updated on 01 July 2008
QuestionWhat impact will the recent changes to the taxation of foreign domiciliaries have on the UK economy?
Non-doms are people who reside in the United Kingdom but were born to a foreign father, and have declared that the United Kingdom is not intended to be their permanent home. Prior to 6 April 2008, the UK tax regime permitted non-doms to live and work in the United Kingdom subject to a charge on income and gains accrued in the United Kingdom only. Foreign income and gains were only taxed to the extent that they were remitted to the United Kingdom. This benign system of taxation for non-doms was relatively unusual, with other wealthy countries adopting a more stringent approach by taxing residents on all global income, but it is widely agreed that it was this unique system that helped build London as a financial centre by attracting major investors, the super-rich and talented foreign individuals to the City.
The chancellor has defended his decision to go ahead with the proposals, despite heavy criticism and lobbying from business leaders, in order to create a better balance between a fair tax system and a competitive economy. Advocates of the shake-up believe it is reasonable to expect those living in the United Kingdom to make an adequate contribution to public services and that to have it any other way would be discriminatory. However, the fallout is expected to be a mass exodus of non-doms from the City and a massive blow to our economy, with the thorn in the side of many being the much publicised £30,000 annual levy to non-doms who have been resident in the United Kingdom for over seven years.
Remittance and the £30,000 fee
UK resident non-doms currently use the remittance basis of taxation whereby offshore income and gains are only chargeable to UK tax if remitted to the United Kingdom. Broadly speaking, a 'remittance' would have occurred if such funds had been received in the United Kingdom. This would have applied to physical transfer of cash to the United Kingdom, but constructive remittance could also have occurred in other circumstances, such as making a payment for services rendered in the United Kingdom directly or indirectly from offshore funds.
The new rules introduced by the chancellor will see the meaning of 'remittance' extended to include any overseas income or gains that are enjoyed in the United Kingdom, in most part to curtail the use of loopholes. It will now catch, for example, certain gifts made to family members who then remit the gifted property. Other loopholes such as 'source ceasing', which took advantage of the fact that remitted income was only taxable if the source still existed in the tax year of remittance, have been blocked.
Most notably, non-doms who have been resident in the United Kingdom for seven of the last 10 tax years and are over age 18 will be subject to an annual £30,000 charge if they wish to continue to be taxed on the remittance basis. Although the £30,000 charge is optional, those who do not pay it will be forced to disclose and pay tax on all overseas income, unless that income is less than the de minimis limit of £2,000 per year. Individuals are entitled to opt in and out of the remittance basis each tax year as they please, but those opting in with a yearly overseas income of over £2,000 will face a further blow, as they will no longer be entitled to their personal allowances (eg, the income tax allowance of £5,435 and capital gains tax (CGT) exemption of £9,600).
The current rules, confirmed in this year's budget, have been reached after a series of climb downs by the chancellor, who was forced to review the situation after it was poorly received (the £30,000 charge formerly applied to both adults and children, and the de minimis limit formerly stood at £1,000). In addition, the chancellor has now classed the levy as a tax charge instead of a stand-alone charge. This was demanded in order for non-doms, in particular US ex-pats, to be able to obtain tax relief in their home country and avoid double taxation on the same income.
Arguably of equal controversy are the changes to non-dom taxation in relation to offshore structures. Non-domiciled individuals who have offshore companies or interests in offshore trusts will now be subject to UK tax on income or gains in particular circumstances, in a bid to prevent such structures being used to defer or avoid UK CGT. From 6 April 2008, both UK and foreign gains made by offshore companies to non-domiciled UK resident shareholders who own more than a 10% interest in them will be attributable to UK tax on an arising basis.
Offshore trusts were previously a source of tax-free capital for non-doms as neither the settlor nor the trustees were subject to CGT in the United Kingdom at the time of disposal. The position now is that non-dom beneficiaries receiving capital payments from an offshore trust will pay tax on the trust gains represented by trust capital payments if brought to the United Kingdom.
Will this jeopardise our economy?
Although the long-term effect is hard to predict, many believe the overhaul will have disastrous consequences for the UK economy through the mass exodus of businesspeople and entrepreneurs from the City. The measures, which the government no doubt hopes will raise tax revenues, may have the opposite effect through lost tax brought about by those leaving. Of particular concern is the expected loss of wealthy and talented individuals from the capital, and the resulting loss in inward investment. The latest treasury figures suggest non-dom residents contribute around £12 billion to the United Kingdom's GDP and pay £4 billion in income tax alone. Non-doms also account for around 40% of senior posts in the City, predominantly in financial services. The UK economy and growth is very much reliant on this sector in particular, as can be seen by the devastating effects the credit crunch has had on both the US and UK economy.
However, the financial services sector is not the only industry that may be affected. Maritime services providers are reeling at the prospect of shipping companies and Greek ship owners leaving the United Kingdom, in turn affecting insurance providers. The accountancy and legal profession have also criticised the measures, fearing loss of lucrative private client work. The London Stock Exchange could also be in for a rough time, as businesses contemplate whether floatation ought to be moved to alternative jurisdictions.
All this against the backdrop of the current economic crisis makes for bleak reading. However, the fear of mass exodus is at present just that - a fear. Even though the changes were rolled out in April, it appears that fear has not yet turned into reality. A recent study by Barclays Wealth has found that for the moment most non-doms are staying put due to the economic slowdown, the weakness of Sterling against the Euro and the housing market slump, which is making it difficult for them to dispose of their houses profitably. The £30,000 charge will not of course make a noticeable difference to many of the capital's foreign millionaires. Perhaps the concessions made by the chancellor may also be enough to stop a few in their tracks. But the general consensus is that it may be too late - the trust of foreign professionals has been broken by a tax system they believe is becoming volatile and unpredictable. Emerging tax-friendly jurisdictions will no doubt be happy to welcome them with open arms in the coming years.
Keisha Williams is a trainee in the tax department of Reed Smith.