The New UK - What’s Your Plan? - Tax Authorities

Executive summary

The change of Government has brought a new shape to the UK tax landscape for entrepreneurs and wealthy people, that creates both challenges and opportunities.

On the one hand, the coalition Government wants everyone to pay their share towards restoring the public finances. That means a clampdown on tax avoidance where rules will be tightened and scrutiny will increase.

On the other hand, the Chancellor has declared Britain "open for business" and has set out to make the tax system more stable, transparent and competitive.

So what does this mean for you now? You can expect fewer short-term tax changes, less complexity, and more encouragement of entrepreneurship. Personal taxes are likely to stay at recent historic high rates as corporate taxes come down.

To make the most of this new environment, it may be an appropriate time to replace short-term tactics with a more holistic, durable strategy. You need to check that your tax planning still actively supports the three-to-five-year goals for you, your family and your business.

Structures that have proved effective for you in the past may not suit the new landscape. Now's the time to revisit your strategy – for example – in an environment where personal taxes are rising and corporate taxes falling, does it still make sense for you to hold assets personally rather than in a UK company structure? Alternatively, does the increase in entrepreneur's relief mean that you should consider widening the shareholder base in your business?

In this drive towards transparency and accountability, you should also consider your position with regards to Her Majesty's Revenue & Customs (HMRC). The Government may be taking a tough line, but it is realistic. There is now a greater opportunity to build a long-term relationship with HMRC to reach arrangements that are mutually acceptable.

You should consider the consequences of saying "It won't be me" and failing to think ahead. To navigate the new tax landscape, you need to start planning now and take control

Time for a rethink

Under the last Government, taxation of entrepreneurs and the wealthy became increasingly complex and unpredictable. In response, some individuals and families took a short-term, tactical approach to planning their affairs.

This fluid environment was bad news for those seeking stability and predictability. Faced with uncertainty, a number of wealthy individuals left the UK and many more have considered the option.

The new Government has said it wants to simplify and make fewer changes to the tax system to restore the UK's reputation for stability and competitiveness. What does this mean for your arrangements – now and in the long run?

In the short term, changes to rates of taxation and the application of a new tax policy may make structures that were previously effective less desirable. That means taking a hard look at your affairs now to make sure you are not using outmoded structures.

Tax planning is likely to become less reactive and more transparent. This creates the opportunity to make plans that support your overall business and personal goals over the next few years.

The Government's desire to make the UK competitive is matched with a need to maximise tax revenue and to demonstrate that everyone is paying their way. So what should you do when confronted by stricter rules and greater scrutiny?

Planning is essential. In particular, there is greater scope to build a transparent relationship with HMRC as the spotlight turns on those with complex tax affairs.

In short, faced with a new landscape of increased stability, transparency and responsibility, you have the chance to take a holistic view to tailor your tax arrangements to your medium-term business and lifestyle choices.

First the bad news

The Chancellor aims to eliminate the structural budget deficit over this parliament. On top of the much-discussed spending cuts, the Government will seek to maximise its income through taxation. Tax avoidance, as defined by the Government, is being closed down wherever possible – and that means greater scrutiny of the affairs of wealthy individuals and families.

The launch of HMRC's High Net Worth Unit (HNW Unit) last year and the recent commitment to provide funding to tackle tax avoidance, made clear its intention to focus on the affairs of those with complex tax arrangements. This clampdown echoes shifts already taking place in countries such as Australia, Ireland and the United States to name a few.

Specific measures the Government is considering or has proposed include a general anti-avoidance rule, a review of the rules for non-domiciled individuals, and a statutory residence test. Each, if adopted, would tighten the regime for entrepreneurs and wealthy individuals.

In the current economic climate, the wealthy are likely to receive more attention not just from HMRC but in the media. Individuals, whether they have high or low profiles, may find themselves exposed to scrutiny and must be able to explain their arrangements when questions are asked.

In the short term, changes to rates of taxation and the application of a new tax policy may make structures that were previously effective less desirable.

No need to leave

We don't think all this is a reason to start packing for Geneva or Jersey. The Chancellor knows that driving people abroad or into increasingly complex tax arrangements is no way to raise revenue.

