Synopsis

The United Kingdom ("UK") comprises England, Scotland, Northern Ireland and Wales and is one of the member states of the European Union. It has an area of some 244,100 square kilometres (94,250 sq. miles) with an estimated population in excess of 57 million. London is one of the world''s leading centres for banking, insurance and other financial services; lying between New York and Tokyo it is the third leg of the world''s capital markets. Not the least of its attractions is that it is a politically stable English speaking country.

The corporation tax rates are relatively low compared with other EU nations. From April 2008 smaller companies having a net profit of under £300,000 per annum will be liable to 21 %, whereas the higher rate of corporation tax will be 28%.

Generally speaking, a UK company is taxable on its world wide income at the rates indicated above but various possibilities exist to create low tax or no tax UK entities which can be used to great advantage.

UK Holding Company Characteristics

At the same time, a UK company is also an extremely useful vehicle for the collection of foreign dividend income as, in general terms, a full credit is given against UK tax for any tax paid on the remitted profits before arrival in the UK. Thus as long as the dividend income has already suffered tax at a rate higher than or equal to the applicable UK rate (28%/21%) no UK tax will be payable on that income either on arrival or on distribution. For example, a Spanish subsidiary of a UK company would pay tax on its profits at 35%. If the Spanish subsidiary distributed profit by way of dividend to the UK parent no further tax should be levied on arrival in the UK because a credit would be given for tax paid in Spain. This makes the UK company an extremely attractive holding company vehicle for investment into Europe or otherwise and in most cases will be more attractive than competitive structures available through the Netherlands, Austria, Switzerland etc. At the same time, if the UK company is owned by an offshore tax exempt company, the dividend income received by the UK company from its foreign subsidiary can be absorbed by the offshore exempt company parent. It should be noted that any sale of shares would be subject to capital gains tax but there are a number of methods which can be used to reduce or avoid this tax.

UK Company trading as Fiduciary

A UK company is incorporated and enters into an agreement with the offshore company. Under that agreement, which is committed to writing and executed by both parties, the UK company agrees that it will trade on behalf of the offshore company as its nominee. All contracts of purchase and sale, all the invoicing and all the general correspondence will be made in the name of the UK company and the UK company receives all the revenues from such business as nominee for the offshore principal. The agreement should state that all monies received are received as nominee for the principal save insofar as there will be an agreed fee which will be retained by the UK company. That fee may either be expressed as a flat fee for all the trading done on an annual basis or, more usually, expressed as a percentage of the gross revenues received. The standard form is that 10% of the invoice total in respect of each transaction is retained by way of fee by the UK company.

The practice of the UK revenue is to accept, subject to certain conditions, that non UK source monies which are first received by the UK company but will ultimately be passed over to the offshore company are received as nominee and are not therefore subject to UK corporation tax. On the basis that 10% of profit is retained by the UK company, UK corporation tax will have to be paid on this amount. The effective rate of UK taxation will be reduced to approximately 3% (10% of the 30% maximum corporation tax rate).

In order to protect the trading profits from UK taxation it is essential that no trading activity must occur within the UK. What constitutes UK trading activity would be construed by reference to the normal indicia such as the place where the contracts of sale are executed and the place of acceptance of an offer made outside the UK. The offshore company must of course be non-resident in the UK for tax purposes itself. This means that its central management and control must reside outside of the UK.

The nominee fees received by the UK company will of course be liable to taxation insofar as they generate a profit for the UK company. The amount of remuneration which the UK company receives may also be subject to UK transfer-pricing legislation as contained in the Income and Corporation Taxes Act 1988. Such legislation is likely to apply where the UK nominee and the offshore principal are under common control.

One solution to the problem of common control is that the UK company should be beneficially owned by a third person. If the client has doubts as to the safety of such an arrangement he should realise that the contract between the two companies is enforceable and that in any event the vast majority of monies will be immediately passed over to the offshore company. However, even when there is common control between the two companies, provided a commercially viable relationship exists between the two companies and the rate of fee retained by the UK company is in line with what might be expected of an arms-length transaction, there is no reason why the inland revenue might make a direction adjusting the UK company’s deemed remuneration.

