UK: Private Client Tax: In The Spotlight - July 2013

The New Inheritance Tax Debt Rules – Death And Taxes Become Less Certain

By Julia Rosenbloom

Changes to debt deduction rules were announced in the recent Budget and are effective from 17 July, when the Finance Act received Royal Assent.

Previously the position was that inheritance tax (IHT) was chargeable on the net value of the estate (total assets less any debts). The new legislation carves out exceptions to this general principle and disallows the deduction of liabilities in whole or part where money is borrowed and:

  • is used to finance (directly or indirectly) the acquisition, maintenance or enhancement of assets qualifying for IHT relief (business or agricultural assets or woodlands);
  • the position is as above but the assets are excluded from IHT; or
  • is not repaid by the estate of the deceased.

With regard to the first point, the deduction is only disallowed if the liability was incurred on or after 6 April 2013.

So, let us say that Mr Graves borrows £200,000 today to expand his business and the bank takes a charge over his home, which is worth £500,000. Under the old rules, on Mr Graves' death, IHT would have been due on the net value of his home (£300,000) and the whole of the value of his business should have been IHT-exempt. Under the new rules, the £200,000 loan would not be deductible and IHT would be payable on the gross (£500,000) value of the house, representing an additional IHT liability of £80,000 (40% of £200,000). This common commercial situation is caught, notwithstanding the absence of any 'tax avoidance' motivation.

As regards the second scenario, assets are excluded from IHT where the individual is non- UK domiciled (and not deemed UK-domiciled for IHT purposes) and the asset(s) is situated outside the UK. Let us say that Mr Graves is non-UK domiciled and, instead of investing £200,000 in his business, he invests in overseas property. Again the loan will not be deductible for IHT purposes and this will be the case even if the liability was incurred before 6 April 2013.

The third element can catch a variety of situations (some which are "contrived" and some which are not).

Despite some recent clarifications, there is still uncertainty with regard to how the legislation might apply in certain circumstances. Further, the policy message is contradictory and at odds with the Government's general encouragement of small businesses. Similarly, the rules attack certain 'innocent' situations whilst completely missing the target in other cases.

The message for all taxpayers is that IHT is something that needs to be given careful thought over the long term and individuals with any form of debt which they are hoping will be offset against their gross assets for IHT purposes should have their situation professionally reviewed.

The Demise Of BPR For Holiday Lettings?

By Martin Denniss

A recent tribunal ruling has cast considerable doubt over whether furnished holiday lettings can qualify for business property relief (BPR) and thus be exempt from inheritance tax (IHT).

Prior to 2008, HMRC had accepted that the majority of furnished holiday lettings would qualify for BPR. However, in November 2008, HMRC changed their view and said that they would look more closely at the level and type of services that are provided in deciding whether BPR would be available.

The underlying technical issue is that BPR is not available where the business consists wholly or mainly of holding investments. Whether or not the holiday letting activity constitutes a business of wholly or mainly the holding of investments is the crux of any analysis of a particular case.

This view has now been tested in the courts in the Pawson case which concerned 'Fairhaven', a large bungalow on the Suffolk coast which had been let as furnished holiday accommodation. The property was cleaned between lettings and a gardener tended the garden. After an initial victory for the taxpayer in the First-tier Tribunal the verdict was overturned in the Upper Tribunal in HMRC's favour. Perhaps more important than the verdict itself are some of the comments made by Mr Justice Henderson in his judgement.

Justice Henderson expressed the view that a holiday letting business was a typical example of a property letting business, albeit one of a specialist nature, and as such should be treated as mainly that of holding a property as an investment.

In order to qualify for BPR, owners of furnished holiday lettings will now need to demonstrate that they are providing a 'holiday experience' rather than just the simple provision of accommodation. However there is still no clarity as to the scope of the activities that would be considered sufficient to obtain this.

In another recent IHT case heard by the First-tier Tribunal, the tribunal ruled that the trustees of the David Zetland Settlement were not entitled to claim BPR on a commercial property (Zetland House), even though there was proactive management of the property and provision of a number of services and facilities to the tenants. In arriving at their decision, the tribunal drew on the principle in Pawson that the relevant test is not the degree or level of activity, but rather the nature of the activities which are carried out.

In reaching its conclusion, the tribunal noted the Pawson case had set the bar high in terms of turning an actively managed investment business into a non-investment business.

Will You Stay Or Will You Go? The New Residence Rules You Will Have To Live With

By Susan Roller and Laura Evans

The statutory residence test (SRT) applies from 6 April 2013 and it is HMRC's objective that the new legislation will make it easier to determine whether an individual is UK resident or not. While most taxpayers will have greater certainty, the new legislation is extremely prescriptive and complicated in certain areas, so great care is needed to understand what action is needed to ensure a residency position is not inadvertently compromised.