While asking the wealthy to pay their share, Mr Osborne has pledged to "slow down the pace of change" and bring stability to tax policy. The launch of the Office of Tax Simplification (OTS) and the decision to scrap the pre-Budget report are two obvious demonstrations of his intent.

The Chancellor summed up his approach when launching the OTS in June 2010: "Simpler, more competitive tax rates will help us show the world that Britain is open for business."

We believe the emergency Budget in June 2010 set a clear direction for tax policy over this parliament. In general, personal taxes are staying at recent historic high rates while corporate taxes are coming down.

The 50% tax rate on higher earners is likely to stay for the rest of the parliament, though it may be reduced in future. We also think capital gains tax will remain unchanged following the introduction of the new 28% top rate. However, corporation tax is set to fall from 28% to 24% over four years.

So what does this rebalancing of personal and corporate taxation mean for the wealthy or entrepreneurs? As discussed in more detail later, it may mean that holding assets personally can become relatively less attractive than a UK company structure, especially given the level of scrutiny expected for more complex arrangements. Individuals investing for long term wealth accumulation, whether using traditional pension arrangements or holding investments directly, might need to revise their approach. Another general theme is that activities classed as real wealth generation – producing or selling goods and services – will be treated more favourably than those based on investment or speculative activities. Alongside the capital gains rise to 28% from 18%, the Chancellor unexpectedly increased materially the lifetime limit on entrepreneurs' relief from £2 million to £5 million in a measure designed to demonstrate commitment to commercial enterprise. This limit is likely to remain stable or to increase over the years and is an important opportunity if you are a business owner thinking about realising some or all of your wealth.

Doubts may linger that the Chancellor's aspirations may fall short. After all, it was Mr Osborne whilst in opposition who originally questioned the position of non-domiciled UK residents, and the Government's policies will have to take account of the range of views within the Conservative-Liberal Democrat coalition.

Even the best of intentions may be knocked off course by a dip back into recession. But as long as the economy keeps growing, we expect considerably more stability in fiscal policy over the next five years than in the previous five years.

To make the most of this new environment, you need to check that your tax planning still actively supports the three-to-five-year goals for you, your family and your business.

Fewer tactics, more strategy

Before budgets or pre-Budget reports under the last Government, some individuals acted in advance in an attempt to insulate themselves from tax rises. If taxes rose as expected then the strategy paid off, but results varied and it could be a time consuming, stressful and sometimes costly way for people to conduct their affairs.

For example, before the last Government's final Budget of March 2010, many people rushed to sell businesses and assets because they expected an increase in capital gains tax and speculated that entrepreneurs' relief might be reduced or abolished. But capital gains tax went unchanged and the limit for entrepreneurs' relief was increased to £2 million from £1 million so that many people paid £80,000 more tax than if they had taken no action.

With a more stable period predicted, it's time to replace these short-term tactics with a more durable strategy. For this new approach you will need to establish a clear understanding of your current and future asset base and make a call on your expected income flows and capital and revenue expenditure. With offshore structures under greater scrutiny in the UK and internationally, you will need to make a realistic judgment on the operational substance of such arrangements. You should also think about your appetite for complexity in tax affairs, bearing in mind HMRC's drive to understand individuals' overall positions and the potential stress and time involved in answering enquiries.

For owner managers, qualification for entrepreneurs' relief will be a key issue. In reviewing your options, shareholders in businesses should consider their medium-to-long term strategy, including a possible sale or part-exit, succession planning, and whether to remain in the UK after a sale. Indeed some may wish to consider an exit before sale, and if this is to be achieved successfully, very careful planning is required to mitigate capital gains tax. These are all emotional as well as business issues and people should seek appropriate professional advice when weighing up the consequences for themselves and their families.

Making the new regime work isn't about artificial short-term arrangements; it's about taking a sensible view on how to arrange your wealth as part of a pragmatic strategy developed in recognition of a more transparent environment.

Historically, it was effective to hold assets in your own name and to pay either personal tax or capital gains tax. However, with corporation tax set to fall from 28% to 24%, it may now be attractive to hold assets in a UK company. The reduction over four years is an important change, but holding assets in a UK company may still incur a higher rate than offshore structures available. However, the UK structure can provide more certainty and transparency, and is likely to be more favourable to HMRC.

