HOW TO REDUCE YOUR TAXABLE INCOME Income offshore With the so-called ‘amnesty’ currently being offered by HM Revenue & Customs (HMRC) – see elsewhere in this edition of Schmidt Tax Report – this is quite a hot topic at the moment, but for the purpose of this article we will be talking only about wholly legitimate and fully disclosed tax planning (which is the only sort of planning Schmidt Tax Report advocates). Basically, what we will be looking at here are three ways to save tax by putting income offshore, which could be categorised as the simple method, the less-simple method and the complex method. Thank you for nothing? Before going into the detail, though, it’s difficult to resist the temptation to comment briefly on the ‘amnesty’. Elsewhere in this edition of Schmidt Tax Report, its limitations are exposed to view fairly comprehensively, and from a purely practical standpoint (ignoring the moral aspect of things for the moment) it seems to us that HMRC, by adopting such a mean-spirited approach to the problem, has missed an opportunity – an opportunity that was much more effectively grasped by the Irish tax authorities the other year when they offered a no-strings-attached amnesty. This is anything but, and purely from the prudential point of view a lot of people will be considering whether to disclose or not. While complete disclosure is the only thing that we recommend here in any circumstances, there seems to be no particularly strong motivation for those who have decided not to come clean in the past to come clean now. Of course, the carrot of possibly reduced penalties may not seem very appetising, but there is always the stick of automatic disclosure by offshore banks etc., which could take the decision entirely out of the taxpayer’s hands. A problem with this from HMRC’s point of view is the enormous amount of information it could conceivably receive, together with the difficulty of allocating enough time to its analysis, and the ability of taxpayers to move out of those jurisdictions where the Revenue has the power to require the information. So the stick may not be such an invincible weapon as HMRC would like us to think. Having said all the above, we hope we won’t be accused of inconsistency, or being mealy mouthed, when we say that full and complete disclosure is the only morally acceptable option in our view: not because HMRC or the Government has any kind of moral right to our money but simply because it’s wrong to tell lies. Having got that off our chest, let’s move on to the real purpose of this article, which is to show how putting money offshore can legitimately be used as a tax-planning strategy. Simple planning   The very simplest form of offshore tax planning comprises a short deferral of tax: some jurisdictions can still be found where interest paid on the bank deposit can be paid gross, that is without the 20% deduction of tax that applies, for example, to UK bank deposits in the names of UK-resident taxpayers. So interest received in the year ended 5th April 2008, for example, will not suffer a tax charge during the year, but will give rise to a liability to make a payment through the self-assessment mechanism on 31st January 2009: an average deferral of the tax of 16 months. For those who, though resident, are not domiciled in the UK, on the other hand, this could end up being not so much a deferral as a permanent saving. Non-UK domiciliaries are not chargeable to tax on offshore income unless that income is remitted to the UK. And if it does need to be remitted, there are clever (and legitimate) ways of avoiding the tax even then. Less-simple planning   Even if everyone concerned is UK-domiciled and -resident, a longer deferral of tax is possible by putting money in trust offshore. Provided (and this is a very big proviso) the settlor of the funds, that is the person from whom the funds originated, is excluded, together with his spouse, from enjoying any benefit from the trust in the future, tax is not suffered by the trust in the UK all the time the income is rolled up offshore and not paid to a UK-resident beneficiary. If a lot of money is involved, this sort of deferral can be very useful, and it includes the situation where individuals put money in a trust for their children. There is always the possibility of the beneficiary being non-UK-resident when the time comes to distribute the income. Complex planning   Things get a lot trickier when you don’t want to wave goodbye to the money you are putting offshore but wish to retain the ability to benefit from it yourself in the future. For non-UK domiciliaries, you simply need to make sure that the offshore trust or company receiving the income (which can include non-UK-sourced trading profits) is genuinely non-UK-resident. This, in essence, means doing it properly as far as the offshore agents are concerned and not trying to take short cuts. Remittances can ultimately be made, very often, by one of the clever methods briefly mentioned above. For UK-resident and -domiciled individuals, on the other hand, we are now in very difficult territory indeed. First of all, the income concerned, which you have put offshore, has to be real offshore income. It’s no good incorporating your corner shop in Balham in a Bermuda company, because that Bermudan company will pay UK tax itself on the profits of the UK trade. So the investment, or trade, has to be genuinely located outside the UK. So far, this is the same whether you are domiciled in the UK or not. For UK domiciliaries, though, there is an added hurdle to overcome, which is anti-avoidance legislation relating to the transfer of assets abroad. Where a person basically sets up any kind of offshore arrangement, as a result of that arrangement income is received by a non-resident company or other entity, and the person doing the setting up can be expected to benefit from the income in the future, then, subject to one important exception, the UK individual who did the setting-up will end up paying UK income tax on the whole of the offshore income., which is very painful, especially if income is thereby charged at 40%, which would have only suffered 30% (or 28%) if it had just been put into a UK-resident company in the first place. The one exception, though, is a very important one, and this is where it can be shown that there is a commercial reason for setting up the offshore arrangements. If there is a commercial reason, HMRC will not charge tax on the UK-resident individual based on the offshore entity’s income. One straightforward example of a commercial reason is where you are doing business offshore and there is an expectation, or even requirement, that businesses carried on in that country will be incorporated in a limited company based in that country. The Revenue can hardly quarrel with that justification. Another commercial justification for using an offshore entity might be simply that the business, or assets, is really situated in that other country, and there has been no artificial transfer of assets away from the UK. The ownership of substantial investments and real property in other countries may come into this category. If we are talking about the profits of a business, and that business, say, depends on good IT connections, the choice of a country which is advantageously placed with regard to Internet access can be commercially highly desirable. In this connection (if you’ll forgive the expression), we understand that the Isle of Man, for example, is well placed from the point of view of quick connections between the UK, Ireland and other countries. So, although no one should think that avoiding tax on offshore income by UK domiciliaries is easy, it’s not impossible either, providing you can tick the right boxes.