Tax Planning for Expatriates
Figures from the Office of National Statistics show that record numbers of people are leaving Britain every year. Over the last 10 years, 1.6 million Britons have emigrated. Of those who left in 2006, nearly one in three went to live in Australia or New Zealand and a quarter went to Spain and France. There has been substantial immigration over the same period.
Our experience at 35 Finance is particularly with Spain, where we have decided to focus our attention, but we do have experience of advising British expatriates living in a number of other countries, including France, Cyprus, USA, and Hong Kong. Obviously, the tax regime differs in each country, but there are some general principles that can be provided, with some specific examples from Spain and France.
Things to consider when moving abroad include the timing of becoming non-resident for tax purposes in the UK. It may be possible to take a tax holiday for a few months while establishing residence in the new country. If it looks likely that an offshore trust will be advisable, then this should be established before becoming resident in the new country.
If staying abroad for at least five years, it may be possible to sell UK property without incurring UK Capital Gains Tax. The inheritance tax laws in the country of destination will almost certainly be different from the UK, and estate planning will need to take into account the UK's tax laws as well as the new country's laws on inheritance. This will almost certainly mean making a Will in the new country.
Mortgages may be tax-deductible in the country of destination, like here for rental income. Having a mortgage on the house may reduce its value for local succession taxes.
There may be Wealth tax in the country of destination, and it is important to understand the local income taxes, and any double taxation agreement with the UK. In day-to-day living terms, expatriates may find the tax rates higher in Spain than in the UK, for example. The starting rate of income tax is 24%, rising to 43%. Unlike the UK, there are two other tax bands in between.
For people retiring abroad, it is important to consider the payment of pensions, and the way these are taxed in the country of destination. In Spain, the taxation of pension annuities is more favourable than in the UK, because the capital return element is not taxed. Consideration should be given to transferring pensions abroad to a QROPS (Qualifying Recognised Overseas Pension Scheme).
Non-Domiciles living in the UK
Previous to the 2008 Finance Act, people who were not born in the UK and classified as non-domiciled, were only taxed on their income and gains arising in the UK, or remitted to the UK from abroad. This has changed, so that now they are taxed on their worldwide income and gains in excess of £2,000 per year, once they have been resident here for seven out of the previous nine years.
There is a special provision for high net worth individuals who may prefer to continue to be taxed on the remittance basis. They are allowed to pay a standard tax charge of £30,000, in order to retain their right to be taxed only on what they remit to the UK.
The main tax planning opportunity, other than the use of offshore trusts, is to wrap offshore investments in an offshore Investment Bond. Because this is non income-producing, there is nothing to declare on the tax return provided withdrawals do not exceed 5% per year, and it may be possible to postpone incurring a chargeable gain until such time as the individual is no longer resident in the UK.
Becoming Non-Resident
Normally, a tax year is taken as a whole when determining the tax residence status, but a tax year can be split in certain circumstances. If an individual leaves the UK to live abroad for a period of at least three years, he or she will be treated as non-resident from the day of departure. Similarly, if they leave to take up full time employment for at least a year, they will be treated as non-resident from the day of departure.
This can create the opportunity for a tax holiday, when the individual is not resident anywhere for tax purposes. For example, the tax year in Spain runs from 1 January to 31 December, and so anyone moving there in the second half of the year will not become tax resident until the following year. This can provide an opportunity to arrange affairs in a more tax-efficient manner, for example using an offshore trust.
To remain non-resident and not ordinarily resident in the UK, the following conditions must be met:
· Less than 183 days spent in the UK each year, including arrival and departure days
· Average of less than 91 days per tax year spent in the UK over the last 4 years.
Provided these conditions are met, then there will be no capital gains tax on disposals in the UK, no UK tax on FOTRA (Free of Tax for Residents Abroad) securities (e.g. Gilts), and a claim can be made using form R105 for interest from building societies and banks to be paid free of tax. If there is earned income in the UK, normal tax allowances can be claimed.
