Non-domiciliaries - Vote for SRM, please!

MALCOLM GUNN FTII, TEP discusses forward contracts with the Revenue.

ONE OF THE most enjoyable, and perhaps amazing, things about working in tax is its ability to spring surprises. It is not like growing tomatoes or building cupboards which are both established and well defined arts. With the tomatoes, you know that the more muck you throw on, the bigger they grow. With the cupboard, the more carefully you measure the bits of wood, the less wobbly it will be when you have finished.

Tax is different. I often meet practitioners who claim to know virtually everything there is about their specialist subject, a humbling experience when the most that I can manage might be a single sentence of information about it! However, the truth is that tax has the fascinating ability to hide secret doors in its dark corners and if one is fortunate enough to stumble upon the key, suddenly the door will spring open and beyond it whole new vistas suddenly appear before your eyes. I am about to unlock one such door here. I think I can safely say that only a handful of practitioners have known of the existence of it, a staggering fact given the mobility of tax staff between firms and pooling of information through the professional institutes.

The hidden door

It came to light in press reports late last year that the Revenue had concluded agreements for lump sum tax payments each year over a fixed term with a handful of very wealthy non-domiciliaries resident in this country. So instead of their having to work out their tax each year like the rest of us, these few individuals had the deal under which they would pay the Revenue a fixed sum each year for a certain number of years stretching into the future and no more questions would be asked. The report caused a certain amount of indignation amongst taxation practitioners, who felt that something was going on which should have been in the public domain long before. Equally outside the profession there has been considerable comment that a few wealthy people had been favourably treated outside all the normal tax rules. I am hoping that I shall to some extent set the record straight on both these issues, although admittedly all is not sweetness and light.

Official silence

One may search the Revenue manuals from end to end and, so far as I am aware, not a single phrase is uttered on this topic. Initially, this strikes as being highly alarming. We were given to understand that all Revenue practices and concessions were now published and in the public domain and, in an era of Open Government, we are supposed to know what is available from the Revenue and what is not. Why has nothing at all been said about these forward contracts? Why is it that only a lucky few appear to have been treated to the benefit of them and what has the Revenue got to hide?

Matters are not improved by the quality of answers to Parliamentary Questions on the topic. There were two questions recorded in Hansard, 27 February 2001, column 510W asking how many taxpayers have these arrangements, the answer provided by Dawn Primarolo was as follows:

'The Inland Revenue has a small number of agreements of this sort, entered into at various dates since 1988 though none of the individuals concerned has been absolved from the general obligation to file a tax return. Whether an individual is a British subject, and the question of their nationality, are not features of the agreements which have been made. The policy in relation to these agreements is currently under review.'

One immediately notes that this answer, given as a reply to two questions, in fact did not answer those questions at all; the Members of Parliament wanted to know how many taxpayers were involved, and although that information is undoubtedly known, it was not provided. I believe I have seen a number mentioned of 25 in unofficial reports. One is used to politicians answering the question which they would like to be asked, and not the one they were actually asked, but it is rather contemptuous of Parliament for a Minister to pretend that she has given an answer to a question when in fact the issue, for unexplained reasons, was ducked entirely.

There was a further question from Mr Gordon Prentice (who had raised one of the previous questions) recorded in Hansard, 2 April 2001, column 41W. He wanted to know what factors the Revenue takes into account when entering into these agreements. Also he asked where the initiative came from – was it the Revenue or the taxpayer? And again he asked how many agreements there were. The answer provided this time, again by Dawn Primarolo, was:

'The agreements in question do not absolve individuals from their obligations to file tax returns. They establish the tax liability or tax treatment of certain income or gains for future years, which must then be reflected in the returns for those years. The circumstances in which these agreements have been made are varied. Typically they agree a practical basis for taxing future income or gains where there would otherwise be particular difficulties in establishing an exact figure.

'Most of the agreements currently in existence were entered into in the periods 1988-91 and 1995-97.'

Once again one notes that none of the questions asked has been answered, and woolly answers to a different set of questions have been offered. I thought I lived in a democracy which I could be proud of; I have been disillusioned.

After making some enquiries, I discovered that policy in relation to these types of agreement is dealt with by the Revenue's Cross-cutting Policy Division at 22 Kingsway, London WC2B 6NR. I wrote to them for information. Unfortunately because one of the agreements is currently the subject of a judicial review action (which will no doubt provide a wealth of information if and when it comes to court) the Division was unwilling to provide any information at the present stage.

