Liability to UK tax

UK residents are liable to tax on their worldwide income and gains that arise or accrue in a particular taxable year (“the arising basis”). A UK resident who is not domiciled in the UK in that year (“a foreign domiciliary”) may make a claim to be taxed on their non-UK-source income or gains to the extent only that they are remitted to the UK (“the remittance basis”). A foreign domiciliary will remain liable to an arising basis of taxation as regards their UK-source income and gains. Additionally, a foreign domiciliary who elects for taxation on the remittance basis in a particular year and who qualifies as a long-term resident must pay a charge (“a remittance basis charge” or “RBC”) of £30,000 for that year if they have been resident in the UK for at least 7 of the previous 9 years but fewer than 12 years, or £50,000 if they have been resident in at least 12 of the previous 14 years. Business investment relief (“investment relief”) is one of the reliefs which allow sums to be received in the UK without taxation under the remittance basis. The rules which define what constitutes a remittance to the UK and the conditions which need to be satisfied to secure Investment Relief are complex and not always clear. The summary below is intended to be a helpful guide but as the financial and domicile circumstances of non-residents and foreign domiciliaries will vary considerably, potential claimants of Investment Relief should seek specialist advice.

Remittance to the UK

An individual’s non-UK source income or chargeable gains (“relevant foreign income”) are remitted to the UK if relevant foreign income is:

• brought to, or received or used in the UK for the benefit of the foreign domiciliary or others who are also treated as relevant persons by the rules (“relevant persons”). Relevant persons includes husbands and wives, civil partners, children and grandchildren under the age of 18, associated close companies and settlements; or
• used to pay for a service which is provided in the UK to or for the benefit of the foreign domiciliary or other relevant persons; or
• used (or anything derived therefrom) is used outside the UK to pay a debt which relates to a service provided in the UK to or for the benefit of the foreign domiciliary or other relevant persons (or which relates to other specified property);
(all of which might be termed “primary purposes” though this is not a term used by the rules) or
• given to a third party and then applied for any of the primary purposes; or
• transferred to or for the benefit of a third party as part of a ‘back to back’ connected operation pursuant to which the third party provides property which is applied for any of the primary purposes.

Investment relief

Investment relief has been available since 6 April 2012. It is designed to encourage non-domiciliaries to invest in UK trading companies. If relevant foreign income is brought into or received in the UK and within 45 days is used by a foreign domiciliary or other relevant person to make a qualifying investment then it is not treated as being remitted to the UK provided a claim is made by the first anniversary of the 31 January following the tax year in which the relevant foreign income is brought into or received in the UK. If all or some of the relevant foreign income is brought into or received in the UK but not invested then it is not treated as being remitted to the UK provided it is taken offshore within that 45 day period.

A person makes a qualifying investment (“a qualifying investment”) if:

• Condition A: shares or securities are issued to him by or if he makes a loan to a company (and a loan is only regarded as made when it is drawn down) which must have certain characteristics (“a target company”); and
• Condition B: additionally the foreign domiciliary or other relevant person does not (directly or indirectly) obtain or become entitled to obtain or expect to obtain any related benefit including a benefit received outside the UK (“a condition B prohibited benefit”).

There are two no-benefit rules in the legislation. The condition B prohibited benefit rule requires that there must be no related benefit at the time of the investment; and the extraction of value rule, described below, applies if there is a benefit later on. The condition B prohibited benefit rule is severe in that any benefit disallows the entire relief.

Target Companies

A Target Company must have the following characteristics:

• a limited company none of whose shares are listed on a
recognised stock exchange (a “private company”); and
• carry on one or more commercial trades or be preparing to do so within the next 2 years (an “eligible trading company”); or
• exist for the purposes of making qualifying investments in trading companies and hold at least one qualifying investment or be preparing to do so within the next 2 years (an “eligible stakeholder company”); or
• be the holding company of a 51% eligible trading company subsidiary and belong to a group of private limited companies all of or substantially all of whose activities are concerned in
carrying on commercial trades or, it is reasonable to expect, will be so concerned within 2 years (an “eligible holding company”).

A commercial trade includes a business carried on for generating income from land; must be conducted on a commercial basis and with a view to the realisation of profits; and includes the carrying on of activities of research and development from which it is intended that a commercial trade will be derived, or will benefit.

Condition B Prohibited Benefit

The condition B prohibited benefit rule requires that the foreign domiciliary or other relevant person must not (directly or indirectly) obtain or become entitled to obtain or expect to obtain any related benefit. A benefit includes the provision of anything that would not be provided to the foreign domiciliary or other relevant person in the ordinary course of business or would be provided in the ordinary course but on less favourable terms or not on arm’s length terms.

The rules are drafted very widely. “anything” means anything in money or money’s worth, including property, capital, goods or services of any kind and “provision” includes any arrangement that allows a person to enjoy or benefit from the thing in question (whether temporarily or permanently). A benefit is “related” if it is directly or indirectly attributable to the making of the investment (whether it is obtained before or after the investment is made) or it is reasonable to assume that the benefit would not be available in the absence of the investment.

