Whilst tax has always been a major political issue, since the start of the financial crisis it has rarely been out of the spotlight. The government is trying to do an awkward balancing act to protect tax revenues, close perceived loopholes which are exploited by the unscrupulous, address perceived imbalances in the system, whilst at the same time trying to protect UK interests and ensure the UK remains an attractive place to do business. These competing, and to some degree incompatible goals, have resulted in major changes to the tax system over the past few years. FA 2012 was the longest finance act in history; FA2013 is set to be no different. Throughout the year the government has launched over 60 consultations into the tax system with approximately half of these affecting individuals and many of which will be introduced from April 2013.
Whilst most have tax advisors, it is easy to fall into comfortable patterns and not assess the impact changes will have on our tax affairs. It is important individuals actively review their position in light of these changes; below I have considered some of the major changes.
Statutory residence test (SRT)
The long debated statutory residence test will be introduced from 6 April 2013. The clarity of a statutory residence test has generally been welcomed; individuals will no longer need to rely on case law and the more intangible factors to determine their residence. However, at over 55 pages the length does a lot to undermine its intended purpose.
In broad terms the SRT consists of three successive tests. If you meet one test, there is no need to consider later tests. A detailed consideration of these tests is outside the scope of this article, but in outline the tests are as follows in the box (right).
Day counting, depending on if you have previously been UK-resident and the number of factors you have connecting you to the UK.
The connection factors in Table 1 & 2 depend on if you have been resident in the UK in any of the previous three tax years.
The rules also change the method of splitting the tax year for people moving to the UK, giving relief for people working outside the UK. The SRT will not change the effect of the operation of the UK’s network of double tax treaties.
The SRT will be of the utmost importance to the internationally mobile who spend time working in the UK and other countries. Not only will they have to ensure they apply the rules correctly, but they also keep the correct records in case of enquiry by HM Revenue and Customs.
High-value residential property tax changes
From the 6 April 2013 there will be a new Annual Resident Property Tax (ARPT), and the capital gains tax regime will apply for the first time to certain non-natural persons (broadly companies and partnerships with a corporate partner) owning residential property valued at more than £2 million. A punitive rate of stamp duty land tax will also apply at 15%, instead of the usual 7%.
Whilst much of the publicity about these measures was regarding the avoidance of stamp duty, there are many reasons why people would hold their property in this sort of structure, to minimise inheritance tax, or for anonymity, who will also be caught.
The problem many people have with existing structures is they may have been put in place 10+ years ago and forgotten about. It is important in light of these changes that the existing structure is reviewed and to ensure that it is still fit for purpose.
The capital gains tax regime will only apply to gains accruing post 6 April 2013 and be charged at 28%. Despite initial suggestions the regime would also apply to disposals of shares by non-resident trusts in offshore companies, the charge will only be on the disposal of UK property by non-natural persons. The ARPT has been set at relatively modest levels (see Fig.1).
For most people it will be a question of weighing up the non-tax benefits (such as anonymity) with the tax consequences. When considering the tax costs, it will be a question of considering the potential costs of undoing the structure, the likely ARPT changes, capital gains tax and stamp duty and the potential exposure to UK inheritance tax. If the decision is made to unwind the structure, it is important to ensure whatever structure is put in place is one that suits both long and short-term planning.
If the decision is to keep the existing arrangements, it is important to be aware of the new ongoing reporting requirements as returns will need to be made to HMRC annually, and the property valued every five years.
Income tax relief cap
From 6 April 2013 there will be a cap on sideways loss relief on the greater of £50,000 or 25% of an individual’s taxable income.
This only affects currently uncapped reliefs, the main being trading loss against general income, income tax relief on loan interest and share loss relief. Since the government U-turn this cap will not affect charitable donations.
Whilst the cap will not affect the ability to carry forward trading and other losses to be relieved against future profits of the same trade, it will have a large impact on some individuals. Individuals who invest in an unquoted trading business, who make trading losses on their sole trade/partnership, or who borrow funds to invest in a partnership will be particularly affected.
The proposed operation of the rules is particularly harsh on individuals who have two or more businesses, as it is possible to end up being taxed on more money than you have earned in a period. For example:
Mr Smith is a member of two trading partnerships. He makes a loss of £200,000 in partnership A, and in partnership B he make a profit of £100,000. The maximum loss from partnership A that he will be able to set off against the profit of B is £50,000. This will leave Mr Smith with taxable profits for the year of £50,000, despite having a net loss position of £100,000.
Individuals who will be affected by this new cap should look at making any claims as soon as possible, especially on losses arising from negligible value claims on shares in unquoted trading companies where they are likely to have a measure of flexibility about the timing of the loss.
