14 August 2014

Funding UK Investment - HMRC u-turn on loan arrangements for remittance basis users

Overview

  • UK resident, non-UK domiciled remittance basis users who have borrowed funds for use in the UK and secured their borrowings on foreign income or gains should review their arrangements urgently.
  • Until recently, taxpayers have been able to rely on HMRC guidance stating that no taxable remittance will arise as a result of these arrangements, provided that the loan is on commercial terms and is serviced and repaid from "clean capital". 
  • It is thought that many remittance basis users will have relied on HMRC's guidance in order to structure tax-free investment in the UK.
  • On 4th August, HMRC changed its guidance with immediate effect.  Loans taken out on or after that date which are used in the UK will be treated as triggering an immediate taxable remittance of any overseas income or gains used as security. 
  • Those with existing loans secured by non-UK income or gains are required to take remedial steps before 31st December 2015.
  • Advice should be sought on the options available to re-structure existing arrangements and (going forward) to fund further investment in the UK.

The remittance basis

UK resident non-UK domiciled individuals who claim the remittance basis of taxation are subject to income tax and capital gains tax on non-UK source income and capital gains only to the extent that they are remitted to the UK.  The definition of "remittance" is complex, but broadly non-UK income and gains will be treated as remitted if they are brought to, received in, or used in the UK by or for the benefit of the taxpayer or certain persons connected to the taxpayer.

The debt remittance rules

Basic planning for remittance basis users involves maximising the amount of "clean capital" (meaning funds other than unremitted income or gains) which can be used in the UK without triggering a tax charge.  Until recently, a possible solution for those who did not have enough clean capital to fund a new investment (for example, the purchase of a property) was to borrow the funds needed and use unremitted income and gains as security for the loan. 

The legislation governing this type of arrangement (known as the debt remittance rules) states that a remittance is triggered if non-UK income and gains are "used in respect of" a loan which is used in the UK.  While it is clear that the use of foreign income or gains to service or repay such a loan will trigger a remittance, it is less clear whether a remittance is triggered merely by virtue of the overseas income and gains being "used" as security (or whether, the security is only "used" if it is enforced).  Plausible arguments can be made on both sides, and in the absence of reassurance from HMRC it would have been a brave taxpayer who was prepared to second guess the courts.

Previous HMRC guidance – "yes you can"

Fortunately for some (at least until earlier this week), reassurance came in the form of published HMRC guidance stating that it would not treat non-UK income and gains as remitted merely by virtue of their being used as collateral.  Planning which relies solely on HMRC guidance (which is not binding, and can be withdrawn at any time) must always come with a health warning. Nevertheless, many will have felt that this type of arrangement, having been effectively "rubber stamped" by HMRC, was relatively low risk.  A number of remittance basis users will have taken the opportunity to fund further UK investment, particularly where other options were not available.

Revised HMRC guidance – "no you can't"

It is important to emphasise that the debt remittance rules have not changed.  HMRC's interpretation of the rules has simply been revised.  In HMRC's view, loans which are used in the UK will now be treated triggering an immediate remittance of any foreign income or gains used as security.

The reasons given for the change of approach are not entirely convincing.  HMRC incorrectly refers to its previous guidance as a "concession", which applied only to "loans made on commercial terms that were regularly serviced using foreign income or gains".  This is disingenuous.  The guidance was not a concession – it was merely a statement of HMRC's view of the legislation, which may or may not be upheld by the courts.  It is true that the previous guidance acknowledged that, if the use of offshore income or gains as security triggered a remittance, there would be double taxation if a loan was both secured on, and serviced or repaid using, foreign income or gains. However, the view that the security itself did not trigger a remittance was not dependent upon the loan being serviced from taxable funds.  The guidance expressly stated that "the [loan] could also be serviced and repaid using non-taxable income and capital sources; in which case there would be no taxable remittances of foreign income or gains [as a result of the servicing/repayment]… there is still no remittance of the collateral in this circumstance".

A more compelling explanation for the change may be implied from the statement that "HMRC is seeing large numbers of arrangements which are not considered to be commercial… for example, loans repaid from non-foreign income or gains that are not charged as a remittance".  The cynical will interpret HMRC's change of heart as driven by economic reasons, rather than a belief that their previous guidance had been misinterpreted.

What to do – existing arrangements

The revised guidance requires taxpayers to notify HMRC of existing loans which are secured on foreign income or capital gains, and gives them a choice between the following two options:

(a)    repay the loan before 5th April 2016; or

(b)    provide HMRC with a written undertaking by 31st December 2015 that the "tainted" security either has been or will be replaced with "clean" security by 5 April 2016. 

In some cases, it may be possible to restructure borrowings to retain UK investments without triggering a remittance. The deadlines may seem generous, but for those who have borrowed to fund long-term investments, restructuring may not be easy, or cheap.  Those with existing arrangements should consult their advisors before deciding what to do.

Funding future investment in the UK

It is disappointing that, at a time when government consultations on tax changes are increasingly the norm, this announcement came out of the blue.  Many of those affected will feel a sense of injustice about the fact that planning which was seemingly endorsed by HMRC has been unceremoniously swept away in a manner which might have been expected to be preserved for abusive tax avoidance schemes. The arrangements targeted were a wholly foreseeable result of HMRC's published guidance, which taxpayers will have acted upon in good faith.

However, all is not lost for remittance basis users who are out of clean capital and wish to invest in the UK.  In some cases, "business investment relief" will provide a solution which, being contained in legislation rather than relying on HMRC guidance, one might expect to be less vulnerable to being withdrawn without notice. 

 

 

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