For over a century, the UK has attracted people seeking better fortunes — fleeing the horrors of wars, following the economic beckoning of the centre of the Empire or looking to start a business in a safe environment. Following the introduction of the Tier 1 Investor visa in 2008, the UK has also been the destination of choice for wealthy migrants. Together with the beneficial taxation of foreign domiciliaries, this route has offered unparalleled opportunities to enjoy the British way of life with little or no tax liability.
Perhaps the most important outcome of the Tier 1 Investor route has been the possibility to remain in the UK indefinitely after as little as two years and become a British citizen after six years. Unfortunately, with the doubtful value of the British passport in the post-Brexit reality, many are now forced to reconsider their plans — whether it was worth spending three quarters of the year in the UK to obtain the document that no longer promised any travel or work benefits in the rest of the EU. Those who can afford it, turn to other EU countries offering citizenship by investment — Cyprus, Malta, Portugal. The rest are hoping to enjoy the resurrected blue passports.
Although it is easy to focus on the negative side of leaving the EU, beside the lack of access to the European freedoms, it is difficult to come up with the direct disadvantages caused by Brexit for those HNW migrants who want to make the UK their home. In this month’s article, prepared with the help of our colleague Igor Persidskiy, I have considered the tax implications particular to Tier 1 Investor migrants and made a few planning suggestions.
Many of you of course know about the International Business Structuring Association (IBSA) of which IFS Consultants is the founding member. The IBSA has refrained to date from including any Brexit centric discussions at our meetings but we don’t believe we can ignore these realities any longer, which is why our next UK meeting is going to be devoted to planning our way forward in a very uncertain European community.
Click here for details of the discussion and to register your attendance.
With warm regards.
Tax planning considerations for Tier 1 HNW migrants in the UK(1)
The UK encourages foreign direct investments by granting high net worth individual investors and entrepreneurs the right to remain temporarily in its territory, with the associated tax benefits of the resident “non-dom” regime. Similar rights are extended to members of their immediate family. After a qualifying period, whose length generally depends on the amount invested in the British economy or growth of the British business, the individual and their kin can obtain indefinite leave to remain (ILR) in the UK. Later, they can even apply for settlement in the UK to become British citizens.
The Immigration Rules that regulate the process are complex and subject to frequent and unexpected changes. In the latest amendments to the rules published on 7 March 2019, the Home Office announced sweeping reforms of the Tier (Investor) category alongside with the launching of the Tier 1 (Innovator) category.
The Home Office’s explanatory notes are comprehensive; however, clients rarely submit applications themselves. Usually they engage a triad of advisors who are experts in the fields of UK immigration law, financial and tax planning. It is not a coincidence that tax consultants are right at the end of the list — experience has shown that despite moving to a high-tax country, seeking comprehensive tax advice often comes as an after-thought, when the investments are made, and the arrival dates are set. This article highlights the primary tax planning considerations relevant to non-domiciled investors and entrepreneurs at different stages of the UK immigration process for high-value migrants.
There are two routes that most high-value migrants can take — Tier 1 (Investor) and Tier 1 (Innovator). The latter replaced the old Entrepreneur category, although there is also a new Start-Up pathway, which is unlikely to be pursued by anyone without pre-existing strong ties with the UK.
The Tier 1 (Investor) category is for high-net-worth individuals who can afford to invest at least £2 million in the UK. The investor does not need a job offer in the UK nor is he required to prove a good command of the English language although the latter will be required when applications for the ILR and settlement are made. The investment funds must be their own savings, which the investor has held for at least 2 years. The holding period has gone up from 90 days, which had been the condition under the old regime. Investments in UK Government bonds no longer meet the investment criteria and a few new conditions applying to investments into active and trading UK registered companies were imposed. Also, mandatory due diligence and “Know Your Client” enquiries should be carried out by a UK bank in respect of sources of wealth of all Tier 1 (Investor) applications after 29 March 2019. Up until a few years ago, a substantial number of investors making the application had been wives of wealthy foreigners; the latter, together with the couple’s children being her dependants. Under the old rules, the dependants — particularly the husband — were free to visit the UK as they please without any commitments as to the duration of visits. Currently, in order for dependants to meet the UK settlement requirements, they must spend the same length of time as the main applicant in the country, which has alienated a significant number of applicants.
