For many years the UK has been a highly attractive place to live for foreign expatriates, both in general and specifically for financial reasons.
Individuals resident, but not domiciled, in the UK have traditionally enjoyed the ‘remittance basis’ of UK taxation, only paying UK income or capital gains tax when they remit overseas income or investment gains to the UK.
However, this benign tax regime changed with legislation introduced by the Finance Act 2008. Since then, ‘non-doms’ have been able to continue to access the remittance basis, but they have no UK personal allowances for income tax and no annual exempt amount for CGT, unless their unremitted foreign income or gains are less than £2,000.
In addition, any non-doms who have been resident in the UK for more than seven out of the past 10 years will only be able to choose the remittance basis if they pay an annual tax charge of £30,000.
The annual charge is payable in addition to any UK tax due on remitted income or gains. Non-doms will have the choice each year of whether to pay the charge and claim the remittance basis, or to be taxed on all their worldwide income and gains whether they are remitted to the UK or not.
UK less attractive
Along with the impending introduction of the 50% income tax rate from April next year, these fundamental tax changes have made the UK a much less attractive place for non-doms to live. Recent surveys from KPMG and HSBC indicate that many wealthy expatriates living in the UK are considering returning home or moving themselves and their businesses to a more tax-friendly destination.
However, it is also clear that a great many wealthy expatriates have no intention of leaving in the near future as they wish to remain living and working in the UK for business, cultural and family reasons.
Financial advisers dealing with non-doms have seen a dramatic rise in activity as a result, as non-doms take action to minimise the negative effects of these tax changes within the context of their overall financial planning (which needs to recognise that ultimately most non-doms will return home or leave the UK for another location at some point in the future).
The remittance dilemma
The first point to be assessed is whether it is best for the client to pay tax on worldwide income and gains as they arise, or to face taxation on the remittance basis on only those earnings and assets brought into the country.
Once this appraisal has been made, the client should structure their financial affairs in a way that makes it easy for them to deal with potentially complex HMRC reporting requirements. Non-doms choosing the remittance basis should typically have an offshore current account with additional separate accounts for their original capital, arising income, and capital gains.
The 2008 Finance Act also affected the tax-efficiency of investment structures commonly used by advisers to help non-doms to manage their UK tax exposure. For instance, new rules changed the capital gains tax regime for offshore trusts so that settlors are tax-assessed on receipt of capital payments from trustees. In addition, the income and gains of non-UK closed companies are now taxed as income and gains of the owners as they arise in respect of UK assets.
Offshore bond solution?
With the effectiveness of other structures being eroded, cross-border life assurance policies are emerging as the tax-efficient legal ownership structure of choice for holding non-doms’ assets. With ‘portfolio bond’ products available from Luxembourg, Ireland and the Isle of Man based subsidiaries of many major UK, European and North American financial services groups, these are playing an increasingly important role in helping advisers manage their non-dom clients’ investments whilst minimising their UK taxation.
With many wealthy non-doms from EU member states being based in the UK, European life assurance contracts have witnessed a period of dramatic growth. Lombard International Assurance, Luxembourg-based life company that targets high net worth individuals, has seen its UK non-dom business increase by 30% in the last year.
“Life assurance contracts can play an important role in helping advisers to manage their UK resident non-domiciled clients’ investments, providing an alternative to paying UK taxes or electing for the remittance basis of taxation, while allowing them to retain their existing investment management arrangements” says David Steinegger, Lombard’s chief executive.
Steinegger’s comments are echoed by leading lawyers in the UK. “The unique way in which life assurance contracts are treated for UK tax purposes creates significant tax planning opportunities for UK resident individuals,” explains Paul Whitehead, a Partner at Berwin Leighton Paisner LLP, a law firm headquartered in the City of London.
“The recent changes in UK taxation, which mean that capital gains tax charges can arise when distributions are made by offshore trusts to UK resident non-UK domiciliaries, have made tax efficient investment more difficult. The range of investments that enable an individual to prevent a tax charge on funds used in the UK has also been considerably reduced. As a result, life assurance contracts are even more attractive for UK non-domiciliaries, providing a level of flexibility for investment and potential tax efficiency that is not possible to match in any other way.”
No tax liability
Holding assets in a life assurance structure means these investments do not create any liability to UK income tax or CGT provided that no withdrawals are made in excess of the cumulative 5% per annum tax deferred allowance, and provided that no other chargeable events occur, such as the death of the last life assured, or changes are made to the lives assured.
This can be a considerable benefit to a UK non-dom, as Whitehead points out: “For example, the rules would allow an individual to place, say, £5 million into a life assurance contract, which can be invested in a wide range of investments under a discretionary mandate, and to withdraw up to £250,000 per annum for 20 years to use in the UK without a UK tax charge.”
This also provides privacy for wealthy non-doms as there is no requirement for the structure or “income” payments of up to 5% per annum to be disclosed on the client’s tax return.
There is another major benefit for the many wealthy non-doms who are EU nationals and who are likely to return to their home country or another EU jurisdiction.
Advisers using a European life assurance contract to structure their non-dom clients’ wealth can create a solution which acts as a tax shelter when UK resident while at the same time complying with the fiscal rules of their home country. “The timescale for full tax benefits in the EU national’s home country will normally start from the moment the life assurance structure is put in place,” notes Steinegger.
Tax complexity
This means that UK advisers who are less familiar with tax planning opportunities elsewhere in the EU will need to work with a product provider that has a detailed understanding of the relevant laws and tax rules in their non-dom client’s permanent home country or their planned future country of residence if this is different.
Making use of an open architecture life assurance structure means that the adviser and their non-dom clients can retain their preferred investment advisers while having the freedom to invest in an almost unlimited range of funds.
Finally, there is another important consideration for a UK resident non-dom in that any assets they own in the UK are subject to IHT on death. Helpfully, a Luxembourg, Ireland or Isle of Man based life assurance structure is not a UK-situated asset.
From a financial adviser’s perspective, a cross-border life assurance structure can provide an important element of financial planning for all non-doms, whether they are using the remittance basis or not, by holding their worldwide investments in a way that does not generate annual income or an IHT liability, and which controls the timing and amount of any tax charge caused by cashing in part or all of their bond.
It is important that advisers are thorough in their planning for non-dom clients, with Whitehead adding: “The rules on the UK taxation of life assurance contracts are complex and there are pitfalls that can be very costly to fall into, so it is important to take expert advice and to use an experienced high quality provider who knows how the system works.”
Steinegger is clear that there is a major opportunity for financial advisers to make a real difference to their non-dom clients’ financial planning: “Governments around the world are increasing taxes on private wealth and removing opportunities to legitimately avoid taxes, and the UK is no exception. The main focus of financial advisers in these testing times must be to recommend onshore fully-compliant financial structures to their wealthy clients, non-doms included, bringing certainty to their financial planning and helping them navigate these difficult waters.”
Bryan Low is managing director of Isle of Man-based offshore life insurance industry consultancy business Acuity
