase all assets held by them at 6 April 2008. This will have the effect of washing out all the accrued gains arising up to that date and securing an effective exemption from capital gains tax for foreign domiciled beneficiaries. It is only the trustees who can make this election, not the settlor or the beneficiaries.The election applies to all non domiciled beneficiaries whether or not they are taxed on the remittance basis. This election has to apply to all assets owned by the trust and by any underlying company on 6 April 2008—to the extent that gains made by the underlying company would have been apportioned to the trustees under Taxation of Chargeable Gains Act 1992, s 13 (TCGA 1992). This election will not create a deemed disposal but when the relevant asset is disposed of, the gain will be attributed to the period before and after 6 April and only the gain for the period after 6 April will be taxable. The attribution of the gain will not be made on a time basis but on the basis of the value of the asset at 6 April. The rebasing election does not have to be made in the abstract, but must be made by 31 January following the end of the first tax year in which a capital payment is received by a resident beneficiary.
One of the concerns about the election for rebasing is that it may require a wholesale disclosure of information by the trustees to HM Revenue & Customs (HMRC) and this was the aspect which caused so much trouble. There is no information requirement contained within the Finance Bill (other than that the election must be made in the way and in the form specified by HMRC—but not yet specified) and the explanatory notes contain the following passage at para 63:
“The trustees will be required to provide additional information to HMRC about trust assets. Trustees of non resident settlements have been assured in a letter from the acting chairman of HMRC, Dave Hartnett dated 12 February 2008 that in applying the provisions set out in this schedule, HMRC will not require any additional disclosure”.
It is difficult to gain much comfort from this paragraph because HMRC clearly needs to satisfy itself that the part of a gain which will be chargeable to tax is accurately calculated and it can hardly do that without requiring disclosure of all the relevant information. Perhaps what this means is that HMRC will only require relevant details in respect of the assets actually disposed of.
Offshore companies
The attribution of capital gains made by non resident companies to the shareholders under TCGA 1992, s 13 has never applied to foreign domiciled individuals and this exemption was going to be removed. domiciled and foreign domiciled individuals were going to be treated exactly the same and any gains made by the company would be fully attributable to the resident shareholder without the benefit of a rebasing election which does not apply to companies.
However, the Finance Bill contains a relaxation which provides a kind of remittance basis for foreign domiciled shareholders. If the company makes a gain on an asset which is situated outside the , the gain will only be attributed to the resident and foreign domiciled shareholder to the extent that it is remitted to the .
Offshore trusts
Foreign domiciled settlors of offshore trusts will continue not to have the trustees gains attributed to them, but they will be taxed just like any other beneficiary (assuming the settlor is a beneficiary), on the basis of capital payments. However, a foreign domiciled beneficiary will be chargeable to tax on the remittance basis in respect of trust gains—but it will not matter whether those gains are made on UK assets or foreign assets; it is only when the beneficiary receives a capital payment in the UK that the gain on the asset will be taxable. This contrasts with the position of foreign domiciled individuals owning assets which are fully chargeable to capital gains tax despite their foreign domicile.
£30,000 Charge
It was announced in the Budget that the £30,000 non-dom charge can be attributed to specific items of foreign income, the idea being ensure a double tax credit in other countries. It was also suggested that if the income on which the £30,000 tax is paid is later remitted to the , that would not be a taxable remittance. However, the fine print of the Finance Bill shows this is not so helpful after all. This will only apply if all other unremitted and otherwise untaxable income is remitted first.
HMRC proposed to allow the charge to be paid out of foreign income without it representing a remittance. However, if the £30,000 is first paid into a UK bank account for onward payment to HMRC, that would be taxable remittance. It is only if the charge is paid directly to HMRC from an overseas account that the charge will not be treated as a taxable remittance. HMRC adds that individuals will need to keep sufficient records (such as a copy of the cheque drawn on an offshore bank account) to demonstrate that the payment was sent direct. Cynics have suggested that this is a way for HMRC to learn about offshore bank accounts owned by the taxpayer so it can then make further enquiries. The paranoid will no doubt establish a new foreign bank account exclusively for this purpose, to avoid further HMRC intrusion.
CAPITAL ALLOWANCES
JD Wetherspoon has had a long running dispute with HMRC in connection with its claims for capital allowances for expenditure on fitting out and refurbishing its public houses. It goes back a bit—the appeal related to their accounts for the year ended 31 July 1999 and involved expenditure totalling £33.7m—but the principles embodied in the case remain relevant.
Naturally, the case involves an examination of an enormous number of different items of expenditure but one of the important issues was whether panelling on the walls was plant, or whether it had become part of the premises. The special commissioners said it was an issue of principle whether or not the panelling retained its separate identity—and even if it did, should it be considered to be part of the premises?
We know from the House of Lords in Inland Revenue Commissioners v Scottish and Newcastle Breweries Ltd 55 TC 252, [1982] 2 All ER 230 that an embellishment to a pub (in that case expenditure on murals) creating a particular ambience, was plant and not part of the premises. This sounds promising and in the case of JD Wetherspoon, the special commissioners accepted that the panelling was an embellishment to create ambience for the purposes of the trade. They also said that as the panelling only covered part of the walls, it did appear visually to attain a separate identity.
However, they still reached the conclusion that the panelling became part of the premises and did not qualify as a plant. Not an easy conclusion to understand but it shows that the distinction between what is part of the premises and what is not, can be extremely fine—so fine that a decision of such clarity by the House of Lords can be distinguished by the special commissioners.
CGT: CONTRIBUTION OF ASSETS TO A PARTNERSHIP
HMRC has issued Brief 03/08 relating to the capital gains tax treatment of a contribution of an asset to a partnership.
The application of the capital gains tax rules to partnerships has always been difficult and HMRC issued a Statement of Practice D12 in 1975 which set out a practical framework for the operation of the legislation. There have been one or two difficulties, but generally this has been accepted as a sensible means of dealing with capital gains tax issues for 30 years. (I cannot resist the observation that we all said that about IR20…)
The Statement of Practice does not deal with the situation when a partner introduces an asset to a partnership by means of a capital contribution. HMRC says that in these circumstances s/he should be treated as having made a part disposal of the asset equal to the fractional share that passes to the other partners. Unless they are connected persons (in which case market value would apply) the consideration to be taken into account would be the value credited to the partner in the partnership accounts.
It is understood that in the past, such capital contributions may have been treated in the same way as changes in the profit sharing ratio and the allowable costs apportioned rather than using the part disposal formula. This latest HMRC Brief is really intended to make it clear that the part disposal formula is the correct method of calculation and no other basis will now be acceptable by HMRC.
