New rules for non-domiciled individuals – avoid the minefield with Gillian Everell’s guide.
As a result of the new rules for non-domiciled individuals the UK taxation treatment of certain investments (especially retirement planning vehicles such as personal or occupational pension arrangements) may prove a minefield for those who will for the first time be paying tax in the UK in respect of their worldwide income and gains emanating during the tax year.
Pension arrangements – conditions for UK tax deduction:
- A UK income tax deduction can only be claimed by an individual on contributions made to an overseas pension scheme which has registered with HMRC.
- The individual must have been a member of the scheme prior to his arrival in the UK, have UK taxable earnings of at least the same amount of the contribution and have informed HMRC of his intention to claim income tax relief.
- The contributions must also have previously qualified for relief in the individual’s home country.
Whilst this may seem like a large number of conditions to be met, the vast majority of contributions to standard personal or occupational pension arrangements would qualify under these rules. In the case of overseas Small Self Administered Schemes (SSAS) or Self Invested Pension Plans (SIPPs) a more detailed review may be necessary to ensure any contributions will qualify for relief.
In addition, many double tax treaties, including the arrangement between the UK and the US, extend tax relief in one country to essentially equivalent schemes established in the other country. This would allow US nationals to continue to contribute to US domestic plans that are broadly equivalent to UK employer sponsored portable schemes such as 401K arrangements and group arrangements to which employers will often match employee contributions.
Income tax relief is currently available in the UK for domestic purposes, in connection with contributions, up to the lower of the individual’s earned income or the annual allowance of £245,000 for 2009/10. This annual allowance does, however, also include any employer contributions so care needs to be exercised when trying to ensure that contributions are kept within this limit to avoid the significant tax charge which results from excess contributions.
However, in his Budget address in April 2009, the Chancellor introduced new provisions, with effect from 6 April 2009, so that the amount of contributions on which an individual can gain full tax relief at the higher rate is limited to £20,000. Contributions above this level will be subject to a 20% income tax charge which will be collected via the annual self assessment tax return. Going forward, pension contributions as a way to reduce an individual’s income tax liability will need to be considered more cautiously.
There is some light amongst the gloom as there are transitional provisions allowing full relief for contributions made at least quarterly under an arrangement entered into before these new rules were announced on 22 April 2009. A pattern of regular contributions prior to 22 April 2008 but less than quarterly will increase the £20,000 limit to £30,000.
When it comes time to draw on the pension fund, it is less clear as to whether under the provisions of the UK/US double taxation agreement a lump sum payment, which would be tax free in the UK, would receive the same treatment in the US. It is recommended that specific advice is sought before any such payment is received.
Employee Benefit Trusts (EBTs)
These are popular arrangements whereby equity in a company is placed on trust for the benefit of the employees and their families. It is often possible for an employee to borrow against the value of the shares within the trust which have been allocated for them, in advance of any amounts being distributed.
HMRC are increasingly reviewing such arrangements and where the employee has been resident in the UK for 17 of the last 20 tax years and is therefore subject to UK Inheritance Tax on a worldwide basis or where the company is resident in the UK, contributions to the employee benefit trust will need to be carefully structured to ensure they do not give rise to an immediate inheritance tax liability at 20%.
Amounts received from an employee benefit trust will still be considered to be taxable earnings in the UK even if received when the individual no longer holds the employment. Where interest free loans are received this will be considered a taxable benefit with the taxable amount calculated with reference to HMRC’s approved rate of interest.
It must also be kept in mind that for US citizens and long term permanent residents, the tax deferral achievable by funding the EBT is not effective and such arrangements may therefore be unsuitable.
Roth and traditional IRA
When it comes to making contributions, Individual Retirement Accounts (IRAs) are treated like traditional pension arrangements. This means that UK tax relief will be available in respect of contributions to both Roth Special Form IRA’s (tax free in the US on exit) and Traditional IRAs (where tax relief is available in the US on contributions) in line with the rules outlined above.
In terms of receiving distributions, in the case of a Roth IRA, the double taxation agreement between the US and the UK provides for a distribution to be exempt from tax in the UK to the extent that it would be exempt in the US. This means that withdrawals from this IRA (which are considered in the US to be from taxed income) should be exempt from UK tax. With a Traditional IRA, the UK treatment follows the US treatment and therefore sums are taxed on withdrawal.
In conclusion, retirement planning, and particularly, pension contributions to a standard personal or occupation pension arrangement and an IRA, remains tax efficient. However, with the new pension rules introduced from 6 April 2006 well established, and the further changes which took effect from 6 April 2009, it is vital to keep track of the level of contributions being made by you and your employee to ensure that tax charges are not triggered unexpectedly. It is also important to ensure that the type of vehicle being used is the most appropriate to your worldwide tax obligations and any long-term retirement strategy.
Gillian Everall, Frank Hirth