Private Client Focus | Calling time on tax evasion

The tide has been changing for tax evaders for many years now, but even the most cool-headed of culprits must have felt the heat when politicians’ denouncements were plastered over the broadsheets: George Osborne proclaimed tax evasion to be “morally repugnant”, a stance echoed by David Cameron who revealed, in the wake of the Jimmy Carr saga, that he too considers individuals not paying their fair share of tax to be “morally wrong”. It is clear that Brits have had enough of recession and spending cuts, and that squirreling away cash in a secret Swiss bank account is no longer something to brag about, as some once did.

Her Majesty’s Revenue and Customs is getting tough: for 2011/12 tax returns, penalties for deliberate, offshore tax evasion range from 100 to 200 per cent of the outstanding tax (depending on the territory of the undeclared funds). HMRC has the power to assess an individual’s historic tax liabilities over 20 years, so when interest and penalties have been added to the tax, being caught is for many likely to mean the loss of all the offshore funds (and in some cases more). Tax evaders now risk having their name and photograph published on the internet and acquiring a criminal record, so the realities of being discovered by HMRC are likely to mean that those who have not yet acted to regularise their undeclared assets will be feeling more inclined to do so than ever before.

Some people think the risk of being caught by HMRC is non-existent and that their secret is safe with their Swiss bank, or pin their hopes on the fact that they inherited the funds from a relation, so it was not their problem. This is now very naïve. HMRC have collated vast amounts of data in a variety of ways, some of them morally questionable (for example when it was stolen and sold by bank employees). Many individuals are therefore astonished when they get a letter out of the blue from HMRC asking questions about their foreign accounts, by which time it is often too late to put things right.

The first issue for UK taxpayers is to understand what tax they should have paid, and for many this is the stumbling block resulting in non-compliant funds, rather than a desire to evade tax. As a starting point UK resident and domiciled individuals are taxable annually on their worldwide income and realised capital gains. However, if a resident individual is non-UK domiciled, they have the option to pay tax on the remittance basis, which broadly means that their non-UK income and realised capital gains are only taxable in the UK if they are “remitted” (the definition of which can cause confusion in itself).
One common misconception is that the remittance basis automatically applies to all UK residents with a foreign domicile. In fact, this benefit has to be claimed in an individual’s tax return (and this was also the case pre-2008 for income tax). Failing to make that election means that an individual is taxable on their worldwide income and gains on a normal, arising basis.

So, what are the options for people who have undisclosed foreign investment portfolios, either established personally or inherited from a relative? The good news is that despite HMRC’s crackdown on tax evasion, their goal (at least for the time being) appears to be to encourage people to come forward. There are therefore still options open to regularise in a relatively favourable and low-key way.

Safe disclosure

For many people the Liechtenstein Disclosure Facility (LDF) will offer a risk-free solution that enables retention of the vast majority of an account’s capital value. The LDF is a disclosure facility agreed between HMRC and the Liechtenstein Government in 2009, which allows UK taxpayers with undeclared liabilities to regularise their offshore assets by only paying certain taxes due over a limited time (the LDF period, 6 April 1999 - 5 April 2009, plus subsequent tax years). Pre-April 1999 liabilities are forgiven. For those UK taxpayers (including individuals, companies or trustees, whether or not UK resident) who qualify for the full benefits of the LDF, the liabilities are subject to a fixed penalty of 10 per cent of the overdue tax during the LDF period, immunity from prosecution and the ability to avoid certain inheritance tax (IHT) liabilities entirely.

The opportunity to avoid IHT liabilities that fall within the LDF period is extremely attractive, and it affects all those who inherited an account on a relative’s or friend’s death before 5 April 2009. In order to benefit, a taxpayer must elect to use the composite rate option (CRO). This entails paying a flat rate of 40 per cent on all income and realised capital gains within the LDF period, rather than paying tax at a taxpayer’s marginal rates, and it also restricts the ability to carry forward capital losses. However, given the potential savings, it is undoubtedly generous.

The other option to regularise open to those with a Swiss bank account is a tax co-operation agreement (TCA) between the UK and Switzerland. Although the respective governments signed a memorandum in August 2011 to introduce the TCA, there has been much speculation about whether it would come into force, as initially indicated, on 1 January 2013. However, a petition to call a referendum in Switzerland has recently failed, so it should now be full steam ahead.

The TCA provides for two-fold regularisation: the first is a one-off withholding payment on 31 May 2013, of between 21 and 41 per cent of the account’s capital value with the account holder remaining anonymous. Provided funds have not been withdrawn from the account since 2002, this will regularise liabilities relating to the assets (not just the current account holder’s liabilities) in relation to IHT, capital gains tax, income tax and VAT. Should taxpayers caught by the TCA wish to avoid this deduction, they must authorise their bank to disclose their name and the existence of the account to HMRC. Going forward, unless account holders authorise disclosure of the account to HMRC they will suffer automatic tax deductions on income and realised capital gains, at just below the highest marginal rates.

The drawbacks
Although a disclosure under the LDF will often be the cheaper method of regularising an undisclosed account, there are some specific circumstances where it may be a more expensive option. One such example is where a UK taxpayer has a life insurance policy which holds an underlying investment portfolio over which they have retained the ability to make specific investment decisions. If such a policy falls within the personal portfolio bond legislation, a particularly nasty annual deemed gain of 15 per cent arises, chargeable to income tax. Tax is charged on the gain regardless of the underlying performance of the investments, and it is cumulative. That means that if such a policy was purchased in 2006 (often in the wake of the introduction of the European Savings Directive) for £500,000, the fact that in 2009 the value of the policy had decreased to £450,000 would not affect deemed gains of £75,000 in the first year, £86,250 in the second year, £99,187 in the third year and so on. It is not hard to see that the value of such an account can quickly be wiped out by these historic tax charges, and in that context a deduction of perhaps 21 per cent of the value of an account under the TCA looks extremely favourable.

Another example of where the TCA may offer a cheaper solution is where a taxpayer has received large amounts of taxable (but untaxed) remuneration into his Swiss account after April 1999. Under the LDF tax would still be payable on the receipt whereas under the TCA it would not. However, if the individual has made withdrawals from the account since 2002 the TCA will not, of itself, provide ?complete regularisation.

Given the complexities involved in determining the most appropriate course of action for each individual, there is no one-size fits all solution to undeclared tax liabilities. Those who may be affected should seek urgent professional legal advice to understand the full extent of their exposure and the options available to them. The Swiss clock is now ticking faster!