So the official response to requests for information on the topic ranges from 'go away' to 'yes these things exist, but we do not want to say any more'. Let me now fill in the missing details.

The full monty

I am very grateful indeed to Peter Nias of international lawyers McDermott Will & Emery who has been very helpful on the subject. Peter was one of the early architects of the agreements, dating as far back as 1987 when he prepared, under the guidance of leading tax counsel, a discussion paper on a Subscription Rate Method of taxation, hence the abbreviation SRM. It turned out to be a case of ask and ye shall receive; when the idea was put to the Revenue, it agreed, no doubt after much negotiation, to strike such deals on an ad hoc basis.

The agreements are available to non-domiciliaries alone; others need not apply. The reason for this becomes obvious when one appreciates exactly what is being settled for the future with the Revenue. And let it be clear that all the initiative must come from the taxpayer; do not expect the Revenue to propose it first.

The remittance basis

The United Kingdom's remittance basis of taxation for those not domiciled here is, I believe, unique in Europe. It is, however, one of the reasons, along with our wonderful climate of rain, why many wealthy foreign people choose to establish themselves here rather than on the continent. This result has long been recognised as being of overall benefit to our economy.

The remittance basis does, however, need considerable ongoing expert management if it is to be successfully employed. Several overseas bank accounts will be required and a certain amount of annual activity in closing some of the accounts, making transfers between others and making appropriate sales of investments in order to close sources and create non-taxable remittable income. Those adept at managing this system can work wonders. Those less expert will create tax problems instead of solving them.

An agreement for a subscription rate method cuts a straight avenue through all this hassle. Instead of entering into all the mitigation tactics known to man, the non-domiciliary will secure agreement from the Revenue to accept a fixed amount of tax each year, or tax at a fixed percentage, in respect of foreign source income and gains. With a bit of luck and a following wind, all parties should be up on the deal. The Revenue collects some tax; the taxpayer saves all the professional costs of administering the remittance basis system, which for a wealthy taxpayer could be a considerable sum each year. He or she is then able to remit such sums as may be wished and of course it is in the wider interests of the United Kingdom for the flow of funds to be into the country rather than skirting round its borders.

Disclosure

Before entering into negotiations with the taxpayer's representatives, the Revenue is likely to require full disclosure of the taxpayer's worldwide assets. Some may prefer not to do this, in which case they may be best left to fend for themselves under the remittance basis. These agreements are for those who are prepared to bare all for the Revenue.

The broad outline

It is then up to the taxpayer's representatives to come up with a proposal which will be acceptable to the Revenue as regards the tax liability on foreign sources. A starting position which has been described to me is that one works out the funds required by the taxpayer concerned to meet United Kingdom living expenses; deduct from that the amount of United Kingdom income; the balance then represents funds which will be required annually from overseas upon which tax liability may be expected.

The United Kingdom sources of income will be taxable in the normal way and that liability is not open to any negotiation. So the fixed sum contract relates to income and gains within the remittance basis only.

One may be able to negotiate the annual fixed payment downwards on the starting point figure. The Revenue may not necessarily press for liability on funds to be brought in for financing a business or other expenditure of a capital nature. Also perhaps it may be relevant to show that if there is a significant amount of remittable capital overseas so that, on the application of the remittance basis, little tax liability would arise for the foreseeable future. So in the final analysis, it is down to negotiating a deal which both the taxpayer and the Revenue feel they can live happily with.

My understanding is that the maximum term for a contract will be six years, although a shorter period such as three years might sometimes be suggested.

Although these agreements will commonly relate to those with very significant wealth, there seems to be no reason why those of more modest means could not also negotiate a similar type of agreement. Bear in mind, however, that there would be the professional costs of negotiation and of course those without complex international finances may find the remittance basis quite easy to live with anyway. In addition, many non-domiciliaries who come here for employment reasons may not have any significant capital overseas and so an agreement could not provide any benefit for them; the Revenue will not be interested in a one-sided deal in which it is the loser. Last but not least, these agreements are creatures in danger of imminent extinction, as I shall explain in a moment.

