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Expat Briefing Editorial Team
17 December, 2013
Since coming to power in 2010, the ‘Con-Lib’ coalition has laid down the welcome mat for wealthy foreigners, especially those likely to contribute to the UK’s future economic growth. However, despite the oft-repeated mantra that Britain is “open for business,” new research suggests that the Government is as much interested in the benefits expats bring to HM Treasury as the wider economy.
Traditionally, the UK has been a relatively favourable destination for entrepreneurs and company bosses to locate themselves, thanks in no small part to its tax rules. Foreigners who are resident in the UK, but not domiciled there (put simply, not born in the UK nor a permanent resident there) do not pay UK tax on foreign income as long as it stays abroad. However, as the banking crisis left the Government with a huge fiscal black hole to fill, these advantages have come under attack. Firstly, the outgoing Labour Government introduced a GBP30,000 charge for the privilege of holding “non-dom” status (the “remittance basis charge”), which was triggered after seven years of residence. In 2011, the charge was increased by the Coalition to GBP50,000 effective April 2012, although the residence threshold was extended to 12 years.
The increased charge was expected to raise an additional GBP200m in tax receipts. But in return the Government waived the charge payable by non-doms for the remittance of foreign income or capital gains to the UK for the purpose of investing in a UK business. In addition, the government has pledged not to introduce any further changes to the non-dom system during the life of the current parliament, due for dissolution in 2015. There were a number of strings attached though. Although the relaxed rules permit non-doms to invest in a business that they already own or work for, they are clouded by anti-avoidance provisions. Furthermore, investments cannot be made into partnerships and PLCs listed on the London Stock Exchange nor can investment be made into a residential property company whose primary business is lettings.
Unconvinced about the Government’s true intentions however, some non-doms have simply voted with their feet, and recent figures suggest that the number of UK residents with non-dom status is on the decline: the number of taxpayers registered to pay the annual remittance basis charge on non-domiciled taxpayers fell by a further 2,000 over the tax year ending March 31, 2011, and has dropped by 17% since the levy was introduced in 2008. However, the vast majority of long-term non-doms still in the UK (about 95% in 2012) seem to have opted not to pay the charge, and instead pay UK tax on global earnings.
Jason Collins, of the international law firm Pinsent Masons, which obtained the figures from HM Revenue and Customs (HMRC) says that non-doms are now much more likely to favour investments with a short-term horizon, so that they are not in the UK long enough to trigger the charge.
“Before, non-doms would make long-term investments, including investments in businesses, but non-doms are now more likely to make shorter-term investments – in things like property – that allow them to leave the UK easily before being hit by the levy. The overall effect is to reduce the positive contribution of non-doms to the UK economy," he said.
Worse still is that, despite Chancellor George Osborne’s previous assertions that this Government is “unashamedly pro-business”, tax policy might at best be being perceived by non-doms and potential investors as inconsistent, and at worst, hostile.
"On the one hand we have entrepreneur visas and investor visas trying to boost the numbers of wealthy migrants, but on the other hand, wealthy migrants are being driven away by the non-dom levy and the constant stream of new measures to tax them more heavily, creating lots of uncertainty," Collins added.
But it is not only the tax rules that might be discouraging skilled individuals and investors from setting foot in Britain. The way they are being enforced by an increasingly aggressive HMRC hungry for revenue is another factor. Indeed, new information obtained by Pinsent Masons shows that HMRC’s tax take from investigations into highly paid foreign City workers living in the UK has jumped to record levels.
HMRC raked in GBP121m in additional yield in 2012-13 from the work of its ‘Expat’ team which investigates highly paid expats, the vast majority of whom work in investment banks, hedge funds and private equity firms. This was up from the GBP117m received in the previous year, despite the fact that the squeeze on investment banking profits meant that City bonuses declined dramatically, down from an estimated GBP4.4bn during the 2011 ‘bonus season’ to GBP1.6bn for bonuses paid out during the 2012/13 bonus round.
The tax affairs of highly paid foreign workers are on HMRC’s radar as these employees usually have complex and substantial remuneration packages, making the amount of tax and national insurance at stake relatively large. However, some features of expat packages have particularly caught the eye of HMRC. For example, the use of dual contracts which assign an element of an individual’s income to a contract for work done overseas, were targeted in the Autumn Statement announced on December 6, 2013.
The Government has also targeted the use of partnerships, primarily to counter the use of limited liability partnerships to disguise employment relationships and the tax-motivated allocation of business profits to corporate partners, which are generally taxed at lower rates than individuals. The Autumn Statement proceeds with proposals to restrict the use of such partnerships, despite warnings in a consultation earlier this year of their impact on the asset management industry and the legions of foreign workers employed in the sector.
