Tax liability in connection with a gift transaction revolves primarily around tax residence and domicile of the persons making and receiving the gift. Readers are reminded that UK tax residence is determined on the basis of the Statutory Residence Test (SRT). The test considers the number of days (midnights) a person spends in the UK during a tax year (6 April-5 April) together with a number of specific factors. These include having a home in the UK, family, work in the UK, as well as the length of time that the person spends in the UK in the previous tax years. Contrary to the popular belief, one can become UK resident even if they spend less than six months in the UK. HMRC have helpfully summarized the SRT in the brochure RDR3 (https://bit.ly/1NwfHop).

Domicile is what determines how closely a person is connected with a particular country. It is a private law concept which under UK law determines availability of certain tax reliefs such as the remittance basis of taxation. People are born with domiciles of origin which can later be replaced by domiciles of dependence or choice. British citizenship is not necessarily an indicator of the domicile. Although, more often than not “British” people born in the UK of “British” parents have UK domicile. Additionally, a person who has spent substantially long periods of time in the UK may acquire deemed domicile which from the tax point of view for mostintentsand purposes is equivalent to the more traditional domicile. To learn more about the concept, readers are invited to consult HRMC’s Chapter 5 of brochure RDR1 (https://bit.ly/1OSQCcw).

Moving from the simple to the complex, it is better to begin considering the UK tax liability of the gift recipients who in most circumstances are not liable to any tax whatsoever. The absence of tax liability does not depend on whether the gift is received from a relative, an unrelated person or from a corporation.

However, at the same time, this is only true provided that the gift is a bona fidegratuitous transfer of the object formerly belonging to the donor. Conversely (and logically), a donee who structured receiving their own income through the gift arrangement with the donor’s help will be liable to tax on the received amount under the usual tax rules. To illustrate these ideas, say a UK tax resident who is receiving an apartment located in or outside the UK from their parents or an unrelated well-wisher, is not liable to tax nor is he liable to report the gift in his UK tax return. At the same time, say if the same person owns a foreign trading company whose shares he transfers to someone who is resident outside the UK, who then uses the dividends from the company to make regular cash gifts to the former, he is likely to have to declare the gifts to HMRC.

Receiving a gift from a corporation is less frequent but not impossible. In the author’s experience, typically a non-UK resident parent with an offshore company would order it to pay for property to be acquired by his children, resident in the UK. The company could also finance the acquisition of other goods and services. It would be less rare for the company’s shareholder to receive distributions from the company in the form of a gift. Provided that the child in this example is neither a director (real or shadow) nor company’s shareholder, the receipt of the funds will not be considered income liable to tax or reporting. Conversely, if the donee in any way controls the company or provides any services for its benefit, the funds will be considered as a taxable distribution interpreted either as dividends, salary or director’s fees.

As mentioned on a few occasions, because bone fidegifts are not considered income or chargeable gains, they are not liable to be reported in the person’s annual self-assessment report. However, a significant gift in the absence of declared income or gains may cause HMRC to inquire into its origin. Therefore, there is an argument in favour of notifying them of the donation in the “white space” in the person’s tax return. Also, significant gifts should be evidenced by deeds of gift. These might be requested by solicitors or banks that might inquire into the source of funds.

The scope of the donor’s tax liability is significantly broader. Beside his residence and domicile, one should consider the object of the gift and its location. Taxes that may arise when making the gift are capital gains tax and inheritance tax. It is impossible to cover all different permutations and the following examples cover the most frequently arising situations.

Most commonly, parents gift money to their children. Practically speaking, in most circumstances, non-UK resident parents can gift money to their UK-resident children without any UK tax consequences, provided that the transfer is made between bank accounts opened outside the UK. One notable exemption is where the parents are domiciled or deemed domiciled in the UK in which case the gift might be considered a potentially exempt transfer (PET).

