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Who said tax wasn't taxing?

Further changes are now being directed towards UK resident non-domiciles who take advantage of the remittance basis of taxation.

In last month’s article we looked at some of the main points to come out of the Pre-Budget report. Unfortunately it didn’t stop there with further changes now being directed towards UK resident non-domiciles who take advantage of the remittance basis of taxation.


You will remember that April 2009 saw the introduction of legislation which sought to tax such UK resident individuals, some say as a knee-jerk reaction to public opinion; others viewed it as HMRC going for those with ‘deep pockets’ who really wouldn’t mind paying £30,000 per year to remain largely outside of the UK tax system. As such, it should have been a relatively easy tax to collect.


Clearly some people were aghast at stumping up £30,000 and as usual, savvy tax planners went to work to exploit the poor drafting. This resulted in the creation of artificial losses for capital gains tax purposes where those remittances came from Foreign Currency Bank Accounts (FCBA). Clearly, things have not worked out quite how HMRC expected, and as is commonplace these days, more legislation has been introduced to try and stop it.


To recap, the changes affect individuals who are liable to tax on their foreign income and gains, and who have elected to be taxed on the remittance basis. These individuals are liable to income tax on the sterling value of the amount remitted at the time of remittance. If the remittance takes the form of a transfer from a bank account in a foreign currency, they will simultaneously dispose of a corresponding part of that account and a capital gain or loss might arise as a consequence.


The existing capital gains tax rule in section 37 of the ‘Taxation of Chargeable Gains Act 1992’ removes any element of double tax charge in this situation. The income remitted is fully taxable (subject to any exemption which might apply), but a double charge to tax is avoided by this rule which excludes the income amount from the disposal proceeds used to calculate the capital gain or loss.


It was evident that the rule went beyond preventing a charge to capital gains tax and did not produce what HMRC deemed to be a fair outcome (for them at least).


Our savvy tax planners had worked out that where the remittance is all treated as income, the rule creates capital gains tax losses that are far in excess of any real loss incurred by the individual. Furthermore, where the remittance is partly income, the rule either creates an excessively large loss or reduces the taxable gain below the real level of gain.


Example

If an individual paid salary in a foreign currency (FC) of FC20, 000 into a FCBA at a time when FC1.00 = £0.50. For CGT purposes, the cost of acquiring the FCBA is £10,000.


In the next tax year he transfers the whole of this amount to the UK at a time when FC1.00 = £0.60, receiving a credit of £12,000 in his UK sterling bank account.


For income tax purposes the taxable amount is £12,000, this being the value of FC20, 000 at the time of remittance.


For CGT purposes the calculation is as follows:


Consideration for disposal of the FCBA £12,000


Less exclusion under section 37 TCGA £12,000


= Nil


Acquisition cost £10,000


Loss £10,000


The loss of course is not a true economic loss; nevertheless, it is still a loss all the same. This is due to the fact that although the TCGA rules adjust the consideration for the disposal of the FCBA, there is no requirement to remove the relevant income element from the allowable cost of the FCBA.


This of course went down like a lead balloon with HMRC!


HMRC off the ropes

Changes to the capital gains tax rules will be legislated as part of Finance Bill 2010. These changes prevent the creation of capital gains tax losses shown in the example above, and will be effective from 16 December 2009.


The legislation is intended to correct this anomaly and as such, where a remittance comprises wholly income, the change will eliminate the loss arising under the current rule. Where a remittance comprises only partly income, the loss attributable to the income element of the remittance will again be eliminated. In addition, the allowable cost attributable to the non-income element of the remittance will be adjusted to ensure it corresponds to the amount of that part of the remittance.


Where necessary, the allowable cost of the bank account will also be adjusted to ensure it corresponds to the amount remaining in the bank account after the remittance.


The result of these changes will be that a double tax charge will be avoided and no relief will be given where no actual loss has been incurred.


Where the disposal is a withdrawal of funds from an FCBA that comprises in whole or in part an amount that is liable to tax as remitted income, the first step is to identify the part of the withdrawal which is taxable as remitted income, and thereafter excluded from the consideration of the disposal under Section 37 TCGA. This is referred to as the ‘Section 37 amount’.


Thereafter, the calculation will depend on whether or not the remittance is wholly or partially the Section 37 amount.


The proposed legislation then goes into the usual myriad of ifs, buts, whether the calculation is being carried out at exactly 3.15pm on a Wednesday afternoon in February etc, all of which can be found on HMRC’s website. However, for those of you not looking for a cure from insomnia, here are some worked examples:


Example 1 - Remittance wholly income, whole account remitted (sterling depreciates)

Account contains foreign currency (FC) FC20,000, cost £10,000. FC 20,000 is remitted at a time when its value is £12,000. The entire remittance is chargeable to income tax.


There is no split between a section 37 amount and another amount because section 37 applies to the whole remittance.


Gross consideration £12,000


Less section 37 adjustment £12,000


Net consideration Nil


Allowable expenditure £10,000


Loss (£10,000)


Loss of £10,000 is not an allowable loss.


Example 2 - Remittance partly income, whole account remitted (sterling depreciates)

Account contains FC 20,000, cost £10,000. FC 20,000 is remitted at a time when its value is £12,000. FC 12,000 of the remittance, with a value of £7,200, is chargeable to income tax.


The section 37 amount is £7,200 (representing FC 12,000. The non-section 37 amount is £4,800 (representing FC 8,000).


Expenditure is allocated pro-rata:


To the section 37 amount, 12/20 x £10,000 = £6,000


To non-section 37 amount, 8/20 x £10,000 = £4,000


The section 37 amount computation:


Gross consideration £7,200


Less section 37 adjustment £7,200


Net consideration Nil


Expenditure £6,000


Loss (£6,000)


Loss of £6,000 is not an allowable loss.



Non-S37 amount computation:


Consideration £4,800


Allowable expenditure £4,000


Chargeable gain £800


The chargeable gain £800 is liable to CGT in the normal way.


Example 3 - Remittance wholly income, whole account remitted (sterling appreciates)

Account contains FC 30,000, cost £30,000. FC 30,000 is remitted when its value is £27,000. The entire remittance is chargeable to income tax.


There is no split between a section 37 amount and another amount because section 37 applies to the whole remittance.


Gross consideration £27,000


Less section 37 adjustment £27,000


Net consideration Nil


Expenditure £30,000


Loss (£30,000)


Loss of £30,000 is not an allowable loss.


Example 4 - Remittance partly income, whole account remitted (sterling appreciates)

Account contains FC30,000, cost £30,000. FC30,000 is remitted when its value is £27,000, of which FC 20,000, with a value of £18,000, is chargeable to income tax.


The section 37 amount is £18,000 (representing ‘X’ 20,000). Non-section 37 amount is £9,000 (representing FC 10,000).


Expenditure is allocated pro rata:


To the section 37 amount 20/30 x £30,000 = £20,000


To non-section 37 amount 10/30 x £30,000 = £10,000


The section 37 amount computation:


Gross consideration £18,000


Less section 37 adjustment £18,000


Net consideration Nil


Allocated expenditure £20,000


Loss (£20,000)



Loss of £20,000 is not an allowable loss.



Non-section 37 amount computation:


Consideration £ 9,000


Allowable expenditure £10,000


Loss (£ 1,000)


Loss of £1,000 is allowable in the normal way.



One has to wonder how much extra legislation will be added to this in years to come; however, you can always bank on somebody, somewhere already interpreting the legislation ‘differently’


Who was it that said tax doesn’t have to be taxing?