"It seems a very short journey from the March Budget, where the Chancellor set out the Government's support for the asset management industry in the UK, to [the] Autumn Statement which targets asset management firms structured as partnerships,” commented Robert Mellor, PwC asset management partner. “A big concern is the extent to which HMRC have taken account of the global nature of the asset management industry and the importance to the UK asset management industry of US citizens and UK non-domiciled who work in the UK.”
Ray McCann, Partner at Pinsent Masons, said that with ambitious targets to meet in terms of bringing in more revenue, “it is no surprise HMRC continues to see what is a highly paid but relatively small group of individuals as offering maximum rewards in terms of tax take for much less effort.”
“Most of these foreign employees work for the biggest investment banks and hedge funds. They are internationally mobile and tend to be at the upper scale of pay rates, often benefitting from more than usually sophisticated bonus arrangements and complex employment agreements.”
“In the last year though, banks’ revenues from investment banking have fallen substantially, which has resulted in a big squeeze on City bonuses. That makes the additional yield that HMRC has achieved from investigations into City expats all the more striking.”
Much space was given over to tax compliance in the Autumn Statement as Osborne announced an unprecedented attack on “fraud, error and debt” in the tax system. However, according to McCann, HMRC is already profiting handsomely out of tax errors committed by expats unfamiliar with the nuances of the UK tax system.
“Expats can easily make mistakes because they haven’t fully got to grips with the UK rules,” he observed. “They may also have income from investments in their native countries or other places they have lived, or even overseas tax liabilities that all need to be properly documented and accounted for to HMRC. That all makes their tax affairs far from straightforward.”
“In many cases, we actually find that it is the employers who are getting the rules wrong on their international employees,” McCann explained. “We regularly see cases where employee expenses – that may be non-taxable where the employee is in the UK for a very short period of time – become taxable due to the contract being extended to a more permanent basis, and the employer misses the change in status.”
To avoid being caught out, expats are advised to ensure that their arrangements are properly reviewed, to avoid the risk that HMRC charges additional tax, national insurance contributions interest and penalties.
Other elements of the Autumn Statement have also cast doubt on the Government’s claims to be welcoming to foreign investors. The most notable was the decision to apply tax on the capital gains made by non-residents when they sell UK property, although this was not entirely unexpected, and the measure brings the UK into line with many other countries that do the same.
Hitting foreign investors with capital gains tax also builds on the taxes introduced last year on gains made by corporates and other vehicles holding residential property worth GBP2m or more, as well as the new annual tax on “enveloped” dwellings, i.e., those owned by foreigners through offshore companies. Some also see the measure as a break in the Government’s implicit promise that foreign investors would be safe from a future property tax if they “de-enveloped” their UK real estate.
"This will be seen by non-resident individuals as a broken promise,” remarked Paul Emery, real estate tax director at PwC. “They were strongly encouraged by the Government to take their properties out of companies so that a future sale of bricks and mortar (rather than shares) is subject to stamp duty. The quid pro quo was that they would not be subject to the annual charge (mansion tax lite) or capital gains tax. Having de-enveloped as they were asked to do, they will in fact be subject to capital gains tax after all.”
"Whilst UK property will remain an attractive asset class for investors, the Government should not underestimate the impact on confidence in the real estate fund/investor community,” Emery warned.
The new CGT will of course also impact UK expats living abroad who have retained an interest in a property in the UK, or who invest in UK real estate.
It must be remembered that while the right-wing Conservative Party is the largest party in the coalition by a large margin, its centre-left Liberal Democrat partner occupies some key cabinet posts as a consequence of their power-sharing deal, which depends on LibDem support for Tory policies. So in a sense, the UK’s somewhat schizophrenic tax policy, which seems to lay the welcome mat down with one hand, and abruptly pull it back up with other, reflects the ideological tussle going on between key figures in the Treasury.
Saying that you’re cracking down on wealthy tax dodgers also appeals to voters, with an election due in 18 months. “The government remains committed to ensuring that those with the most pay the most,” says the Treasury. “This Autumn Statement increases the contribution of the richest by a further GBP3.5bn… through measures to tackle tax avoidance.”
So with the coalition expected to hold firm until the 2015 election, not much is expected to change in the short-term.
Then there is the deficit. When the Coalition took power this was a whopping 12% of UK GDP. Inroads have been made, but the budget gap remains worryingly high, and way above where the Government would like it to be. And while this remains the case, the Government is always going to be tempted to fill its coffers with low-hanging fruit, of which the finances of expats are but one variety.
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