Is London becoming a tax haven?
Earlier this year, an International Monetary Fund working paper classified the United Kingdom as an "offshore financial centre," alongside jurisdictions such as the Cayman Islands and Bermuda. Newly appointed Chancellor of the Exchequer, Alistair Darling, rejected the suggestion, saying in an interview with Accountancy Age that the characterization was "suggested by some organizations on the back of some seriously flawed experimental methodology for identifying tax havens." But some prominent super-wealthy residents of London are taking advantage of the "business interest taper relief" provision enacted in 2000 with the support of Gordon Brown, then the Chancellor, often along with tax loopholes associated with non-domiciled or non-resident tax status, and they pay taxes at a much lower rate than the average Briton.
Business interest taper relief
The newest tax break, one enjoyed by figures prominent in private equity deals, works by reducing the proportion of the capital gain that is taxable by the length of time the asset has been owned, according to Grant Thornton. Business assets attract a maximum taper relief of 75 percent of the gain after two years of ownership. Non-business asset gains are reduced by 5 percent per year up to 40 percent.
Private equity executives pay income taxes on their basic pay and bonuses at the normal 40 percent rate, but a large part of their income comes from the "carried interest," the 20 percent of the profits they can take when they have paid back their investors, usually after reorganizing some of the companies they purchase. The interest on the carry is called a capital gain and they end up paying only 10 percent on their profits.
When Dominic Murphy of Kohlberg Kravis Roberts and Co., Damon Buffini, managing partner of Permira, Europe's largest private equity firm, and Robert Easton, the managing director of the Carlyle Group, partners in private equity firms, were questioned recently by members of parliament (MPs) about how much tax on capital gains they had paid, they claimed they didn't know. Astonished by their responses, Treasury committee chairman, John McFall responded, according to thisismoney.co.uk: "You guys are the really bright guys. . . .I ask you how much you pay in capital gains tax and you can't tell me? I find that amazing."
Non-domicile classification for tax purposes is unique to the UK. Enacted at the end of the eighteenth century around the same time the UK income tax was introduced, non-domicile status was intended to protect the incomes of Britons in the colonies. Initially the non-domicile rule allowed residents of the UK to declare that some other country was their real domicile and pay tax only on the money they "remit" to the UK or earned in the country. Later it was expanded to allow those who were born in the colonies to live in England without paying tax on foreign rents and stocks as long as the money remained outside the country, according to a report in The Guardian. Now wealthy Russians who have emigrated to London can claim non-domicile status as can some Americans working in private equity. Individuals born in the UK may claim non-domicile status in some cases if their parents were born overseas.
The Inland Revenue reported 112,000 individuals filled out the non-domicile form for 2005, but that number may go as high as 200,000 this year, because of an increase in applications following a Treasury crackdown on offshore accounts. Non-domicile status is self-reported on a form with 19 questions that can be downloaded from the internet.
Supporters of the non-domicile rule say that it promotes inward investment. Critics say that that the opposite is true – that it deters investment because it requires non-domiciled residents to pay tax on money earned on global investments that they bring into the country, The Guardian reports.
British citizens can avoid paying capital gains tax on UK investments by claiming non-resident status if they do not spend more than 90 days in Britain on average over four years. British citizens who are non-resident for three years do not have to pay income tax on overseas income and if they move their money into offshore accounts, the money no longer counts as UK-sourced.
Acknowledging the controversy surrounding non-domiciled status and taper relief, Richard Lambert, Director-General of the Confederation of British Industry (CBI), supports the Treasury's ongoing study of the effects of non-domiciles on tax fairness, but objects to any hasty changes or "clunky action," saying they would delight Michael Bloomberg, New York City mayor, because it could drive top flight financial figures from London to the U.S., The Times reports. Mayor Bloomberg has blamed Sarbanes-Oxley for some of the movement of IPO's to London and Hong Kong over the past five years.
The low tax of 10 percent for private equity partners is acceptable, Lambert says, because of the entrepreneurial risk involved in their deals. "Clearly there is a question to be asked on these large deals about whether it is risk or income . . . if it is a duck, it is a duck, if it is a chicken, tax it as a chicken," said Lambert in The Times.
One area where the investments of non-domiciles is visible, is the skyrocketing central London housing market, where luxury real estate prices advanced almost 35 percent from June 2006, the biggest annual gain since mid-1979, according to a report on bloomberg.com. Capital gains and income from these investments earned by non-domiciles go out of the country, the Observer reports, and thus are not taxed. In some cases, the non-domiciles do not even pay the 4 percent stamp duty.