Individuals familiar with counting days in the UK by reference to presence at midnight may need to take on additional record keeping. For instance, some 'leavers' will need to record days of presence in the UK where the visit does not span midnight in order to ensure they do not exceed the permissible 30 days maximum under anti-avoidance legislation.

The new rules can also require a record of days spent elsewhere in the world. Under one test, if a UK 'leaver' has spent more days in the UK than any other country during the tax year, then this will count as a tie to the UK. Therefore a daily diary should be maintained to keep a record of where every night is spent.

An individual may need to maintain a day-by-day record of occupancy of their UK and overseas homes, where they are 'present' for any length of time (i.e. not necessarily only if staying overnight). In the case of taxpayers who may be automatically UK resident, a 91 day period is examined to see whether the individual has his 'only' home in the UK. Crucially, only 30 days in that period have to fall within a tax year for him to be UK resident if various other conditions are met.

Detailed information is also needed in respect of working hours for those taxpayers claiming a residency status in whole or in part on the basis of where they work full-time. They will need to record the amount of work carried out on a daily basis overseas or in the UK, as appropriate. For these purposes more than three hours of work qualifies as a 'work day'. Records are also required where there have been any breaks from work and why these breaks arose, such as annual holiday or sickness.

Even if an individual is treated as UK resident under the new rules there is scope to 'split' the tax year in some cases when arriving in, or leaving the UK, to reduce tax otherwise payable. Double taxation agreements may also need to be consulted.

The detail of the new SRT rules can be torturous. The level of record-keeping necessary will depend on a person's particular circumstances in matters of days spent in the UK, occupancy of homes around the world and working patterns. It is preferable to discuss as soon as possible with your usual Smith & Williamson contact which matters require particular vigilance. In some circumstances, the keeping of detailed daily records is the only way to demonstrate the facts to support a particular residency position.

Annual Tax On Enveloped Dwellings – Do You Have Compliance Issues In Hand?

By Mark Wingate

The annual tax on enveloped dwellings (ATED) applies from 1 April 2013 and those with entities affected should be considering the compliance issues. A number of reliefs from the charge may be available, but to be effective they must be claimed. There are time limits for submitting returns, making claims and making tax payments, and the consequences of noncompliance can soon mount up.

ATED applies to interests in a UK residential property (which is a single dwelling interest with a taxable value over £2m), where a company, or a partnership with a company as a member, is entitled to the interest. It also applies to such an interest held for the purpose of a collective investment scheme.

The legislation applies a charge depending on the level of the valuation, and then permits a claim to be made for relief from the charge, subject to conditions. There are 11 reliefs and further information on these and other tax issues affecting high value residential properties can be found in our briefing note number 241. Where a relief is claimed, the tax is reduced to arrive at an 'adjusted chargeable amount' depending on how many days the relief applies in the chargeable period. Where the relief applies for the full period, the charge will be reduced to nil. However in order for a relief to apply it must be claimed on an annual ATED return or by amending such a return.

In this first year of application annual returns must be filed by 1 October 2013 for chargeable interests held on 1 April 2013, and by the later date of 1 October 2013 or 30 days after the date on which the property first comes within the charge for interests acquired after 1 April 2013.

Failure to make tax payments or submit returns on time can result in interest and penalties being charged.

If you are within the ATED charge applies to you, the message is clear that compliance issues need to be dealt with in a timely manner.

UK Crown Dependencies Open Their Doors And Allow HMRC Access To Client Information

By Andrew McKenna

By 2016 HMRC will have full details of UK resident beneficial owners of bank accounts, companies and trusts which are located in Jersey, Guernsey and the Isle of Man (the Crown dependencies). They will utilise this information to check that income and gains arising from those assets are reflected in the UK tax returns for those individuals. Any additional tax which arises from a failure to have disclosed any income and gains arising from the assets will be recovered with additional late payment interest and a penalty of between 35% and 112% of the tax due. This is dependent upon the location of the funds and the cooperation given and could lead to a lengthy and intrusive enquiry.

Later this year the financial institutions within the Crown dependencies will write to all of their clients for whom they believe details will need to be disclosed to HMRC. They will advise them of the disclosure in 2016 and outline the opportunity to put any un-disclosed matters right by way of the disclosure facilities which are available for each location. Those facilities offer beneficial terms which include a reduced period of taxation from 1999/00 onwards only (as opposed to a maximum of 20 years normally), and a significantly reduced penalty. Rates of penalty include 10% for all years up to 2008 and 20% thereafter, together with a simplified disclosure process which, for the majority, will result in minimal contact with HMRC. These facilities can be used to address not only any tax disclosure relating to the Crown dependency assets but any other matter also requiring disclosure – again on beneficial terms.