Each structure has its benefits and drawbacks in terms of flexibility and cost. Depending on how wealth is generated and your business priorities, a hybrid structure including a UK company and a UK Limited Liability Partnership could provide a flexible arrangement that allows adjustments to be made depending on the balance of the business between income and gains over time.

The key point is that UK company structures may become more attractive in the new environment because corporation tax is falling, fewer tactical changes are needed and more complex options such as offshore arrangements and other less commercial "pre-packed structures" may be less desirable going forward.

In taking a holistic view of your affairs, you should also seek appropriate advice on the income profile and overall structure of different assets to understand how they can be applicable to family members with differing investment and expenditure needs. And don't forget to check that all members of your family are making full use of their allowances, such as entrepreneur's relief.

A range of wrappers, which are tax-efficient long term investment vehicles, can be used to defer tax on assets until the structures mature. These wrappers aren't cheap and are long-term investments but, for those able to ring fence their assets for 10 years or more, they may now be more attractive due to increases in income tax and capital gains tax .

They can suit both entrepreneurs looking to realise their wealth and those who already have a substantial portfolio of assets. For instance, UK residents may choose to wrap up their investments over the course of the product's life to defer income or capital gains tax and reserve the option of paying tax on maturity or becoming non-resident. Alternative structures such as investment partnerships could be considered for shorter term liquidity needs.

Such a broad review of your affairs will require careful planning to take account of interconnected arrangements, and in the end you will have an overall structure that should require far fewer reactive adjustments than in the past.

We don't believe a broad anti-avoidance provision is the right approach if the Government wants to simplify the tax system because it would add a layer of complexity and uncertainty in interpretation. We do, however, expect continued specific measures to target particular types of avoidance, including an intensified focus on artificial structures that have no, or very limited, commercial purpose.

We also expect HMRC to pay increased attention to offshore structures following the independent review of British offshore financial centres led by Michael Foot and more coordinated action on disclosure by the G20 and other international bodies. Some jurisdictions, such as Luxembourg, have already increased requirements so that residents must have a substantive physical presence, while others may be forced to cooperate with authorities in major economies, as Liechtenstein did last year when Germany obtained a list of Germans with interests there.

The grass is greener?

Some high-profile individuals have left the UK to avoid increased taxes and scrutiny and others are thinking about it. But many are doing so without taking proper advice, risking lengthy disputes with HMRC over residence status.

We think it is unlikely that a statutory residency test will be introduced in the foreseeable future but HMRC is continuing to take a far stricter line on those claiming non-resident status.

In the recent Gaines-Cooper case, HMRC successfully argued that Mr Gaines-Cooper's continuing links with the UK meant he had not actually left the country – despite him having a home in another country and limiting his UK visits to the required average of 91 days a year.

If you want to leave the UK, you need to make sure you understand the rules and actions to take to become a non-UK resident – including how to handle continuing UK connections, having accommodation available, the details of any full-time employment contract, and return visits. Not doing so could prove costly and unpleasant.

You should also think carefully about the lifestyle changes required. In the end, most people don't really want to leave the UK. There aren't that many realistic alternative tax regimes, and those that do exist can be unpalatable for personal reasons.

Swiss cantons have been highly active in trying to attract UK taxpayers with the prospect of low tax rates, clean streets, efficient transport and stunning scenery. Other jurisdictions, such as Monaco and the Channel Islands, have also found favour with some people choosing to leave the UK.

We think it is unlikely that a statutory residency test will be introduced in the foreseeable future but HMRC is continuing to take a far stricter line on those claiming non-resident status.

However, few viable alternatives offer the wealth of cultural and social opportunities found in the UK. Much as we may moan about the UK – and not just over tax – for many, personal ties, good schools, a diverse culture and being left in relative peace to get on with our lives make it the least-worst option.

We have encountered clients who have left only to return a few months later. Some have returned from abroad due to encountering rigid rules on everyday activities such as mowing the lawn and using the washing machine. And a number of spouses unwilling to abandon their own networks and lifestyle – or to disrupt those of their children – have also vetoed moves at the planning stage.

Leaving isn't an easy option logistically or emotionally. The alternative to heading for the exit is to stay in the UK with long-term tax planning.

Staying in the UK won't be as cheap as some alternatives in tax terms, but you can at least now look forward to a period of relative stability alongside the UK's other benefits.