Tier 1 (Innovator) is for non-European migrants who want to start a genuine innovative business in the UK by setting up and being actively involved in the running of, a UK business or businesses. Broadly, the applicant needs to invest £50,000 in a UK company and comply with a host of other requirements, including excellent command of English language and having enough money to support themselves in the UK. The new Innovator category requires the applicant to have a detailed business plan, which is subject to reviewed by a UK endorsing body, which includes British universities and business accelerators and whose list is published online.3.. The endorsing body will continue scrutinising the business to ensure that it is sufficiently innovative. With the gradual tightening of the rules allowing foreign students to seek work in the UK after finishing their studies, the Innovator visa is likely to remain as attractive as the now-extinct Entrepreneur, although it’s yet to be seen, how many applicants will take on the innovation challenge.
Both routes allow the migrant to apply for the ILR after a continuous residence period in the UK of five years. This can be reduced to three years for the investor who invests £5 million or the innovators who makes extraordinary progress with developing their business. A further reduction to two years is available to the investor who invests £10 million. Interestingly, the Rules only allow the main applicant to reduce the length of time before they apply for the ILR and exclude their dependants, who need to wait the whole five-year period before submitting the application. There are also strict requirements regarding the number of days that the migrant can spend outside the UK in any 12-month period. Failing to meet them will result in the inability to apply for the ILR and settlement.
Statutory Residence Test
Taxation in the UK primarily depends on a person’s residence status. Since April 2013, residence has been determined under the statutory residence test (SRT). The SRT is explained in brochure RDR3, which also contains useful practical examples, which are worth reviewing by anyone attempting to ascertain their residence situation. The SRT establishes residence status according to the number of days (counting midnights only) that a person spends in the UK during the tax year that runs between 6 April and 5 April of the following calendar year. Residents generally pay tax on their worldwide income and gains, whilst non-residents are generally only taxed on income from sources in the UK. However, individuals resident but not domiciled in the UK can elect to be taxed on the remittance basis where non-UK income and gains are only liable to tax when directly or indirectly remitted (brought) into the UK.
On its own, an individual’s immigration status or current nationality has no bearing on their UK tax liability whatsoever. The migrant should be treated as a regular typically non-domiciled taxpayer who requires the usual pre- and post-arrival tax planning measures. Nevertheless, tax advice should take into account two considerations that pertain to the granting of the Tier 1 Investor or Innovator status.
Firstly, it’s safe to assume that the end goal of most migrants and their families is to settle in the UK. To achieve, this they must spend at least 185 days in any 12-month period in the UK on the rolling basis starting from the day of arrival in the UK under the newly issued leave to enter. This immediately denies the benefit of the UK-residence planning techniques based on the extended periods of absences from the UK. As a result, most tax planning measures should be undertaken before the investor’s arrival in the UK during Stage one as explained below while they are non-UK resident.
Secondly, the Rules require the migrants to physically bring the investment funds into the UK. Unless these are derived from clean capital, accumulated during the period of non-UK residence, the investor or the entrepreneur will suffer the consequences of making a remittance of foreign income or gains, which will be taxed at the appropriate rates. Further remittances might occur where the migrant pays for services rendered to them in the UK, such as various professional fees. Taxation of remittances can be avoided under the business investment relief as described below; however, the expense of planning for the minimisation of tax burden might nullify the tax benefits it aims to achieve.
The Tier 1 (Investor) process
It is possible to split the Tier 1 (Investor) immigration process in three stages. Stage one is preparatory during which the migrant collects documents and submits the visa application. As Stage two, the investor arrives in the UK after receiving leave to enter the country. Stage three involves the migrant making the investment, which will permit them to remain in the UK and to apply for the extension of their stay until they can apply for the ILR and later for citizenship. There might be a period of several months between Stages one and two during which the investor stays in their home country waiting for the outcome of the application. The migrant typically has up to three months from the day of their arrival in the UK to fulfil the requirements of Stage three. The investor should plan to remain non-UK resident at Stage one and even partly through Stage two; and during this period of non-residence he should aim to perform the larger share of his tax planning strategy.