Retiring abroad
The UK State Pension is paid gross, but may be taxable in the country of residence. Income from occupational and personal pensions is normally taxed in the UK under PAYE unless a claim is made for it to be paid gross. There are HMRC forms for individual countries, for example FD5 for France and FD9 for Spain, that need to be filed with the local tax authorities. Completing the form ensures that the pension is taxable in the country of residence, and provides for the reimbursement of any UK tax that may have been paid while the form was being filed. UK Government service pensions (civil service, local authority, armed forces, police, fire, teachers) are taxed in the UK, but may be taken into account in the country of residence for determining the effective rate of tax payable on other income.
When taking the benefits from a pension, it is important to establish whether or not any tax-free lump sum will be regarded as tax free in the country of residence. In France, it is normally treated as tax free, but in Spain it may be treated as taxable. There is also some confusion about how pension annuities should be taxed, because in some countries (e.g. Spain) there is not a clear distinction between a purchased life annuity and a pension annuity.
Pensions can be transferred abroad, provided the receiving scheme is registered with HMRC as a Qualifying Recognised Overseas Pension Scheme (QROPS). Most UK Pension Schemes, including those in drawdown, can be transferred to a QROPS including protected rights. The exceptions are the State Pension, and most Final Salary/Defined Benefit Schemes that are in payment. The Trustees of a QROPS are obliged to report any “Benefit Crystallization Event” to HMRC during the first 5 years of being non-UK Tax Resident. Once this period has elapsed, there is no requirement for the Trustees to report to HMRC. The typical features are:
· Distributions can only be made on retirement, death or total permanent incapacity
· Distributions can be a maximum of 30% cash and 70% must be used to provide an income for life
· There is no requirement for a QROPS to purchase an Annuity or ASP (Alternatively Secured Pension) at age 75
· Potentially suitable for those who have already emigrated from the UK on a permanent basis, Non-Domiciles who will return home, and those intending to emigrate from the UK on a permanent basis in the near future
· QROPS are not suitable for those who remain Domiciled and Tax Resident in the UK or those who intend to return to the UK on a permanent basis.
Buying Property Abroad
If the property is going to be let, it is probably better to get a local mortgage where possible, in order to benefit from any tax relief. Mortgages in Spain are usually for a maximum term of 15 years, and on a repayment basis. Having a mortgage reduces the net value of the property, which can have the effect of reducing any liability to local inheritance tax. In later life, equity release plans can be used for the same purpose.
It is important to establish fully the costs of buying, which may be considerably more than in the UK, and to understand the local property tax system. As well as Notary's fees and Land registration fees, in Spain there is a tax payable on the transfer value between private individuals, known as Impuesto sobre Transmisiones Patrimoniales (ITP). There is also Stamp Duty (Impuesto sobre Actos Juridicos Documentados, AJD) to pay. It is very important to seek legal advice.
Most people will be buying a second home or a retirement home in their own names, but some may be buying property abroad as an investment using a corporate structure. The tax implications of this will need to be assessed, and legal advice sought.
It is very important to assess the implications of owning a property abroad on inheritance and succession taxes. To avoid French succession tax between spouses, for example, it may be advisable to buy the property in joint names, and sign a French community marriage contract (communauté universelle). This means that the surviving spouse inherits the jointly owned assets, and the asset does not have to pass to the children. This type of arrangement does not work if there is a child from a previous marriage, however.
Care needs to be taken with using a corporate structure, for example a société civile immobilière (SCI) in France. The reason the SCI approach has been commonly used by non-French residents is that the French succession laws do not apply to the shares of an SCI, but succession tax may still be payable.
Wealth tax is payable in France on net assets greater than Euros 790,000, but no longer in Spain.
Income and Capital Gains Taxes
Once tax resident in Spain, you become taxable on your worldwide assets. Note that this is different from the UK, where the domicile rules apply (see above). Disposing of a UK property when you are not resident and not ordinarily resident will normally be exempt from capital gains tax in the UK, but you will be liable for Spanish capital gains tax if you are tax resident there, and otherwise you will need to check the local tax laws.