The effect of the gift being considered a PET is that if the person making the gift dies within 7 years, its amount (or its market value in case of a non-monetary gift) will be included in their estate and, possibly, liable to 40% inheritance tax. If the parents in the above example transfer the funds from a UK bank account, it will be considered a gift of the UK situated assets which will be treated as a PET with the above consequences. Usually when the funds are kept in the UK, the easiest way to avoid the effect of the PET is to transfer them to the non-UK parents’ bank account prior to gifting them to their children, thus turning the subject of the gift to a non-UK asset.

When gifting non-cash assets, it is necessary to consider CGT consequences. From the donor’s point of view, a gift is a disposal which may be treated in the same way as a sale. When the gift is between connected persons (for example, family members), the disposal is considered to be effected at the assets’ current market value. Put simply, the difference between the current market value on the disposal and the cost of the acquisition forms what may be liable to tax. Normally, non-UK residents only incur liability when gifting residential real estate located in the UK (also non-residential real estate starting from April 2019) and are not liable to tax when gifting other assets. At the same time, UK residents making gifts are liable to UK CGT regardless of the location of the gift. However, if the donor is not domiciled in the UK and the assets are located outside the UK, they may claim the remittance basis of taxation in which case it is possible to avoid liability when making such a gift. Of course, tax may arise if the recipient later brings the gift to the UK which might constitute a remittance. However, a detailed discussion of these rules falls outside the scope of this article.

It is also necessary to consider IHT consequences when gifting property other than cash. A gift of UK real estate will always constitute a PET since naturally it cannot be moved outside the country prior to making the gift. The same applies to other UK situated assets such as shares in UK companies. Unless specific planning steps are taken in advance, for example taking out inheritance tax insurance, IHT liability may arise to donors who are resident in and outside the UK. Conversely, foreign real estate as well as other non-UK situated assets, for example shares of a non-UK registered company or family diamonds which were removed from the country before the transfer, most likely will not trigger any IHT consequences if their non-domiciled donor dies.

There are a number of exemptions that minimize IHT liability. For example, gifts between spouses are not considered a PET (but transfers between spouses one of whom is not domiciled in the UK may be) as well as taper relief which reduces the amount of IHT in proportion to the time that passes between the gift and death. At the same time, it is necessary to consider various anti-avoidance rules. These include gifts with reservation of benefit (GROB), which apply in a situation where the transferor continues to benefit from the gift after having transferred it to the transferee, for example, continuing living in the gifted apartment. In this situation, unless the donor moves out of the property or starts paying market rate to the recipient, the 7-year term will not start running.

Liability to UK taxes when making gifts which depends on UK residence and domicile statuses as well as on whether the person is taxed on the remittance or arising basis can be summarised as a table:

In conclusion, let’s consider a few additional examples.

Non-UK resident parents who are resident and domiciled outside the UK normally can gift to their UK resident child without any UK tax consequences. However, if they gift property situated in the UK, they should consider possible non-resident CGT liability as well as IHT liability if they die within 7 years from making the gift or if they continue using the property. Although not covered in this article, other possible taxes may include stamp duty land tax (SDLT), if there is mortgage secured over the property, and pre-owned asset tax (POAT) if the parents become UK resident in the future and start using the apartment.

A UK-resident non-UK domiciled child will normally incur no IHT consequences when gifting his non-UK resident parents his foreign real estate. However, if during the ownership period the cost of the property has appreciated (in £) he may face CGT liability, which can normally be avoided only subject to claiming the remittance basis of tax. Also, if in the near future the parents sell the property that they had received and gift the proceeds to the child from their non UK bank account they will avoid UK liability; however, the recipient of the funds may incur CGT liability as the original gain would be considered remitted to the UK unless he proves that the gift is a bona fidegratuitous transaction.

The above article is reprinted with the publisher’s, Wolters Kluwer, permission from Global Tax Weekly, and will appear in issue no.312 dated 1st November 2018.