UK Limited Liability Partnership

This new form of legal entity was created by the Limited Liability Partnerships Act 2000. The essential feature of a limited liability partnership ("LLP") is that it combines the organisational flexibility and tax status of a partnership with limited liability for its members. This limited liability is possible because an LLP is a legal person separate from its members.

The LLP can do anything that a natural person could do. It has the ability to enter into contracts, own assets and will continue in existence in spite of any change in membership. Its existence as a separate legal entity makes it more closely akin to a company than to a partnership. The concept is similar to that of the US Limited Liability Corporation, a US legal entity which is not generally subject to US taxation. Although the LLP is a legal entity, it is taxed like a partnership so no tax is assessed on the LLP but profits are only taxed in the hands of the partners, so if a partner is a non-UK entity and does not trade in the UK, no UK tax will be liable. Thus it may be possible to create a non-UK taxable structure provided that the trading activities take place outside of the UK and the profits are generated from a non-UK source.

The LLP has the following characteristics:

For the purposes of UK tax legislation, a trade, profession or business carried on by an LLP with a view to profit is treated as carried on in partnership by its members (and not by the LLP as such).

Therefore, the LLP is tax transparent. Its profits are taken to flow through to its members and if the members are non-UK resident and the LLP does not receive UK source income, then in theory the LLP should not be subject to any UK tax. It is possible for two offshore companies, carrying on a lawful business with a view to profit, to be the members of an LLP.

Although there are no UK residence requirements for LLP members and an LLP does not require a place of business in the UK, it may be commercially sensible to appoint a UK partner to whom a small profit allocation is made. Certainly, if it is necessary to demonstrate that one of the partners is subject to tax, or if it is important for the LLP to acquire from the Inland Revenue a tax reference number, then a UK partner should therefore be appointed.

LLPs can be registered for VAT, which may be essential for trade that takes place with companies and other vehicles domiciled in EU nations.

An LLP should not be used to participate in pension type products since such activities may make the structure more prone to UK Inland Revenue attack. LLPs should not be registered and structured as non-profit making or charitable vehicles.

OFFSHORE STRUCTURES FOR UK DOMICILED AND RESIDENT INDIVIDUALS

Simple offshore structures have ceased to be effective in reducing taxes for UK resident and domiciled individuals due to a raft of anti-avoidance legislation which has now been implemented by the UK. This legislation requires any UK resident and domiciled person to declare their interest in the offshore company and attributes the earnings of an offshore company to any UK beneficial owners, in proportion to their interests, whether they receive those earnings or not. It would normally be a criminal offence to fail to make the correct declaration on the relevant tax form.

Or in other words: if for example an UK resident and domiciled person beneficially owns 40% of the equity in an offshore company then he will be taxed on 40% of the profits of that company irrespective of whether the company actually pays out any profits and irrespective of how that interest is held.

In the past transferring the shares in the company to a trust would mean that these rules no longer applied so tax may have been legitimately deferred but now TCGA 1992 Section 86 and Part 13 ITA 2007 both operate to remove these advantages and tax the settlor and/or beneficiaries as though they were receiving the profits of the offshore company.

Thus, offshore companies and trusts have ceased to be effective for reducing taxes for most UK domiciled and resident persons.

However, life insurance contracts may be used to “decontrol” the offshore structure for UK tax purposes and allow an offshore structure to be most effective in deferring taxes indefinitely. The UK treats insurance contracts very sympathetically. If the shares of an offshore company are owned by an insurance company and form part of the assets of an insurance contract then the attribution rules referred to above no longer apply. The revenue have tried to remove some of these advantages by creating rules which attribute 15% of the initial life insurance premium as a capital gain taxable upon the owner of the insurance policy. The 15% deemed gain is then taxable in the hands of the policyholder at whatever rate of tax he is subject to. However, if the policy itself is owned by an offshore company and that company is owned by an offshore trust then the 15% charge would not apply and a tax free structure is created which can be used to indefinitely defer tax even when the beneficial owner of the structure is a UK resident and domiciled individual.