During Stage one the applicant prepares and submits documentary evidence of their ability to invest at least £2 million in the British economy. This amount must be in cash and kept in a regulated financial institution (typically a bank) in the UK or overseas. Sometimes instead of clear funds the future migrant has an asset portfolio that includes capital assets and undistributed income, but the Home Office will not take these into consideration. Funds held by companies or trusts are equally excluded. The investor should convert these assets into cash: any gains accumulated in securities and properties should be crystallised by selling them; where there is a right to receive income — dividends, interest, salary, royalties, business profits — this right should be exercised and the proceeds received into a bank account.
It might seem reasonable only to create sufficient cash to fund the £2 million investment. In fact, when converting assets into cash or receiving income, the investor might be subject to a double tax liability, determined by their current tax residence and the source of funds, although this might be reduced under double tax agreements or domestic tax exemptions. However, any non-UK gain that is crystallised and non-UK income that the investor receives after they become UK resident will be liable to UK’s fairly high taxes unless the taxpayer claims the remittance basis of taxation and does not bring the funds to the UK. As a result, the migrant might face the situation where they cannot pay for his life in the UK without incurring a significant tax cost.
The following discussion also largely applies to Tier 1 Innovators except that the funds that they are expected to invest are significantly lower.
Conversely, income and gains received before becoming resident form so-called “clean capital”. If the migrant loans clean capital to someone, the loan principal will always remain clean capital when repaid to the investor (but note the position with regard to loan interest below). Gifts received from related and third parties are also clean capital provided they are not considered to be a form of hidden income or gains distribution. In practice, some UK-resident investors live off the gifts made to them from their non-UK resident spouses, who earn income and gains not liable to UK tax. Clean capital will not be taxed in the UK, whether brought in its territory or not. However, in the case of an investor’s death, clean capital kept in a UK bank account will form their UK-situs asset liable to 40% inheritance tax. Therefore, it might be prudent to bring to the UK only the amounts necessary to fund current expenses.
Clean capital should be credited to a separate bank account and never mixed with non-UK income and gains that might be derived after assuming UK residence. In fact, considering that income and gains are taxed differently in the UK, they should also be kept in separate bank accounts. Moreover, if clean capital generates income — say it has been loaned and the migrant receives interest — this should be paid to the income bank account and not into the clean capital account to avoid tainting it. Counterintuitively, the same cannot be done with gains generated with the use of clean capital. For example, if clean capital is used to buy shares, any gain realised on their future disposal will always form part of the proceeds and it cannot be segregated from clean capital by being paid to a separate bank account.
In a situation where clean capital needs to be used to invest in capital assets, one can think of a few planning options. First, the investment may consist of assets that will not generate gain on disposal, in which case the purpose of the investment would typically be earning income — coupon or dividend — that can be easily segregated in a separate offshore bank account. Alternatively, clean capital can be offered to a bank as collateral to secure a lombard loan used to acquire the assets. Finally, the investor might just buy the bullet and come to terms with paying (typically) 20% capital gains tax (CGT) on the amount of gain brought in the UK as well as professional fees incurred in connection with determining the composition of the mixed fund. Considering that the top 28% rate of CGT on disposal of securities and financial instruments is still significantly lower than the top 45% income tax rate, the very last option may not be the worst, especially seeing that once tax is paid, the taxpayer needs not to worry about future remittances of gains in the UK and can fully enjoy the proceeds.
If the investor runs out of clean capital, they might have no choice but to bring foreign income and gains to the UK and face the prospect of the maximum 45% taxation. They can borrow from an overseas lender provided that the loan is made on commercial terms and the interest is serviced from UK-source income or gains.
There is no requirement or in fact possibility to declare clean capital to the UK tax authorities (HMRC) upon becoming UK resident. Equally, there is no requirement to report the use of clean capital on UK’s tax returns. However, the taxpayer should keep documents that reflect dates and methods of creation of non-UK income and gains to prove that they were received while they were non-UK resident and thus form their clean capital. Such documents include bank statements, sale and purchase agreements, loan agreements. They might be necessary in case of a future dispute with HMRC.