I look forward to welcoming you to the annual IBSA conference next week on 1 November at the Berkeley Hotel, Wilton Place, Knightsbridge, London, SW1X 7RL. The conference, entitled ‘The Growth of a Cosipod‘, has been sponsored by Close Brothers Asset Management and IFS Consultants. As a sponsor, readers of our newsletters can register here and enjoy the benefits of the IBSA member rate of £450 plus VAT for what I believe will be one of the most stimulating conferences. Simply apply the discount code IFS18 when purchasing your non-member ticket.

I look forward to seeing you there.

With warm regards.

Dmitry Zapol
ADIT(Affiliate) LL.M(Tax) LL.B(Hons)
Partner, IFS Consultants, London

The post October 2018 (171) – TAXATION OF GIFTS UNDER UK LAW appeared first on IFS Consultants Ltd.

What is Substance?

The Netherlands has taken a lead in attempting to define whether substance exists within any entity in an international business structure. The Netherlands has always been the jurisdiction where holding companies, finance companies and licensing companies have been created to minimise the tax burden of international corporations, so it is no surprise that there is a greater volume of foreign direct investments routed through the Netherlands than in any other country, even the US. The Dutch government has been trying to deflect its perception as a tax haven for more than 20 years, but has now brought in legislation which it hopes will discourage the use of Dutch companies in artificial situations.

Let me use a simple example of a Dutch holding company owning a foreign subsidiary company, and itself being owned by a foreign parent company. The new substance requirements demand that both subsidiary and parent company have office premises and an annual salary cost of employees of €100,000. In the absence of meeting these two requirements, dividends from the foreign subsidiary company will not be exempt under the holding company participation exemption rules, and dividends paid by the Dutch company to its foreign parent company will be subject to withholding tax and not be exempt.

But is it necessary for a foreign parent company with just one asset, the Dutch holding company, to employ staff at a cost of €100,000 per annum to demonstrate that it has the requisite substance to be able to take decisions relating to its one asset. Or a finance company with one loan? Or a licencing company with one licence agreement? And why aren’t the same substance rules applied to the Dutch holding company itself with just one asset, the foreign subsidiary company? The new rules don’t apply to domestic companies which seems strange if one is trying to define what substance is!

The Multilateral Instrument (MLI)

The BEPS initiative has fifteen action points to combat tax avoidance, which I have described in detail in previous newsletters. One of the action points, and a major target of the OECD, is to prevent the abuse of double tax treaties to create double non-taxation, or minimise withholding and other tax impositions if this does not accord with the intentions of the bilateral parties to the double tax treaty. The recommendation in BEPS has now been embodied in the so-called Multilateral Instrument (MLI) which is intended, at a stroke, to implement the BEPS recommendations without bilateral parties having to re-negotiate each and every of the 2,500 plus double tax treaties that exist.

68 countries signed the MLI on 7 June 2017, and a further 10 have since signed it so that it is in now in force and will be applicable to withholding taxes from 1 January 2019, to corporation tax in the UK from 1 April 2019 and to income tax from 6 April 2019. The problem is that when adopting the MLI, countries are entitled to elect to amend or exclude certain provisions, and thus it may be that where the adoption of the MLI is not identical between two countries, one would have to revert to the original double tax treaty to clarify taxing rights and rates of taxes. The international tax consultant will have his or her work cut out to identify whether the MLI is relevant or not.

Besides the uncertainty of whether a particular double tax treaty is covered by the MLI, my main objection is that although Articles 16 and 17 discuss the mutual agreement procedures where dispute resolution cases should be brought before either Competent Authority, and the principle of reciprocal adjustments should be accepted, there is no binding requirement of the bilateral party to agree on disputes, nor is there a mandatory arbitration clause. Undoubtedly, even if the MLI is applicable to, for example, the definition of a permanent establishment, where the two countries cannot agree on relevant adjustments to tax assessments that may have been made, the rights of the tax payer cannot be automatically enforced through the MLI.