Clawback remittance charge

Investment Relief may be lost upon the occurrence of a potentially chargeable event leading to the relevant foreign income being taxed on the remittance basis (a “clawback remittance charge”). There are four categories of potential chargeable events:

• First, investment relief is lost if the foreign domiciliary or other relevant person who made the investment disposes of all of their holding unless the lesser of the disposal proceeds and the sum originally invested (less amounts previously taken offshore to avoid a clawback remittance charge) are taken offshore or reinvested within 45 days of the disposal proceeds first investment relief may be lost upon the occurrence of a
potentially chargeable event becoming available for use by or for the benefit of the foreign domiciliary or other relevant person.

HMRC require that the relevant foreign income used to fund the qualifying investment be identified with the first amount of value taken out of the business until the total amount invested has been matched. This means that, in general, the investor will not be required to take chargeable gains which arise on disposal out of the UK in order to benefit from the relief. However, if an investor disposes of part of their investment, it may be necessary for them to take the gain arising on that part disposal out of the UK, or to reinvest it in a target company to meet this requirement. The rules define the ‘sum originally invested’ to be the amount of the money used, or the market value of the other property used to make the investment, with market value, for these purposes, being determined as at the date of the potentially chargeable event, rather than as at the date of the investment.

Investment relief is also lost in respect of all of the holding in the target company if:

• Secondly, the extraction of value rule is breached; or
• Thirdly, the 2-year start-up rule is breached; or
• Fourthly, the target company ceases to satisfy the characteristics described above, for example if the company stops trading or becomes quoted – cessation of trade due to insolvency being excluded provided it is for genuine commercial reasons;

unless all of the holding is disposed of and the whole of the disposal proceeds have been taken offshore or reinvested within 90 days of the day on which value is received, or, as the case may be, the day on which the foreign domiciliary or other relevant person became aware or ought to have become aware of the breach or that the target company had ceased to satisfy the characteristics described above. In exceptional circumstances HMRC may agree to extend this grace period where it would be unreasonable to expect the individual to dispose of an investment within the 90 day grace period.

The extraction of value rule is breached if the foreign domiciliary or other relevant person receives (otherwise than by way of a disposal) value in money or money’s worth from:

• the target company;
• an eligible trading company in which the target company has
made or intends to make an investment;
• any 51% subsidiary of the target company; or
• anyone else but in circumstances that are directly or indirectly attributable to the investment or to any other investment made by the foreign domiciliary or other relevant person in any of the foregoing.

Value received includes value received in connection with insolvency. It does not include value that would be treated as the receipt of income for income tax or corporation tax purposes (or which would be so treated if the foreign domiciliary or other relevant person were liable to such tax) provided it is paid in the ordinary course of business and on arm’s length terms. This would cover, for example, the payment of dividends by the target company. The extraction of value rule would be breached, if, for example, the target company were to use funds invested to guarantee loans made to the individual; or if payments were made to a third party which are linked to payments made to the individual.

Proceeds are “reinvested”: if the foreign domiciliary or other relevant person uses them to make another qualifying investment or the proceeds themselves are a qualifying investment whether in the same or a different company.

Mixed funds

The typical mixed fund is a bank account with diverse entries. Funds are distinct and not mixed if they are held in separate accounts or sub-accounts at one bank. If a person holds a fund which includes different types of income/gains, or income/gains of different years, and the person remits part of the fund to the UK, it is necessary to know: which type of income or gains have been remitted, as different rates may apply; or, as the case may be, which year’s income or gains have been remitted, as different rates and different rules may apply to income of different years. Similarly, if the person transfers some assets out of the fund, without remitting the assets to the UK, there is no immediate tax charge, but it is necessary to know which income/gains are regarded as in the remaining fund and which in the transferred assets, when there are later remittances of either the remaining funds or the transferred assets. The legislation sets out rules which are intended to answer these questions. Where an onshore transfer is made from a mixed fund the transfer is treated as being made in a prescribed priority order of differing categories of income and gains. The basis on which differing categories of income and gains are computed for these purposes is complex and investors are recommended to seek advice from their independent and appropriately qualified taxation advisers.

Investment relief and the EIS

The EIS and investment relief are broadly complimentary reliefs. Investors may claim both reliefs from one subscription. EIS funds may control timing of investments by ‘pooling’ funds from non domiciliary investors offshore in order to ensure the 45 day rule is not breached. Remittances to cover fees remain taxable unless discretionary investment management services are provided offshore. EIS funds may coordinate the advance assurance process on behalf of investors.

Roger Blears is an experienced investment funds solicitor who advises clients on the corporate, regulatory and tax aspects of structuring investment funds, including EIS, IHT, VCT and other fund structures.

Roger Blears

0208 159 2501

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