Calculating the tax

The original subscription rate proposal was on the lines that all remittances by the taxpayer to the United Kingdom should pay a fixed percentage of tax which might commonly be one half the basic rate – a compromise figure to take account of the blend of capital and income which might be remitted from overseas. This would be applied to all remittances irrespective of whether they come from an income or capital source overseas. There would be an upper limit in that remittances bearing this lower rate of tax would be only those up to the extent of the disclosed total wealth at the time of entering into the agreement. Any remittances in excess of that total wealth would be taxed on the statutory basis.

This was the early idea with these lump sum agreements, but it seems that with the passage of time, there have been cases in which the fixed percentage method has been replaced with a simple fixed sum each year. Since we are talking about an entirely extra-statutory basis of taxation, in each case it is up to the taxpayer's advisers to negotiate such terms as may be acceptable to both the taxpayer and the Revenue.

Termination of the agreement

The agreement terminates at the end of a fixed period or at an earlier time if the taxpayer either acquires a United Kingdom domicile choice or becomes non-United Kingdom resident for tax purposes.

In order that the taxpayer has the opportunity to continue to benefit from an established capital account outside the United Kingdom, which is free of remittance basis liability after termination of the agreement, a 'taxed capital account' would be set up on termination of the agreement to contain funds equal in value to the amount of the taxpayer's initial wealth at the start of the agreement, less all amounts remitted to the United Kingdom during the term of the agreement and adding all amounts transferred out of the United Kingdom during that time. Returns, including remittances, would continue to be required during the term of the agreement and disclosure of any other movements in the taxed capital account (for example funds transferred out of the United Kingdom) would be required. Funds received during the term of the agreement by way of gift or inheritance would only be included if first received in the United Kingdom before transfer abroad.

Assets comprising this 'taxed capital account' would be treated as having been sold and repurchased on an agreed date soon after termination of the agreement, thereby excluding from the United Kingdom tax any unremitted gain which had accrued, or income which had arisen, at that date. Thus the taxpayer could re-establish a conventional non-United Kingdom bank account structure in order to implement the segregation policy in respect of the balance of his original wealth.

Is it enforceable?

Leading counsel advised in 1987 that if the Revenue entered into such an agreement with a taxpayer, it would be bound by it and it could not unilaterally withdraw from it, except if there were a breach of the terms of the agreement by the taxpayer. It rather seems as though this specific point is the subject of litigation which is expected to surface in due course in relation to one such agreement.

The future

Having elaborated on this extra-statutory system at some length, I now need to explain that, according to the Revenue's Special Compliance Office, a policy decision has been taken not to enter into any further agreements of this type. This is pending a full review of the whole topic.

Hence, as I have said, there is a possible danger of these creatures becoming extinct in the future. All this has come about because of certain adverse press reports and comment, some being along the lines of how very wealthy people can get away with an agreement with the Revenue to pay relatively insignificant amounts of tax. This of course is completely misconceived comment, because those without an agreement commonly pay no tax at all on their foreign sources; the statutory remittance basis enables them to do so. The comments may therefore be considered to be very wide of the mark. If any complaint is to be made, then it would be more pertinent if it were in relation to the remittance basis as a whole. That topic was high on the agenda after the Revenue issued a consultative document on residence and the scope of United Kingdom taxation for individuals in 1988. The Government at the time was fully persuaded that the remittance basis was in the wider interests of the United Kingdom and tinkering with it would produce harmful side-effects which far outweigh the additional tax yield.

Forward contracts with the Revenue are simply mechanisms by which the taxpayer agrees to pay some tax annually on offshore income and gains (instead of remitting only capital and paying no tax on such sources) and the Revenue agrees that complex offshore operations need not be implemented. All parties should be up on the deal.

The contract is entered into under the aegis of the Revenue's general 'care and management' powers. If the Revenue has powers to do deals in relation to past tax liabilities, then why should it not exercise similar powers in relation to the future?

I would urge readers to put behind them any sense of outrage which they might have that some have managed to negotiate beneficial deals of this kind with the Revenue hidden from public view. Certainly it is highly regrettable that there does not seem to be any guidance about them in all the published Revenue manuals and in an era of Open Government none of us expected there to be secrets of this kind lurking in the Revenue's cabinets.

However, putting all this behind us, there must be many readers of this magazine who might now be thinking how well an agreement of this type would suit some of their clients. That being so, surely it is in all our interests for practitioners and the professional institutes to speak up in support of these agreements before the Revenue takes any final decision about them. After all, if such an agreement is a good one for the client, the Revenue and the national economy, all at the same time, should we not now be voting firmly in favour of them?

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