The Principal Purpose Test (PPT)

Article 6 of the MLI states that there should be a preamble to all treaties to include as its intention ‘to eliminate double taxation with respect to the taxes covered by the agreement without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance (including through treaty shopping arrangements aimed at obtaining reliefs provided in this agreement for the indirect benefit of residents of third jurisdictions)’.

Article 7 then introduces the ‘principal purpose test’, which states that the treaty is inapplicable if obtaining the relevant treaty benefit was one of the principal purposes of an arrangement or transaction, unless in accordance with the object and purpose of the treaty.

So, besides the uncertainty around substance, we now have the uncertainty around the applicability of the MLI to double tax treaties, and indeed the principal purpose test only requires there to be a tax objective (even if the structure otherwise is entered into fully for commercial reasons) for the treaty to be inapplicable. Such subjectivity (the principal purpose test and substance) is undesirable and their interpretation may only be understood in future once court cases have been adjudicated.

So BREXIT is not the only issue creating considerable uncertainty in the current business climate. The clampdown on tax avoidance must be welcomed and I believe is fully accepted by most reputable international tax consultants. At the same time, countries are still vying with each other to provide tax incentives where commercial activities are undertaken for the benefit of the economy (which of course requires ‘substance’) and are designed to encourage employment of appropriate personnel. Thus, the patent box regimes in the UK, Ireland, Netherlands, Luxembourg and many other countries introduce tax rates from 2.5% in Cyprus to 5.2% in Luxembourg to 6.25% in Ireland and 10% in the UK.

Let’s suppose a client wants to create a research and development company and hopes to obtain minimum withholding taxes incurred on future royalty income from say Brazil. Brazil doesn’t have a double tax treaty with the UK or Ireland but does have one with Luxembourg which affords benefits in respect of royalty income derived from a Brazilian company. So the client sets up an R & D operation in Luxembourg which can benefit from the 5.2% corporate tax rate and no withholding tax on distributions. Despite being a full valid entity with substance which meets the intentions of the Luxembourg government to encourage R & D operations in the country, there may indeed be no argument that one of the principal purposes of setting up such an operation is to achieve relevant treaty benefits with Brazil.

I will be examining some of these issues at the IBSA conference on 1 November to be held at The Berkeley hotel, Knightsbridge, London, with several colleagues where we review a fictitious case study of my creation, and consider the issues whereby an entrepreneurial project can develop into an international business. Besides considering the international tax structure with colleagues from the US, Netherlands, Luxembourg, Switzerland, Russia and the UK, I will discuss the issue of BEPS, the MLI and fairness in taxation with Philip Baker QC and Filippo Noseda. The conference will also consider non-tax issues such as how to protect the intellectual property created by the entrepreneur, and how to finance the development of the business using crypto currency and other new concepts of finance. To reward my long suffering readers of my newsletters, you can register for the conference at the discounted rate of £450 (instead of £750) by applying the code IFS18.

As for BREXIT, I am still hopeful for a fudged agreement on the lines of a Canada + arrangement of free trade, but allowing free movement labour for a transitional say ten year period to prevent a hard border requirement in Ireland. In other words, the old political trick of kicking into touch anything that cannot currently be resolved and leaving the problem with a future government. We shall see!

With kind regards

Roy Saunders

The post September 2018 (170) – SUBSTANCE AND THE MLI appeared first on IFS Consultants Ltd.

Firstly, I want to thank my cousin Kalypso Nicolaidis who is Professor of International Relations at the University of Oxford, and who has written a paper entitled ‘Brexit and the Compatibility Paradigm’ which can be reviewed in detail on the IBSA website (link). She has explained in detail the concept of ‘Mutual Recognition’ which forms the basis of this article.