PROPERTY PURCHASE IN THE UK - TAX CONSIDERATIONS

INHERITANCE TAX

The general rule is that the death of the owner of UK situated property gives rise to a charge to UK inheritance tax irrespective of the domicile or residence of that owner so non-resident individuals could not avoid paying UK inheritance tax on the value of any property they had within the UK on their death without taking suitable precautions. The current rate of inheritance tax is 40% although the first £312,000 of value is exempt. It is important to note that the value of ALL property and assets situated within the UK must be aggregated and inheritance tax is payable on the total. Therefore, if a non-UK investor has several UK properties the total inheritance tax bill would be 40% of the amount by which total value exceeds £312,000.

If property is purchased in the name of a non-UK company then, as a corporation never dies, UK inheritance tax is avoided.

On purchasing property in a corporate name the shares of the corporation become part of the estate of the ultimate beneficial owner and it might therefore be the case that inheritance tax is assessed on the shares in accordance with the rules applicable in the home jurisdiction of the owner and/or in the jurisdiction of incorporation of the company. The value of the shares will clearly be equal to the value of the property registered into the name of the company. We would therefore recommend that an offshore company sited in a jurisdiction which does not make any charge to inheritance tax is utilised to effect the purchase. If this were done then it would only be necessary to consider whether inheritance tax would be payable in the home jurisdiction of the ultimate owner. If the shares of the company were transferred into a suitable trust structure then, as a general rule, all inheritance tax could be avoided as would the need to obtain probate. Enclosed with this information are details on Isle of Man offshore companies, which is our recommended jurisdiction for incorporation, together with details on discretionary trusts which contain an indication of the fees that would be charged by our own organisation and gives further explanation of the benefits accruing.

INCOME TAX

Rental income generated by the letting of a UK sited property owned by an offshore company is calculated as though it were the profits of a trade or business carried on within the UK but is taxed as investment income at the basic rate of income tax, currently 20%. The rent is therefore subject to UK tax irrespective of the method of ownership. Sums spent on maintenance, repairs (but not improvements) insurance, rates and, most importantly, interest payable in respect of any loan taken out to purchase the property may all be deducted from rental income prior to the calculation of the tax due. Where properties are owned by a company as an investment the company may additionally deduct management expenses (TA 1988 Section 75).

Please note that The Finance Act 2000 introduced new transfer pricing regulations which require that loans must be made on normal commercial terms applicable between third parties. Any additional interest paid over and above the normal commercial terms would be disallowed as a deduction against tax. Transfer pricing regulations apply only when the loan is made or guaranteed by a connected party i.e. somebody who has an interest in the profits or shares of the borrower but the rules also apply when a connected party guarantees a loan from a third party. For example, if an offshore company was set up to own a UK property and obtained a loan which was guaranteed by a director or other associated person then the UK Revenue may adjust the interest rate or the amount of interest paid to normal commercial terms. Generally they consider that a third party bank would not lend more than 80% of the property price so if the personal guarantee has been used to obtain more than this percentage they will disallow the interest paid on that additional amount. Alternatively if the loan was made by a private individual then interest could only be deducted at a rate normally offered by banks.

It is important to note that a tenant should deduct tax from rent paid directly to a landlord whose usual place of abode is outside the UK (TA 1988 Section 349) and account to the UK Inland Revenue for such deduction (TA 1988 Section 43). The current rate of tax which must be withheld on such payments is 20%. It is possible to obtain the Inland Revenue’s permission to waive this requirement and receive the rents without deduction of tax.

If a UK resident director or other employee of the property owning company lived in the UK property without paying commercial rent then this may be considered by the Inland Revenue to be a benefit in kind received by that director and tax would be assessed on the market rental value. If the intention is to purchase UK property to live in for any lengthy period of time then the inhabitee of that property should avoid being registered as a director of the owning company or have the property owned directly by a trust.