The Rules also allow the investor to rely on money that is owned either jointly with or solely by his close relative (spouse or partner). If the close relative is a lower rate taxpayer then, subject to the rules of their residence jurisdiction, the investor can gift the assets to the relative, which she can dispose of subject to the payment of a smaller amount of tax.
Provided the requirements of Stage one are satisfied, the investor will receive the leave to enter the UK as a Tier 1 (Investor). The arrival to the UK should be timed with regards to the residence planning considerations as discussed next. At the same time the investor should not delay their arrival in order to satisfy the continuous residence requirement required to apply for the ILR at the end of his stay.
“Connecting factors” of tax residence
Under the SRT, UK residence may be acquired automatically if the individual spends over 182 days in the UK in a tax year, has a home in the UK without having a home abroad or works in the UK on a full-time basis. If the migrant is not UK resident automatically, they might be resident under the sufficient ties test. This looks at the connections that the individual has with the UK in any tax year. The relevant factors include having a family — spouse or minor children — resident in the UK; availability of UK accommodation (rented or owned), working in the UK for over 40 days during the tax year (continuously or intermittently; for a UK or a non-UK employer or a in a self-employed capacity); and length of visits to the UK in the preceding tax years. The more UK ties the investor has in a tax year — the smaller number of days they can spend in the UK during that period without becoming UK tax resident. It is also possible to be automatically non-UK resident under a separate set of circumstances, for example, if one works abroad on full-time basis and they spend under 91 days in the UK with a limited number of UK work days.
Residence is determined for the entire tax year starting from 6th April regardless of the taxpayer’s relocation date. However, there is a possibility to split the tax year and only begin UK tax residence from the day of arrival in the UK. This is typically achieved by starting to have a home in the UK or by commencing full-time employment in the country.
Experience shows that in the tax year of arrival in the UK, most migrants have two ties: they acquire a home in the UK and their families become UK resident. The SRT allows them to stay in the UK for up to 120 days without becoming resident here provided they are not UK resident automatically. However, there are plenty of pitfalls and before determining their residence situation, the migrant should avoid buying accommodation in the UK or entering into long-term leases, moving family and sending children to school and spending over 90 days in the UK in any tax period. Additional planning opportunities might be offered by the tie-breaker clause in the residence article of the double taxation treaty that the UK might have with migrant’s residence State, although complications might arise that stem from the mismatch between the tax years’ periods. This typically arises if the migrant is coming from a country where a tax period is the same as a calendar year, which may conflict with the UK’s 6th April-to-5th April tax year. HMRC provides an interesting explanation of this rule in part INTM154040 of its International Manual (http://tinyurl.com/INTM154040)
Remittance rules and Business Investment relief
Under Stage three, the investor must invest £2 million by way of share capital or loan capital in active and trading companies that are registered in the UK. Similar rules apply to the innovator although the amount is £200,000.
Provided that the investment comprises clean capital accumulated during Stage one, there will be no UK tax consequences on bringing the funds in the UK. In the opposite scenario, where the investments consist of foreign untaxed income and gains made after the date of first becoming UK tax resident, these will constitute remittances, on which the migrant will be taxed at their applicable income tax or CGT rate. HMRC explain the meaning of remittance in part RDRM33140 of its Residence, Domicile and Remittance Basis Manual (http://tinyurl.com/RDRM33140).
If they satisfy terms of the business investment relief (http://bit.ly/1wq9Wj6) the invested amounts shall not be treated as remittances and shall not be liable to UK tax. There are additional income tax and capital gains tax reliefs such as EIS, SEIS and VCT intended to encourage investment in the shares of unquoted trading companies. Finally, if the investor is appointed director or taken on as an employee of the company in which he has invested, he might be able to receive a substantial reduction on future disposal of its shares under the terms of the ‘Entrepreneurs’ Relief’ where the personal tax rate may be 10% on gains made.
Thus, pre-arrival tax planning for a Tier 1 migrant is a complex matter that should be done prior to finalising immigration plans. Future migrants should consider their medium to long-term planning strategy, which includes residence planning, creation of clean capital and acquisition of assets in the UK.
Law as stated on 16 April 2019
Law as stated on 16 April 2019