We have heard about Michel Barnier repeatedly referring to the integrity of the single market which would be threatened if the UK enters into a free trade agreement with the EU. Generally, a free trade area, such as EFTA, is made up of countries (Iceland, Liechtenstein, Norway and Switzerland) in different locations without a common external border surrounding the member states. The EU is different in this respect, in that it has created a common external border (albeit that non-Schengen countries have border controls), and the single market therefore allows member states to disregard the ‘rules of origin’ of goods and allows those goods to pass freely between member states. The EU considers that if the UK is outside of the single market but within a customs union, the EU would have to rely on the UK applying the relevant customs tariffs and accounting to the EU for these tariffs. Would this indeed affect the integrity of the single market?

Let’s look at an example. Assuming goods arrive from Africa to say Spain and thence through France to Germany. Spain imposes the relevant EU/African tariff and allows those goods to travel to their destination. The EU relies on Spain to impose the appropriate tariff and there is no central body supervising the accountability of Spain to impose the correct tariff. The ultimate regulatory authority is the European Court of Justice, and this will only become involved in cases of disputes. In other words, the EU as a body recognises the rights of individual member states to apply the relevant tariffs for the purposes of the customs union, allowing free movement therefore of goods throughout the single market.

The issue is therefore why cannot the EU apply this mutual recognition procedure to the UK in respect of both tariffs and customs regulations if it is no longer part of the European Union? On the basis that there is a free trade agreement between the EU and the UK, which apparently all sides wish to have, the stumbling block appears to be only in respect of goods that arrive in the UK and are destined for the EU. It is in respect of these goods that the UK needs to impose the appropriate EU tariff and account to the EU for this tariff. Cannot the UK be trusted to do so? After all, it has been trusted to do so for the last forty years under the mutual recognition procedure and to apply different regulations according to the nature of goods, eg toys have a different regulation to agricultural products. These EU regulations only come into conflict with the mutual recognition procedure if the countries don’t apply the appropriate tariffs or provide the relevant certification, and these conflicts should be resolved by EU regulators and ultimately the European Court of Justice. The UK should therefore accept in the future that conflicts in respect of goods and services destined for EU countries should indeed by resolved by the ECJ.

Brexiteers should recognise that we have actually created many of the EU regulations that have been adopted by EU member states, such as in the areas of financial services and medicine. So, having created these regulations and procedures, why would the UK be unhappy to fall within the jurisdiction of the ECJ and regulatory authorities in respect of these goods and services? In other words, we are already one of the most EU compatible countries, so we should adopt compatibility rather than divergence when discussing pragmatic solutions with the EU.

As regards free movement of labour, again it seems in the interests of both the UK and the EU to accept migration of individuals throughout the EU and its partnership with the UK. This is provided that there is some degree of control that migrants should not be allowed to settle in a country merely to take advantage of the more beneficial social welfare in that country. This goes for the UK but also for Germany, Italy, Denmark and other EU countries that have experienced problems in assimilating unemployed migrants who are there merely to benefit from their social systems.

One of the reasons for voting ‘Remain’ in the June 2016 referendum was not to restrict immigration between EU countries but to attempt to impose some aspect of realism for EU countries haemorrhaging funds to support migrants without any benefit to the relevant economy. The partnership model with the EU may ultimately achieve this objective, but the UK should certainly accept free movement of labour if employment exists.

Will there be a deal before the EU council of ministers meet in October? It seems unlikely, although there are certainly more positive signs coming out of discussions between Dominic Raab and Michel Barnier. What is more likely is that the no-deal threats will continue until early March next year when, hey presto, a deal will be reached. And what will be the likely outcome of that deal? Probably a free trade agreement under the control of (ultimately) the ECJ with the continuation of the mutual recognition procedures which have been in place for the last forty years. However, because the deal will be a last minute one, the various regulations, certifications and other legislative agreements that need to be put in place will come within a so-called transition period which may not have a finite term. This seems to have been the position with regard to the Swiss and Norwegian agreement with the EU where there still exists a degree of inconclusiveness in certain areas.

So who will be the winners and who the losers? The ‘Remainers’ may feel that they have succeeded in maintaining the status quo, whilst the ‘Brexiteers’ would have claimed victory that we are now a Sovereign State again outside of the control of the EU (which will not, in fact, be the case if the above trading scenario is adopted). And the general public? They will wonder what the last two to three years has been all about, and count the cost of Brexit as the ultimate political blunder of this generation.

