New 'profit fragmentation' tax rules could affect non-doms, says expert

"Non-doms may find that income on which they currently enjoy the remittance basis of taxation may be treated as UK source under these provisions and therefore subject to tax even if not remitted to the UK," Healy-McAdam said. She was commenting following the publication of draft legislation and a consultation response on proposals to introduce new tax rules to target 'profit fragmentation'.

The new rules are designed to tackle tax avoidance where some or part of the profits of a UK business are moved to an offshore entity where no or very little tax is paid. Such entities are often owned by an offshore trust where the UK individual is neither the settlor nor beneficiary, but some benefit from such profits can accrue to a linked person.

HM Revenue & Customs (HMRC) believes that current anti avoidance legislation is ineffective against these schemes and so intends to implement new rules from April 2019. The rules identify tests which, if met, will ensure that the profits are taxed on the UK resident individual.

Broadly, the new rules provide that a 'profit fragmentation arrangement' occurs where arrangements have been made between a UK 'resident party' and an 'overseas party' and a 'related individual' and value is transferred which is derived from anything done for the purposes of or in connection with a business subject to tax. For the rules to bite, the value transferred to the overseas party must be greater than it would be if the transaction has been at arm's length and there has to be a tax mismatch. There will be a tax mismatch if less than 80% of the UK liability is paid on the income in the offshore jurisdiction. A related individual must also have a 'power to enjoy'. 

The 'power to enjoy' test is based on the Disguised Investment Management Fees legislation and includes where value is available for the benefit of the individual who procured the transfer, increases the value of his assets or those held for him, or where he may control the application of the value transferred.

There are some exemptions from the rules on transfers for contributions to a registered pension scheme or overseas pension scheme, or to an offshore fund or to a charity.

The rules provide that where an arrangement occurs, the UK resident party will have to notify HMRC on or before the submission of their tax return for the period. Where it is 'reasonable to conclude' that the arrangements were entered into to obtain a UK tax advantage, HMRC can issue a counteraction notice to remove the advantage and the UK resident party will be taxed on the alienated profits in the UK. Where appropriate double taxation relief may be claimed.

Under the original proposals, set out in the consultation document published in April, HMRC could require up front payment of the tax if it considered that the new rules applied.

"Thankfully the idea that a notice could be issued by HMRC requiring the tax to be paid early – before the taxpayer had the chance to put forward detailed arguments contesting the liability - has been dropped for now. However, HMRC is going to monitor the position, so this proposal could come back onto the table in the future," said Healy-McAdam.

Since July 2014 anyone who has used a scheme disclosable under the Disclosure of Tax Avoidance Schemes (DOTAS) rules may have to make an accelerated payment of tax if HMRC issues an accelerated payment notice. A 'pay now argue later' advance payment regime also exists in relation to diverted profits tax.

Where a scheme has already been disclosed under DOTAS, it must also be disclosed under this legislation.

Where a current 'scheme' is caught under anti-avoidance legislation such as transfer of assets abroad, then that legislation will take precedence, however, notification will still be required.