UK: Collateral Damage

Last Updated: 13 August 2014
Article by Piers Master

Until 4 August 2014, the effect of HMRC guidance was that non-doms who were using the remittance basis could pledge foreign cash or investments, representing their unremitted foreign income and gains, as collateral for loans used for UK expenditure - without that being regarded as a taxable remittance. HMRC have just pulled a screeching handbrake turn in relation to this practice. They are now taking the position that such security arrangements do constitute a taxable remittance of the income and gains. This change of position will have serious implications for non-doms who have borrowed against the security of offshore cash or investments, and used the borrowed money in the UK.

Background

In relation to a UK resident, non-UK domiciled remittance basis user (RBU), the concept of a taxable remittance is very wide. A remittance can arise where unremitted foreign income or gains are used outside of the UK, directly or indirectly, in respect of what the legislation calls a "relevant debt". This means a debt that relates to property brought to, or received or used in, the UK by or for the benefit of the RBU or certain connected persons.

On the face of it, if an RBU pledges foreign cash or investments as collateral for a loan, that is probably a "use" of the income or gains comprised in the collateral in respect of the debt (although there is an argument that there is no "use" unless and until the security is exercised by the lender). In other words, the security arrangement probably gives rise to a taxable remittance, if the loan is used in the UK.

However, strangely, this was not the position that HMRC used to take. HMRC's previous position was that a loan used in the UK, secured against assets representing foreign income or gains, would not give rise to a taxable remittance, provided that the loan was "commercial" and it was "serviced" (i.e. regular interest payments were made to the lender).

Many legal advisors have advocated caution in relation to this guidance, as it seemed a generous interpretation of the law, and might be considered to be an HMRC concession, which could be withdrawn. Nevertheless, the guidance has in practice been relied on by a certain number of RBUs (particularly those that did not have enough clean capital to bring into the UK without a tax charge, but wanted to purchase UK property).

HMRC have now done what some advisors feared, and have performed a volte face in relation to such borrowing arrangements. Affected RBUs will now need to consider unwinding existing loan arrangements or, if this is impossible, funding a heavy tax charge on the remittance of the income and gains contained in the collateral.

HMRC's new position

HMRC's newly published view (as from 4 August 2014) is that foreign income and gains that are contained within a non-UK account will be remitted as soon as they are pledged as collateral for a loan used in the UK. HMRC now state that their previous view was a concession, although this was far from clear from the previous guidance.

With respect to "servicing" a loan used in the UK, the position remains as before. If foreign income or gains are used to pay interest on a loan used in the UK, and/or to make payments of principal, that is a "use" of the income or gains in respect of the debt, and will continue to be treated as a taxable remittance of those income or gains. No tax charge occurs if clean capital is used to make interest or principal payments.

Why the U-turn?

HMRC's change of position does not seem particularly principled. They have stated that they are seeing large numbers of arrangements that are not "commercial" or within the intended scope of the original guidance. "For example", HMRC say they are seeing "loans repaid from non-foreign income or gains that are not charged as a remittance". This is a remarkable statement, as there is nothing intrinsically non-commercial about repaying a debt using clean capital.

Reading between the lines, it appears that the previous HMRC guidance was based on an assumption that where a loan used in the UK was secured on offshore collateral (representing foreign income or gains), there would inevitably be a taxable remittance when the loan was repaid. This was obviously incorrect - no remittance would occur if the borrowing was repaid out of clean capital, or if repayment occurred after the RBU had become non-UK resident. HMRC have realised the error in the original assumption and are now hurriedly plugging a hole of their own making.

Who will be affected?

The change of position will affect:

RBUs who already have borrowing facilities in place where assets representing foreign income and gains have been pledged as security, and

RBUs who do not have enough clean capital to bring into the UK and wish to buy UK property (or incur other UK expenditure) and have been contemplating borrowing commercially to fund such expenditure.

Next steps

For those who were contemplating putting such arrangements in place, there may well be no alternative to paying tax on the remittance of income/gains to the UK. However, advice should be sought on the possibility of identifying offshore capital that can be remitted without any tax cost, or at a low tax cost, e.g. due to double taxation treaty relief, the surprisingly wide exemptions for pre-2008 income, business investment relief, etc.

For RBUs who have already borrowed against offshore collateral (representing foreign income or gains) and used the borrowed money for UK expenditure, HMRC will (for a limited period) "grandfather" the previous concession and will allow a grace period for restructuring. HMRC say they will take no action to tax remittances in relation to the use of assets representing income or gains as collateral if the loan arrangements fell squarely within the terms of the concession provided in the original guidance, so long as the RBU:

  • notifies HMRC of the loan with full details, including the amount of foreign income or gains comprised in the collateral and the amount of the loan remitted (if not the full amount); and either
  • gives a written undertaking by 31 December 2015 that the collateral which comprises foreign income or gains has been or will be replaced by other collateral, before 5 April 2016; or
  • repays the loan (or part of the loan that was remitted to the UK) before 5 April 2016.

It is unclear what the deadline is for any such notification. The notification requirement seems extremely onerous. It will be impossible for some RBUs in this position to attempt to assess, with any accuracy, the value of income and gains comprised in the collateral.

Clients in this predicament are likewise in need of urgent advice, to establish whether their existing loan agreements do fall squarely within the terms of the former concession, to assist with the necessary notification to HMRC, and to determine the scope (if any) for restructuring the loan arrangements in a way that will avoid security being taken over assets representing foreign income or gains - e.g. by means of security over a UK home, over assets of a relative by means of a guarantee arrangement, etc.

Failing compliance with the above, a tax charge will arise on the income and gains comprised within the security - probably in the current tax year (2014/15), although this is unclear from the HMRC announcement. And for those RBUs that do not have sufficient clean capital to pay the tax falling due, there will be a double tax hit, as they will need to remit further funds to pay the tax on the original remittance.

Conclusion

It is of note that while this marks a change in HMRC's interpretation of the legislation, it is not a change in the law itself. It is a change of practice, in recognition that HMRC's original guidance pretty clearly had no foundation in the tax legislation.

This slightly farcical situation has arguably arisen due to the absence of a clear definition of the word "use" in the remittance basis code. HMRC's current interpretation of the word seems much more consistent with the spirit of the changes brought in by Finance Act 2008. However, ultimately the issue of whether the granting of security over an asset constitutes "use" of any income or gains comprised in the asset is a question that needs to be determined by the courts - if any RBU is brave or desperate enough to litigate the point.

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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