With kind regards

Roy Saunders

The post September 2018 (169) – BREXIT – THE END RESULT! appeared first on IFS Consultants Ltd.

I was thinking over the summer months of the comparison between the European Union and the United States of America. Citizens of the US refer to Washington as Uncle Sam. I can’t see any citizens of the European Union refer to Brussels as Uncle Fritz or Auntie Helga! So why is this?

Suppose Kentucky has a dire fiscal issue, California a migration problem from Mexico, New York an underfunding of the NYPD police force, or Florida a need to bolster pension funding – their saviour is the federal government in Washington, otherwise known as Uncle Sam.

Contrast that with problems that Cyprus, Greece, Italy and the UK (to name but a few) have experienced in the last decade. I could even include Germany and France in this list. What has happened when they have experienced issues which are damaging to their economic or social fabric?

Cyprus appealed to the EC in 2013 for a bail out of their banking problems, but was punished by the EU and refused a bail out by the powers that be, with two banks going into bankruptcy/administration. Greece did get its required bail out after months of riots and has now endured 6 years of austerity in attempting to fall within punishing fiscal policies of the EU whose arbitrary effects are economically questionable. Italy now has a very severe migrant issue (as has Germany) and again we have far right politics forging dissention and division within the country. And we have Brexit. How has the EU reacted to the wishes of the British public (albeit through a relatively slender majority in June 2016)?

Punishment is the word that comes to mind, and indeed has been voiced by those within the EU committed to maintaining the Brussels hierarchy in absolute power. And we all know what happens to dictators with absolute power. Too strong? Writing this before today’s meeting between Dominic Raab and Michel Barnier, there is currently an impasse leading up to the October meeting of European Ministers. I believe the way Brussels has treated the UK desire for autonomy in a dictatorial manner which has hardened the desire of Brexiteers to leave the EU with what has been expressed as a No-deal arrangement, and which has swayed the hesitant Remainer expressed in my June 2016 article to definitively decide that leaving the EU is our only option, albeit wishing for a deal which is satisfactory to all sides.

That deal should be relatively easy to negotiate, with goodwill on all sides. Why should there be what can only be effectively a trade war (with tariffs imposed between the UK and the EU), when the original concept of the EU was a common market to improve the economies of all EU countries. That improvement is still relevant, perhaps even more so to EU countries who export more to the UK than the other way around. And at a stroke, this solves the Irish border issue.

All countries should take responsibility for their own borders, but should agree on free movement of labour (labour implying actual employment rather than migrating to engineer social welfare benefits). Individual sectors of the economy, being agriculture, financial services, travel or whatever should have individually agreed compacts and if necessary should fall within the remit of the European Court of Justice if the UK has a negotiated agreement with the EU. And there should be monetary payments from the UK to the EU for shared platforms, such as anti-money laundering, terrorism and tax evasion measures adopted by the EU countries generally. How hard can this be?

It can be hard if the word punishment is used in the thinking of the European Commission. The UK voted to enter the Common Market, at that time, to ensure trade stability and prosperity that would discourage any more wars in Europe. That means we didn’t want any member State to punish another with force. It may well be that the European Union loses more member States if they allow the UK to leave the EU without punitive measures, but that freedom is what we all signed up to. If Cyprus, Greece or Italy wants to leave a Union which no longer serves their purpose, then the Union is not what they want and should recognise this.

This is why I voted to Remain, so that we could influence the European Commission in a positive way to adapt to sovereign requirements. It is time for the European Commission to recognise the need for sovereign rule and forget the dream of a United States of Europe, made up of countries with different cultures, different languages, different social requirements, and different economic interests.

With kind regards

Roy Saunders

The post September 2018 (168) – BREXIT appeared first on IFS Consultants Ltd.