23 November 2018

By Emma Heelis-Adams

Since April 2017 the remittance basis of taxation has not been available to non-UK domiciliaires ('non-doms') who have been resident in the UK for at least 15 out of the previous 20 tax years. This change means that many long-term UK residents who were previously taxed on the remittance basis are now subject to tax on their worldwide income and gains. 

A quid pro quo for the removal of access to the remittance basis of taxation was the opportunity for non-doms to 'cleanse' offshore mixed funds. This opportunity is only available until 5 April 2019 and, due to the complexity involved in many cleansing exercises, non-doms must act now otherwise they risk not having sufficient time to complete the process. 

Tax returns and the payment of tax liabilities for the 2017/18 tax year (the first year in which long-term UK resident non-doms could no longer access the remittance basis) are due by 31 January 2019. As this deadline approaches, many non-doms who must now pay tax on their worldwide income and gains are turning their attention to deciding which funds they will use to pay their tax liabilities. If untaxed offshore income and gains are brought into the UK to pay a tax liability (other than the remittance basis charge), the income and gains will themselves be subject to tax. In order to avoid creating an additional tax liability upon paying a tax bill, non-doms may want to make use of either the mixed fund rules or the cleansing rules to ensure that clean capital is used when making payments to HMRC.

In this article we firstly take a detailed look at the existing mixed fund rules, before turning to consider the new cleansing rules. 

The mixed funds rules

A mixed fund is a fund or other asset which contains a mixture, for UK tax purposes, of income and/or capital gains and/or clean capital. This description is overly simplistic, however, as a mixed fund may contain different types of income and/or gains. It may also contain income and/or gains from different tax years, which the legislation determines should be looked at separately.

A mixed fund may be in cash, or may be comprised in an asset. For example, a share in a company or real-estate bought with a mix of clean capital and untaxed income, is viewed as a mixed fund containing capital and income.

There are two broad approaches that can be taken when considering an investment portfolio: look at each asset within the portfolio individually and trace through each asset to ascertain whether it contains income/gains/capital, or look at the portfolio as a whole and treat the portfolio as a single asset. It is understood that HMRC will accept either approach so long as it is consistently applied to that portfolio year-on-year.

For remittance basis users, or those previously taxed on the remittance basis, who have untaxed income and/or gains offshore, it is important to know in what order funds from a mixed fund are deemed to be brought into the UK. If clean capital is brought into the UK then no tax liability should arise. By contrast, if untaxed income or gains are remitted then the taxpayer will usually find themselves with an income tax or capital gains tax liability.

The rules regarding the order in which funds in a mixed fund are deemed to be remitted to the UK were amended in 2008. The pre-2008 rules still apply to pre-2008 mixed funds and so it is necessary to consider both sets of rules. In some cases both sets of rules will apply to the same mixed fund. In cases involving pre- and post-2008 funds, it is generally accepted that all post-2008 funds will be treated as coming into the UK, prior to any pre-2008 funds.

Pre-2008 mixed fund rules

Prior to April 2008, there were no legislative provisions regarding the order in which funds were deemed to be remitted from a mixed fund and it was necessary to rely on case law. The key case is Scottish Provident Institution v Allan and HMRC used to rely on this as authority for the proposition that income was deemed to be remitted to the UK first from a mixed fund. 

In fact, upon a proper reading of the case, we consider it is more properly authority for the proposition that you cannot 'nickname' funds to turn them into something else (i.e. you cannot call something capital, when it is in fact income and expect it to be treated as capital). The case calls for an examination of the substance of the matter: if there are regular payments in the nature of income, then these are likely to be treated as income. 

HMRC does now take a more nuanced approach stating that 'in the absence of evidence to the contrary' income should be treated as coming out of a mixed fund first.

A taxpayer is entitled to say that if part of a mixed fund has suffered income tax in the UK, that part will come out of the mixed fund first and it is thought that the same should apply to foreign taxed income (so that double-tax relief may potentially be claimed on it).

Planning with pre-2008 income and gains

Many of the pre-2008 remittance planning techniques can still be used to create clean capital in relation to pre-2008 mixed funds. If a taxpayer has a fund which comprises just pre-2008 income and gains, it may be possible to use these funds in the UK without incurring a tax liability. If a taxpayer is able to make use of any of these planning techniques then a cleansing exercise might not be required.