Capital Gains are taxed at a single rate of 18% in Spain, the same as in the UK, but there is no annual exemption. Nor is taper relief available any longer, other than for shares bought before 1995. Realised gains on property can be carried forward to a new property by residents in Spain, and the same applies to investment funds. The over 65s who are tax resident are not liable for capital gains on property.
Income Tax (IRPF) in Spain has a personal allowance of Euros 5,151 for the 2009 tax year, and Euros 918 extra for the over 65s. Earned income, including pensions, is subject to a deduction of Euros 2,652 when the income is greater than Euros 13,260. The maximum deduction is Euros 4,080 for earned income of less than Euros 9,180, and in between the deduction goes on a sliding scale. The tax rate goes in steps from 24% to 28%, 37% and 43%. Pension annuities are taxed more favourably than in the UK.
Savings income such as interest, dividends and proceeds from life assurance contracts are taxed at a fixed rate of 18%. It is no longer possible to claim back the 10% tax credit on UK dividends in Spain, but to compensate for this there is an exemption of Euros 1,500 on dividends (only shares, not collectives).
Wealth Tax in Spain (IP) was abolished during 2008, and backdated from 1/1/08, as part of a number of measures to provide a fiscal stimulus to the flagging economy. Wealth Tax is, however, still a feature of the French tax system.
Inheritance Tax
A UK domicile non-resident is liable for inheritance tax (IHT) on their worldwide assets. In Spain, for example, a non-Spanish resident in Spain is liable for their equivalent succession tax (ISD) also on their worldwide assets, so there is scope for double taxation, although the Spanish tax authorities will take into account any UK tax paid. The top rate of tax for ISD is 81.6%, compared with 40% for IHT in the UK. Clearly this should be a major consideration for people retiring abroad.
Inheritance tax may work differently from the UK. Again, taking the example of Spain, the tax is on the beneficiary, not the estate. If the beneficiaries are not resident in Spain, they will be liable for ISD on the assets they inherit that are in Spain, but they will not be liable for assets elsewhere, which may be subject to IHT on the estate.
Exemptions and reliefs in Spain vary from one region to another. The residence status of the deceased determines whether the Spanish national tax rules apply, or the regional variation, because it is necessary to be habitually resident in the region for 5 years to benefit from local rules. Unlike in the UK, there is ISD potentially payable on first death between spouses. Some regions in Spain (e.g. Valencia) have acted to reduce considerably the impact of ISD, particularly between spouses.
It is important to note that the tax rate between spouses is much more favourable than between unmarried partners. Because the tax is on the beneficiary, there are different tax rates according to how closely related the beneficiary is to the deceased, with more distant relatives or trustees being taxed more harshly. For this reason, it is not generally a good idea for assets to pass in the Will to a Trust. There are complicated personal allowances, equivalent to the nil rate band, that depend on the closeness of the relationship between the deceased and the beneficiaries.
There is a relief for inheriting the main residence in Spain (no equivalent in the UK). Business Property Relief is available at 95%, provided the business is kept going for 5 years after death (cf. 100% BPR in the UK).
Inheritance itself may work differently from the UK, so it is important to have a Will for the new country of residence.
Life assurance payouts are taxed in Spain, with small personal allowances, so the whole of life in trust approach popular in the UK does not work in Spain.
Gifts in Spain cumulate over 3 years (cf 7 years in UK) to fix the tax rate applicable, but there are generally no personal allowances applicable to gifts (varies from one region to another).
For beneficiaries not resident in Spain, one approach to mitigating ISD that has been popular is equity release, taking the cash released offshore, thereby reducing the net assets liable to ISD, and permitting tax planning for IHT using trusts.
Inheritance tax is clearly a very complex area of interaction between UK and local tax laws, with a great deal of scope for planning, but requiring specialist knowledge of the country in question.