A shrinking world

Despite recent measures on non-domiciled residents, the arrangement is still a very good deal. Individuals can live in the UK for seven years without paying tax on overseas income. If they have lived in the UK for seven of the previous nine tax years, they can pay £30,000 to be taxed on a remittance basis, which can still be extremely beneficial for people with significant overseas income.

We expect any tightening of the rules for non-doms under the Government's review to balance public opinion with a desire not to drive away highly attractive residents who contribute to the UK economy.

The world is getting smaller and people in countries such as India, Brazil and China are getting richer – only the United States now has more billionaires than China. These rich individuals are looking to manage their wealth and some are considering coming to the UK while others want expert advice on structuring their global wealth.

These newly wealthy people who settle in the UK are attracted by the country's excellent schools and universities, favourable timezone, transparent legal system and political stability.

They have often accumulated their wealth quickly with little planning or consideration of the requirements of different jurisdictions, where they may own properties, businesses or other assets such as yachts or art. A good place to start is to understand commercial requirements, such as liability protection for assets such as yachts and planes, together with an understanding of which jurisdiction the assets will be used in, before developing a flexible structure to minimise the global tax impact.

Information is global and tax authorities are working more closely together to make sure wealthy individuals pay the correct taxes and it's essential that these people are compliant in all jurisdictions. The UK offers a highly developed infrastructure of services for advising on such matters to combine compliance with effective tax structuring.

Our key message is: plan carefully and take control so that both you and HMRC are satisfied by the best possible outcome being reached.

It's a relationship business.

The Government's tough line on tax avoidance was underlined at the 2010 Liberal Democrat conference, where the party announced an extra £900m of resources to bring in £7bn of revenue by targeting all taxpayers earning £150,000 or more.

The creation of the HNW Unit does mean greater scrutiny of your affairs, but the unit is also staffed by officials who specialise in the tax affairs of successful people, who take an overarching view, and who work more closely with tax advisers than officials scattered across HMRC did before.

The Government's targets for rapid deficit reduction also make long-running exchanges and disputes with taxpayers unattractive to HMRC. Dave Hartnett, Permanent Secretary for Tax at HMRC, has said that HMRC is sometimes too tough in disputes with businesses and that more pragmatism could produce a "surge" in revenue over the next couple of years.

We agree. And though Mr Hartnett was referring to businesses, the same principle applies to how HMRC treats individuals.

We have been closely involved during the establishment of HMRC's HNW Unit and, based on discussions with the unit's leadership team, it is clear that they want a greater understanding of wealthy people and to have open relationships with advisers.

In this climate, it may be beneficial to seek a more trusting and transparent relationship with HMRC and conduct tax planning in an open way. Generally, if your arrangements make sense in the real world then HMRC is likely to treat you accordingly.

The fact is that you, your investment company, your family partnership and all other assets are now managed by the HNW Unit under one account. This departs from HMRC's previous set-up, in which different assets were managed by separate departments within HMRC – often with little communication or coordination.

Through our close relationships with the HNW unit's leadership team, and our understanding of the unit's priorities we can help clients to deal effectively with

HMRC and reach mutually acceptable outcomes. HMRC will seek to identify those who they believe are abusing the system, but by being open it is possible to establish a relationship that results in mutual understanding and pragmatic outcomes.

Planning pays off

We find too many people still think "It won't be me" and don't plan their affairs properly. This is a serious mistake in the current climate and could lead to lengthy, costly disputes with HMRC.

To minimise the potential problems arising, you need someone liaising with HMRC on your behalf at the right times and planning your arrangements with insight into how they will be perceived. We understand how HMRC views certain arrangements and can provide you with guidance around avoiding outmoded structures.

Our key message is: plan carefully and take control so that both you and HMRC are satisfied by the best possible outcome being reached.

With a period of renewed stability beckoning, the UK promises once again to be an attractive place for entrepreneurs, wealthy individuals and families. The Government will take a hard line on perceived offenders while offering a more predictable environment for successful people to organise their affairs.

You will need to review your arrangements thoroughly. Take an overarching view of your assets and priorities – both business and personal – to reap the maximum benefits of this new landscape.

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.

UK: The New UK - What’s Your Plan?