Paradise Papers: Perception v. Reality
As another offshore leak hits the headlines, the familiar cycle of indignation and recrimination begins in earnest as the world takes aim at offshore tax havens and the structures which the rich use to protect their wealth.
Whilst balanced news outlets point out that the majority of transactions involve no legal wrongdoing, this is of little consolation to those who face trial by media for their legitimate tax planning, the legality of which, critics seem to care little about.
A common response to these leaks are calls for greater transparency. This stems from the perception that once offshore structures become more transparent, they will no longer be utilised to evade tax, launder money and fund terrorism.
What increased transparency will not solve, however, is the fact that the public continues to perceive offshore tax planning as morally unacceptable, even where it is acknowledged that no legal wrongdoing has taken place.
The crux of the controversy is at what point tax arrangements become inappropriate. The prevalent view is that arrangements aimed at minimising tax become inappropriate when they involve some offshore element, particularly where the individual using the arrangements is UK resident.
It is often disregarded that the vast majority of offshore structures usually do report their assets, and pay tax accordingly. It is also worth noting that the benefits associated with establishing offshore trusts were largely removed for UK individuals in the Finance Act 1998. Before then, offshore trusts had been extremely popular among wealthy individuals, who benefited from significant CGT advantages by establishing such trusts.
The government has also since introduced a series of changes seeking to combat what are perceived to be the biggest persisting abuses.
Firstly, the Finance Bill (No.2) 2017 makes far-reaching changes to the treatment of ‘non-doms’. Effective from 06 April 2017, non-doms who have been resident in the UK for fifteen of the last twenty years (as opposed to 17 of the last twenty years), will become ‘deemed domiciled’ in the UK and subject to taxation on their worldwide income and gains on an arising basis, rather than simply being taxed on their UK assets and/or any offshore income or gains which they remit to the UK. Moreover, the worldwide estates of ‘deemed domiciled’ individuals will be subject to UK IHT, whereas previously, non-doms only paid IHT on their UK assets.
A stricter rule is now also in place for UK-born individuals, who subsequently leave and acquire a domicile elsewhere. These ‘formerly domiciled residents’ will now become ‘deemed domiciled’, as soon as they become resident again in the UK.
A second common concern has been the extent to which UK property, particularly residential property, is held within offshore structures. Historically properties have been held in this way because ‘non-doms’ are only liable to pay IHT on their death on their UK based assets. Whilst one would assume that this would include UK residential properties, by holding them within offshore structures, these properties were ‘excluded property’ for the purposes of the Inheritance Tax Act 1984 and were not subject to IHT.
To counter this, FB (No.2) 2017, introduced measures to ensure that IHT is payable on all UK residential properties, however held by offshore structures. The legislation achieves this by looking through the layers of beneficial ownership until the ‘ultimate beneficial owner’ is identified, whether this is an individual or a trust. This marks the culmination of government measures introduced since 2013, including the Annual Tax on Enveloped Dwellings, ATED related CGT and increased SDLT on purchases by non-natural persons, which together, have discouraged the holding of UK residential property through offshore structures.
Thirdly, the government has announced specific anti-avoidance rules in the draft Finance Bill 2018 targeting avoidance strategies relating to payments made by, and benefits received from, offshore trusts.
From 06 April 2018 capital payments made from offshore trusts to non-UK resident beneficiaries will no longer be available to be matched against offshore trust gains. These payments will no longer ‘wash out’ trust gains, and therefore no longer allow subsequent payments to be made to UK resident beneficiaries, free of, or at a heavily reduced rate of tax.
Secondly, payments made by offshore trusts to close family members of a UK resident but non-dom settlor, will now be taxable on the UK resident settlor in circumstances where the recipient of the benefit, whether the settlor’s spouse/civil partner, cohabitee or children, are not subject to tax themselves (e.g. because the recipient is not UK resident).
Finally, the draft legislation ensures that offshore trusts cannot make payments to non-UK resident beneficiaries, or remittance basis users (free of tax), only for the recipients to make onward gifts to UK resident beneficiaries. In these circumstances, the ultimate UK resident beneficiary receiving the gift will be taxed, as opposed to receiving the benefit potentially tax free as a gift.
The UK system of taxation sensibly provides for the use of offshore structures to protect the wealth of individuals who have made their fortunes abroad before moving to the UK. To tax individuals on their worldwide assets the moment they became UK resident would deter high net worths from coming to the UK and deprive the government of critical revenue. Income tax is the single largest source of tax revenue and the top 1% of taxpayers contributed 27% of income tax receipts last year. Additionally, as a percentage of the UK ‘tax gap’ (the difference between the actual tax collected and the amount which should be collected), tax avoidance constitutes the smallest element, at only 5% of the total.
The problem arises where individuals seem to benefit from offshore structures, while enjoying all the benefits of living long-term in the UK. This is a legitimate concern which has been directly targeted by successive governments. Unfortunately, in the sensational commentary that follows such leaks, the rationality behind the existence of offshore structures is lost and the measures introduced to limit their abuses, omitted, as the words avoidance and evasion are conflated by commentators who seek to score points by tarnishing all high net worths for the actions of the few.
John Sweeney, Associate
This article was originally published in Bloomberg BNA and can be accessed here.