CAPITAL GAINS TAX

If a profit is realised on the resale of a UK property then UK resident individuals and companies would be subject to capital gains tax on the gain in value with some relief for inflation and length of ownership. Further reliefs may be available where the property has been the individual’s principal private residence with an additional relief if a let property has been an individual’s principal private residence at some time during the period of ownership. Capital gains tax is not payable by non-residents of the UK but there is precedent to suggest that if a property is resold in a relatively short period of time then the profit might be treated as profits of a trade carried on within the UK (the trade being the purchase and sale of the property) and charge to income rather than capital gains tax. However, if the property is held and being let, for a period of at least 3 years the presumption that the profit on resale is other than a capital gain made incidental to the real business of letting of UK property can be avoided.

STAMP DUTY

Rates of Stamp Duty on higher price properties in the UK are now significant. The rates are:-

Up to £125,000 - Nil

More than £125,000 but not more than £250,000 - 1%

More than £250,000 but not more than £500,000 - 3%

More than £500,000 - 4%

If a UK property is owned by an offshore company then Stamp Duty may be avoided by effecting a sale of the property by a transfer of shares in the company leaving the title to the property unaltered. Stamp Duty is payable by the purchaser but, of course, the ability to offer a prospective purchaser a way to avoid the Stamp Duty charge will significantly decrease his acquisition costs and therefore add to the attractions of the transaction. Alternatively, the seller may be able to charge more for the property.

BUDGET 2008 - NON-UK DOMICILE CHANGES TO THE TAXATION OF NON-UK DOMICILED INDIVIDUALS

AMENDING THE RESIDENCE CRITERIA

Statutory legislation that an individual spending 183 days in the UK in a tax year is treated as resident are to be amended with effect from 6th April 2006. From that date, any day where an individual is present in the UK at midnight will be counted as a day of presence in the UK for residence test purposes.

There will be an exemption for transit passengers who remain ‘airside’with a further exemption for individuals who need to change terminals or airports when transiting through the UK allowing people to switch between modes of transport, such as arrival by train and departure by air. In this instance, days spent in transit, which could involve being in the UK at midnight, will not count as days in the UK for residence test purposes. The exemption will not cover passengers who undertake activities that are not to a substantial extent unrelated to their passage through the UK. Individuals holding business meetings whilst in transit not, therefore, benefit from this relaxation.

REMITTANCE BASIS OF TAXATION

Non-domiciled individuals residing in the UK are currently able to avoid UK tax on foreign income and gains unless these are brought into the UK. This is known as the ‘remittance’ basis of taxation in the UK.

• In future, if you have income or gains not brought into the UK in excess of £2,000 you will have to claim for the remittance basis to apply on your Tax Return or be treated like any other taxpayer and be taxed on worldwide income and gains as they arise. The existing basis will continue to apply automatically if overseas un-remitted income or gains are less than £2,000.
• It will be possible to select which years to claim although income or gains arising in a year when the remittance basis was claimed and brought into the UK in a subsequent year will be taxed.
• If a claim is made then personal income tax allowances and the capital gains tax annual exemption will not apply for that year.
• If you are a non-domiciled adult and have been living in the UK for seven of the last nine years and wish to make the claim for the remittance basis then you will need to pay a £30,000 charge for each year of claim. This charge will not apply to children under 18.
• If the charge is paid directly to the Collector of Taxes from the individual’s offshore account it will not be treated as a remittance unless and until it is repaid.
• The charge will be either a charge to income tax or to capital gains tax and should therefore be treated as tax for the purpose of Double Tax Treaties. It will be available to cover Gift Aid donations

WE RECOMMEND THAT NON-UK DOMICILARIES CONTACT SOVEREIGN TO HAVE THEIR OFFSHORE STRUCTURES REVIEWED AND WHERE APPROPRIATE RESTRUCTURED TO TAKE ADVANTAGE OF PLANNING OPPORTUNITIES THAT ARE STILL AVAILABLE TO THEM.

 

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Last reviewed: Wednesday, May 26, 2010

Whilst every effort has been made to ensure that the details contained herein are correct and up-to-date, it does not constitute legal or other professional advice. We do not accept any responsibility, legal or otherwise, for any error or omission.