Planning opportunities include:

  1. Alienation: the taxpayer transfers assets to another person (often his or her spouse), who brings those assets into the UK. This is effective so long as the taxpayer does not benefit from the assets in the UK or the arrangements are an obvious 'conduit'.
  2. Source ceasing: the taxpayer has a fund that contains income from a particular source. So long as that source has ceased (e.g. the bank account has been closed, or the employment from which it was earnings has ceased), the taxpayer may remit the income without incurring a tax liability.
  3. Non-cash remittances: the pre-2008 remittance rules only apply to remittances of cash. If an asset representing pre-2008 mixed funds (e.g. a car) is brought into the UK, there will be no taxable remittance. It is arguable, however, that this only applies to income and not gains.
  4. Deemed gains: where the legislation deems there to be a gain, but there are no proceeds of sale (e.g. a gift to a trust) then under the pre-2008 rules the gain could not be remitted to the UK because there were no proceeds to which the deemed gain could attach.
  5. Servicing loan interest offshore: where the capital of a loan has been used in the UK, the interest on the loan can still be serviced offshore using pre-2008 income and gains without a taxable remittance. However, the capital of the loan must still be repaid using clean capital to avoid a remittance.

In addition to the traditional pre-2008 planning techniques, the transitional rules enacted when the legislation was amended in 2008, also allow for non-taxable remittances in certain situations:

  1. Income and gains already brought to the UK pre 6 April 2008, (even if no tax was payable on that remittance), can not be subject to a tax liability now.
  2. Property, other than money, acquired before 12 March 2008, cannot be remitted to the UK. This transitional rule was intended to mirror point three above, so was intended largely to apply to chattels (e.g. a car). However, the transitional rule was drafted more widely and could, for instance, apply to shares purchased with pre-2008 income and gains before 12 March 2008. This transitional rule means that such income and gains cannot be taxably remitted to the UK.
  3. Until 6 April 2028, the interest on pre 12 March 2008 loans used to acquire UK residential property can still be serviced using offshore income and gains (including post 2008 income and gains) without a taxable remittance occurring.

Post 2008 mixed fund rules

The Finance Act 2008 set out specific rules regarding mixed funds. The legislation was drafted with the aim of providing clarity in this area (rather than being an anti-avoidance provision) and whilst there are some lacunas in the legislation, it does largely achieve what was intended.

The legislation sets out several different categories of income, capital gains and capital and then sets out the order in which those categories are deemed to be remitted to the UK from a mixed fund. In broad terms:

  • Income is remitted first, followed by capital gains and then by capital
  • All funds from a tax year are deemed to be brought into the UK prior to the funds from a preceding tax year (e.g. all income, gains and capital of the 2010/11 tax year will be deemed to be brought into the UK before any income, gains or capital of the 2009/10 tax year).

This ordering by tax year is potentially advantageous to those who will no longer be able to access the remittance basis of taxation from April 2017. Those individuals will be subject to UK tax on their worldwide income and gains, so offshore income and or/gains from the 2017/18 tax year (and future tax years) in an account will be subject to tax in the UK. The post 2017/18 offshore income and gains in the account will be treated as coming into the UK first if there is a remittance from that account. As the income and gains will already be subject to tax in the UK, there can be no further tax upon remittance. Therefore, a taxpayer could consider using these funds to pay their UK tax liability for the 2017/18 tax year, without incurring an additional liability which would be incurred if untaxed pre-2017 income and gains were brought into the UK.

The 2017 re-basing relief (available to those who became deemed domiciled on 6 April 2017) may provide a further advantage as it seems that a realised gain which benefits from 2017 rebasing will still sit at the top of a mixed-fund and should therefore come into the UK first and tax-free if there is a remittance.

The rules do however throw up some quirks particularly where mixed funds are lent to a relevant person (e.g. an offshore company). The mixed funds may be deemed to be in two places at the same time in relation to the taxpayer: both in the company and represented in the debt owed to the taxpayer. In some cases one remittance can even lead to two potential tax charges where both clean and mixed funds have been transferred to an offshore company. Advice should be sought in any situation involving the transferring of mixed funds to another relevant person where there may subsequently be a remittance by the taxpayer or the other relevant person.

Offshore transfers

Before moving on to consider the cleansing rules, it is necessary briefly to consider the 'offshore transfer' rules, as the cleansing rules work by altering the application of the offshore transfer rules.

The 2008 legislation sets out the position if an 'offshore' transfer is made from an offshore account. An offshore transfer is a transfer where funds are transferred or otherwise spent offshore, rather than brought into the UK. In such a case, a proportionate amount of each category of income, gains and capital in the account is treated as being transferred. 

An anti-avoidance provision provides that an offshore transfer does not include a transfer which is made with the intention of there being a remittance to the UK in relation to the transfer.

The cleansing rules

The word 'cleansing' in this context is something of a misnomer. The rules do not allow income and gains to be cleansed. Instead, the rules allow a mixed fund to be segregated into its constituent parts, allowing clean capital to be accessed which would not otherwise be accessible without first remitting income and gains into the UK.