Changes to tax rates
One good thing to come from the budget is the top rate of tax for people with an income over £150,000 will drop from 50% to 45% (42.5% to 37.5%, including the 10% credit, for dividends) from 6 April 2013.
One shouldn’t forget that the reduction in income tax revenues is to be paid for by the cap on income tax relief and the APRT and capital gains tax on high-value property. It is down to the taxpayer to ensure they are correctly navigating these changes to ensure they don’t end up penalised by the changes and take advantage of opportunities available.
Gains and income of offshore structures
Continuing the theme of good news, especially for UK residents who hold assets or run their business through offshore structures, are the announced change to the anti-avoidance rules of S.13 TCGA 1992 and the Transfer of Assets Abroad legislation. The goal of these changes is to ensure UK domestic legislation is compatible with EU treaty freedoms, on establishment and free movement of capital.
S.13, in certain circumstances, would attribute capital gains realised by a closely held company outside the UK to the UK resident shareholders in proportion to their shareholding in the company. E.g., a Spanish company with UK shareholders would end up with the gains being attributable and taxable on the UK shareholder, regardless of whether the funds are distributed from the company.
Obviously, this rule could have punitive effects and results in a company resident outside of the UK being taxed differently from a UK resident company. The proposed rules will provide exemptions for gains on:
The shareholder level at which the S.13 charge operates is also increased from 10% to 25%. There are similar changes in the Transfer of Assets Abroad legislation.
The transfer of assets rules aimed to prevent people using offshore shelters to avoid UK income tax. Where assets have been transferred abroad and income became payable to a ‘person abroad’, an income tax charge would be imposed on individuals where UK-resident individuals could still enjoy the income and/or receive a capital sum. Within the current rules there are exemptions if the transfer was not made for a tax avoidance purpose, or the transfer was a genuine commercial transaction not intended to avoid tax.
To comply with EU rules, for transactions made on or after 6 April 2012, there will be new exemptions:
Another welcome change to the rules is that a ‘person abroad’ will no longer include a non-UK incorporated company that is merely UK-resident because it is centrally managed and controlled in the UK. There are also other very useful clarifications within the new rules regarding the interaction with other income tax charging provisions and double tax treaties.
The changes to both S.13 and the transfer of assets rules abroad are welcome and these have been seen as a stumbling block for people who wish to incorporate offshore structures into their business. However, the new rules are not without their criticism; one very large question that remains is if the rules go far enough to be compatible with EU rules. There is also significant criticism that the rules are far too complex. The new legalisation makes reference to the EU treaty; any application of the new rules will require a working knowledge of EU law further complicated as EU law is subject to decisions by the European Court of Justice. Both of these points can cause significant difficulty in determining the scope of the new rules.
General anti-avoidance rule (GAAR)
The GAAR will be of vital importance to anyone who enters into tax planning arrangement or complex tax structures. The GAAR can be seen as symptomatic of HMRC’s approach of recent years, as anyone who regularly deals with HMRC will have noticed a significant hardening of their attitude.
The GAAR has been introduced with the purpose of counteracting “tax advantages” arising from “abusive” “tax arrangements”. The scope of the GAAR is very wide indeed: it will apply to income tax, corporation tax, capital gains tax, inheritance tax, stamp duty and the new ARPT. The terms have also been as equally widely defined:
There is no clearance procedure under the GAAR, and it will be HMRC who will determine which arrangements require action. Whilst there will be an advisory panel on the GAAR made up of a range of interested parties (representatives of business, tax advisors and wider interest), which it is hoped will bring some clarity and fairness to the application of the GAAR, the decision of the panel will not be binding on HMRC. The opinion of the panel must be taken into account by the court/tribunal if the application of the GAAR is appealed, but the extent to which the opinion of the panel will be respected remains unclear.
The actual application of these rules will depend on what HMRC consider acceptable practice. Whilst the draft HMRC guidance sets out a number of examples of what is acceptable and what is likely to be considered abusive, we are going to need a lot more examples to see where the actual boundary between acceptable and unacceptable tax avoidance will actually lie.
There are massive changes affecting individuals coming into force, which, hopefully, will bring certainty in the long run. However, any change from accepted practice or new untested legislation creates uncertainty. Given the scale of the new rules it is important individuals carry out a review of their tax affairs to ensure they don’t fall into any traps and are maximising the new benefits.
Stephen Kenny is a tax manager at Rees Pollock specialising in private client tax, acting for professional partnerships, company directors, business owners, high-net-worth individuals and non-UK domiciled persons. He also advises on trust taxation for both onshore and offshore trusts. Kenny is qualified as a Chartered Accountant, Chartered Tax Adviser, member of the Society of Trust and Estate Practitioners, and has a LLM in Tax Law from Kings College London. He joined Rees Pollock as a tax specialist in October 2010.