What is clear is that the secrecy and relative inaccessibility of information on UK individuals with assets in the Crown dependencies (and indeed other UK linked overseas territories) will become a thing of the past from 2016 onwards.

Those with undisclosed tax matters are advised to take specialist advice and rectify their position via the beneficial Crown Dependency or Liechtenstein Disclosure Facilities, whichever is applicable, to significantly reduce their tax exposure to HMRC. Those individuals whose affairs are in order but who have interests overseas which will be disclosed to HMRC, need to be prepared to respond to an HMRC challenge and show that their affairs are compliant. With this in mind you should discuss with your tax adviser what proactive action can be taken now to ensure that you have all the necessary material collated and retained to rebuff any HMRC enquiry.

TECHNICAL CORNER

Maximising Your Tax Relief When Gifting Shares To Charity

By Daniel Fowler

Where the value of quoted shares is to be used to benefit a charity there are two routes for the individual donor to attract tax relief. The donor may sell the shares and donate the cash, receiving an extension to their basic income tax rate band of the grossed up amount. Alternatively, they may gift the shares to the charity, thereby receiving a deduction against income tax and exemption from capital gains tax on the deemed disposal. Generally, the latter will afford greater tax relief for the individual donor, provided that they have sufficient income in the year of gift and the shares stand at a gain.

It should be noted that not all charities have the facility to receive shares and other charities might not accept the shares of certain companies on ethical grounds.

In addition to quoted shares it is also possible to gift:

  • units in an authorised unit trust
  • shares in an open-ended investment company (OEIC)
  • an interest in an offshore fund
  • a 'qualifying interest in land'.

Gifting shares in an offshore fund subject to income tax can be even more beneficial as the gain is 'washed out' at the 45% tax rate.

Another consideration might include the flexibility of the cash gift aid scheme. It is possible to carry back a charitable donation to the previous tax year provided a claim is made before the tax return for the earlier year is submitted to HMRC. This can be particularly beneficial where marginal rates of tax were greater in the earlier year. Gifts of shares cannot be carried back to the previous tax year.

Close Company Loans - The Noose Tightens

By Imogen Hilton-Brown

A close company is one that is controlled by five or fewer participators (and their associates), or by participators who are directors. A shareholder is a participator.

When a close company makes a loan to or advances money to a participator (or an associate) a charge arises on the company equal to 25% of the loan or advancement. Relief from this charge is available when the loan/advancement is repaid or the loan is written-off.

In the past it was possible to avoid the effect of these rules in certain circumstances as follows:

  1. A loan could be made to an intermediary such as a partnership containing both individuals and non-individuals. The partnership would not be a 'participator' or an 'associate' for these rules.
  2. A participator and a close company of which they are a participator may be members of a partnership. If the partnership made a loan to the participator it was contended that this was not caught.
  3. The close company made a loan to an individual participator. The loan was repaid before the corporation tax needed to be paid. Shortly after this a 'new' loan was issued.

Proposals

There are three changes which have been proposed to deal with the loopholes. These are effective from 20 March 2013.

  1. The rules will apply where the loan is made to any form of partnership in which a participator (or their associate) is a partner.
  2. The rules will apply to arrangements where value is extracted from a close company and a benefit is conferred on an individual (or their associate) who is a participator in that company.
  3. There will be a 30 day rule to deny relief for loans repaid where the amounts repaid and redrawn exceed £5,000. Where it applies, the repayments are treated as repaying the redrawn amounts in preference to the earlier loans. For loans exceeding £15,000 where arrangements are made to re-advance the loans at the time repayments are made, there is no time limit. However in both cases if the repayments result in an income tax charge on the individual (for example due to the repayment being made from company dividends or remuneration being voted), then these rules on the treatment of repayments will not apply.

Loans to participators remains a very hot topic as the Government intends to consult later in 2013 on the structure and operation of the tax charge on such loans.

DID YOU KNOW?

HMRC Over-Reach Themselves In Applying Late Filing Daily Penalties

By Martin Denniss

Taxpayers who are more than three months late in filing their self-assessment tax return become subject to a late filing penalty of £10 per day.

In a recent appeal, the first tier tribunal (FTT) considered the specific legal requirements for a valid notice of the £10 daily penalty. The law says that in order for a taxpayer to be liable to the daily penalty, HMRC must decide that the penalty should be payable and must give notice to the taxpayer specifying the date from which the penalty is payable.

HMRC relied on the wording in the self-assessment tax return and payment reminder (SA reminder) and the SA326D notice (notifying the charge to a £100 fixed penalty). However the FTT took the view that those notifications were not specific enough, particularly as they did not show the precise date from which the penalty was payable.

Any taxpayer who has become subject to daily penalties should consider whether the outcome of this case is applicable to their own circumstances.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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