The cleansing rules effectively 'switch off' the usual ordering rules for transfers made from mixed funds, so that an offshore transfer made under the cleansing rules should not be a 'proportionate' transfer in the manner described above. This opens up the possibility of transferring out individual elements of each account to access clean capital that is part of the mixed fund (and otherwise unreachable).

In order to qualify for the relief under the cleansing rules, an individual must:

  • be domiciled outside the UK (and not born in the UK with a UK domicile of origin)
  • have been a remittance basis user in at least one tax year since 2008.

The transfer needs to be made on or before 5 April 2019. The cleansing must be effected by way of a transfer from one offshore account to another offshore account and a nomination must be made of what element of the mixed fund the transferred funds contain. HMRC advise that the nomination should be made at the same time as the transfer.

The cleansing rules only apply to 'money' and therefore, where a mixed fund is comprised in an asset (e.g. an investment portfolio) the asset will have to be sold in order to take advantage of the cleansing opportunity. The practicalities and time involved in liquidating large investment portfolios mean that if a non-dom wants to use the cleansing rules in relation to an investment portfolio, the liquidation process should be started immediately.

The rules provide that only one nominated transfer can be made from a mixed fund account to a newly segregated account. This does not, however, prevent a number of new segregated accounts from being opened and provided there is only one transfer from the original mixed fund account to each of these new segregated accounts, the cleansing rules can apply. This means that multiple transfers out can be made from the same account, allowing, if desired, the separation of different types of income and gains and income and gains from different tax years.

The legislation very specifically provides that if an over-nomination is made, the nomination will be ineffective, meaning the cleansing will have failed. By way of example, a taxpayer may think he has a mixed fund containing £10 and £90 capital. He transfers £10 to a new account and nominates this as income. He thinks that he has therefore created a pot of £90 of clean capital which has can remit to the UK without incurring a tax liability. If it subsequently transpires that there was only £9 of income in the first account he will have made an over-nomination. The nomination is ineffective and so the transfer out of the first account will have been an offshore transfer under the standard rules. The taxpayer will, therefore, still have income in his first account and if he brings funds from the account into the UK, the income will be deemed to be brought into the UK first, triggering a tax liability. It is therefore very important that taxpayers only transfer out the parts of a mixed fund which they can clearly identify.

One solution to this problem is to always take a conservative approach when deciding how much income/gains to nominate. In the above example, the taxpayer could have transferred £7 to the new account and nominated that as income. When it subsequently transpired that there was only £9 of income in the original account, there would not have been an over-nomination. The problem with this approach is it leaves income in the original account.

A potentially better solution is to calculate the capital in an account and then take a conservative approach to transferring out an amount to be nominated as capital, creating a new capital pot and leaving behind a mixed fund. This approach is not strictly in line with the wording of the legislation but it is understood that HMRC will not take the point and therefore in practise this may well be the best solution.

Foreign currency presents something of a difficulty in relation to the cleansing rules, as non-GBP funds are only converted into GBP at the point of remittance. Yet for many individuals undertaking a cleansing exercise there is no immediate intention to remit funds to the UK. The inability to know the GBP value of the fund creates difficulties in terms of determining the value to be nominated (which, as discussed above, is crucial to making the nomination effective). The professional bodies in this area have suggested that so long as a consistent year-on-year approach is applied for each specific foreign currency account, a mixed fund analysis can be carried out in either the foreign currency or in GBP. However, HMRC has replied to this suggestion to say that further discussion is required. HMRC comments to date refer to the position set down in its current guidance: that is for foreign currency bank accounts performing the analysis in the currency concerned with the conversion to sterling only occurring when the remittance takes place. Any cleansing concerning a foreign currency account will therefore require a careful consideration of the most appropriate route to take.  


In conclusion:

  1. The mixed fund rules and offshore transfer rules are complex and can create traps for the unwary, leading to inadvertent remittances of income and gains to the UK.
  2. There are, however, multiple potential ways in which pre-2008 mixed funds can be used in the UK without creating a UK tax liability.
  3. The cleansing rules present a one-off opportunity to create a pot of clean capital which can then be brought into the UK tax free.
  4. Undertaking the calculations to analyse what is in a mixed fund and then applying the cleansing rules may be a time-consuming process, as may be the process of liquidating investments, and so taxpayers must act now in order to take advantage of this opportunity.
  5. Where taxpayers who can no longer access the remittance basis need to pay their 2017/18 tax bill by the end of January 2019, it is worth remembering that the post 6 April 2017 income and gains in a mixed fund, which are deemed to be brought into the UK first, can effectively be brought into the UK tax free, as they will already be subject to UK tax.

Key contact

Headshot John Barnett

John Barnett Partner

  • Head of Partnerships
  • Private Client Services
  • Tax

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