Tax Planning for Expatriates
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. After being resident in the UK for 12 of the previous 14 years, the remittance basis charge will increase to £50,000 in April 2012. The tax charge will be removed when non-doms remit foreign income or capital gains to the UK for the purpose of commercial investment in qualifying UK trading businesses. The existing remittance basis rules are being simplified for nominated income and the taxation of assets remitted to and sold in 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.
If an Excluded Property Trust is set up before completing 7 years residency, the capital can be kept out of inheritance tax. Because it is a settlor interested trust, you can still have access to the capital.
UK Domiciles Living Abroad
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.
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).
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.
Full time work abroad is defined as: employment under one or more contracts of employment for at least 35 hours per week; or carrying on one or more trades or professions wholly abroad and spending an average of at least 35 hours per week engaged in that work.
The tax year in Spain runs from 1 January to 31 December, and so anyone moving there in the second half of the calender year will not become tax resident there 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 (midnights) 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.
Guidance notes IR20 and HMRC6 provide the definition of residence in the UK.
The Gaines-Cooper vs HMRC case rumbles on. Earlier court decisions determined that Mr Gaines-Cooper had remained a UK resident because he had never made a 'distinct break' with his UK lifestyle. This decision has been upheld in the Supreme Court, on the grounds that IR20 reflects current case law, and that people at whom it is aimed should infer that a 'distinct break' with UK social and family ties is needed in order to become non-resident.
The Finance Act 2012 is set to introduce a statutory residence test. The conditions will be much tighter than now: an individual will be non-UK resident in a tax year when he/she spends fewer than 10 days in the UK in that tax year; or fewer than 45 days in the UK provided he/she was non-UK resident in each of the previous tax years.
Where it is not absolutely clear, an individual who has family in the UK (e.g. spouse, children under 18) is likely to be regarded as resident in the UK. If you have residential accomodation available to live in, and family living in it, then you are likely to be regarded as resident in the UK. If you have an employment or self employment in the UK, and work here for at least 40 days in the tax year (based on at least 3 hours per day), then you will also be regarded as resident.
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
· 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.
An alternative is Qualifying Non-UK Pension Schemes (QNUPS) which were announced in February 2010. These are a type of trust that allows retired expatriates to pay money into a pension scheme. They may offer tax advantages in some countries.
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 €800,000, but no longer in Spain. French residents are taxed on their worldwide assets, unless otherwise provided by a tax treaty. Non-residents are taxed only on the value of thier assets located in France. Business assets, antiques and works of art are all exempt from wealth tax and a deduction of 30% of the value of the principal residence is granted. The rate levied is progressive, from 0.55% to 1.80%.
Income and Capital Gains Taxes
Once tax resident in your new country, you may become taxable on your worldwide assets. 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 may be liable for local capital gains tax in your new country of residence.
Spain
Capital Gains are taxed at the savings rate of 19% up to €6,000 and 21% on the excess in Spain. 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 is applied to the 'base liquidable' after certain deductions, which for 2011 are €13,662 for a single person with 1 child, or €15,617 with 2 or more children. With a spouse who has income of less than €1,500, the deduction is €13,335, or €14,774 with 1 child, or €16,952 with 2 or more children.
The tax rate goes in steps from 24% (€5,050 - 17,360); 28% (€17,360 - 32,360); 37% (€32,360 - 52,360); 43% (€52,360 - 120,000); 44% (€120,000 - 175,000); 45% (>€175,000).
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 19% up to €6,000 and 21% on the excess. 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 €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.
France
French resident taxation is based on worldwide income. The family unit is taxed, and married couples cannot normally submit separate tax returns. The total taxes, including local property taxes, welath tax and social surtaxes are limited by the 'bouclier fiscal' which prevents more than 50% of income being paid in taxes.
The main tax in France is the 'impot sur le revenu'. The total taxable income of a family group is divided into a number of units, depending on the number of family members. The tax liability applicable to a single unit is multiplied by the number of units to arrive at the total amount of tax payable.
Tax is charged at progressive rates up to 41%. Employment income is taxable after deducting mandatory social charges and a standard allowance for professional expenses of 10% of taxable employment income, or actual documented expenses.
60% of dividend income is taxable and resident individuals benefit from a tax free allowance of €1,525 for a single taxpayer and €3,050 for married taxpayers, as well as a credit of €115 or €230 in respect of dividends for single/married taxpayers.
For dividends and certain fixed return investments French tax residents may elect tax to be witheld at source at the time of receipt and not subject to any further taxation ('prelevement liberatoire'). The flat rate is 18% plus special social surtaxes to a total of 30.1%.
Income from capitalisation contracts (life assurance contracts under which accrued proceeds are compounded) are subject, upon election, to the 'prelevement liberatoire' at variable rates: 35% if less than 4 years, 15% between 4 and 8 years, 7.5% if over 8 years.
Rental income forms part of taxable income after deductions of expenses such as repairs and property taxes. For property in the UK, rental income is taxable in the UK, but the income is also taken into account in France. It is added to your income to calculate the effective rate (taux effectif) of tax in France.
Under the new UK/France double taxation treaty of 1 January 2010, gains arising from the sale of UK property are subject to French capital gains tax of 31.3% including social charges.
Inheritance Tax
Spain
A UK domicile non-resident is liable for inheritance tax (IHT) on their worldwide assets. In Spain, 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. In 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.
France
French inheritance or gift tax is payable by the beneficiaries. If the deceased or the donor is tax resident in France, tax will be due in France on worldwide assets. Tax will be due on all personal and real property located in France, regardless of whether the donor or beneficiary is tax resident in France.
Inheritance tax is levied on assets at their fair market value, with allowances taking into account the relationship between the deceased and the beneficiary.
No inheritance tax is due between spouses or same sex partners.
Tax free allowances exist for gifts by parents or grandparents to children.
The tax is levied at various rates from 5% to 60%, depending on the relationship between the donor and the beneficiary and certain allowances.
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.