The UK tax authority, HMRC, are busy writing to thousands of private individuals who they think may owe additional UK tax, or at least need to explain their ‘offshore’ income and gains. The HMRC letters cause a range of reactions, from sheer panic through to comments such as “shall I put this letter in the bin?”; neither of which is recommended! Ideally a calm and considered response is recommended, with expert tax support. Here we look at some of the issues we are seeing in practice.
India’s tax transparency position
To crack down on perceived tax evasion and avoidance, the Organisation for Economic Cooperation and Development (OECD) established the Common Reporting Standard (CRS). The CRS is a multinational agreement which calls on participating countries to obtain financial information from their financial institutions and automatically exchange that information with other jurisdictions. Take a look at our interactive map demonstrating the status of the CRS on a global basis.
Transparency continues to be an important topic of conversation for private clients – please see the BDO World of Private Clients research report which includes analysis into the latest trends and challenges linked to tax transparency and reporting.
Both the UK and India were early adopters of the CRS which means the flow of data between the two countries is now well advanced. Data analytics by HMRC to identify individuals where there may be a tax loss is also sophisticated and often unbeknown to private individuals living in the UK. In practice we see HMRC issuing these so-called ‘nudge’ letters to UK resident individuals with a financial link to India. The nudge letters are designed to prompt individuals to review their UK tax position and check whether there are any undeclared offshore income and gains, i.e. from Indian sources or other sources outside of the UK.
What are HMRC looking into?
We see nudge letters from HMRC that specifically focussed on Indian bank account income, investment gains, an individual’s domicile position and property held in India.
There are three main types of bank accounts which are available for overseas investors in India or Non-Resident Indians (“NRIs”):
- Non-Resident Ordinary accounts (“NRO”);
- Non-Resident External accounts (“NRE”);
- and Foreign Currency Non-Resident accounts (“FCNR”)
NRE accounts in particular offer an attractive proposition for overseas investors (those not living in India). Not only do they typically offer high rates of interest, but there is also the added benefit that any interest earned is tax-free. This is the Indian government’s way to entice inward investment for India’s future economic development.
UK Tax implications
As with most situations involving the UK tax legislation, foreign bank account reporting and compliance is rarely straight forward. Specific tax advice should be sought based on individual facts and circumstances. Being clear about personal residency and domicile status for tax purposes in both countries is a crucial starting point.
In generic terms, UK resident and domiciled individuals are subject to tax on their worldwide income and gains on an arising basis; this is regardless of the tax-exempt status in India. Foreign Tax Credit relief is available in respect of tax deducted at source on NRO accounts. However, tax credit relief is restricted to 15% in accordance with the UK-India Double Tax Agreement (“DTA”). It is therefore important that NRIs inform their Indian banks of their NRI status so that the tax deducted at source is restricted to 15% and not the standard 30%.
UK resident individuals who are non-domiciled in the UK (and not deemed domicile in the UK) can elect to be taxed on the remittance basis of taxation. As a result, UK tax is only payable on foreign income or gains that are remitted to the UK. Individuals who have been resident in the UK for at least seven of the previous nine tax years will have to pay an annual charge of £30,000 to elect for the remittance basis to apply. The charge increases to £60,000 once UK residency is at least twelve of the previous fourteen tax years. Furthermore, a claim for the remittance basis of taxation results in a loss of an individual’s UK personal allowance as well as their Capital Gains Tax annual exemption. Where the total unremitted foreign income and gains is less than £2,000 the remittance basis of taxation applies automatically with no loss of personal allowance or annual exemption.
Could Tax Sparing Relief help you?
NRE and FCNR accounts are tax-exempt to incentivise inward overseas investment to India.
The issue however is that this tax-exempt incentive is lost as UK resident individuals are taxed on an arising basis on their worldwide income and gains. So, a UK resident individual who is a higher-rate taxpayer suffers no Indian tax liability on any interest earned in an NRE account but is liable to a 40% tax charge in the UK. No Foreign Tax Credit relief would appear available as there is no foreign tax to relieve.
To overcome this issue, the UK-India DTA allows for a specific notional tax credit relief known as Tax Sparing relief. The idea is to give investors in India a measure of relief where they have been offered a tax incentive. This notional tax credit relief is restricted to a period of ten years after the exemption (from Indian tax) or reduction is first granted.
Tax Sparing Relief is a little-known relief which can be valuable when determining the UK tax position of UK resident individuals who hold Indian bank accounts. It appears not only in the UK-India DTA but in DTA’s between the UK and other countries too, including Bangladesh, Kenya, Mauritius, Pakistan, and Sri Lanka.
Undisclosed Indian bank interest
Understanding the UK tax implications of income arising overseas, including consideration of any reliefs that may be available, can often be complex. Failing to take appropriate advice can be costly in terms of intrusive tax investigations and increased financial penalties.
UK resident individuals with bank accounts in India (or overseas) are advised to seek professional UK tax advice to understand their UK position. Where a disclosure to HMRC is required in respect of historic UK tax liabilities individuals can use HMRC’s Worldwide Disclosure Facility (“WDF”).
Coming forward voluntarily can reduce the exposure to penalties. Under HMRC’s Requirement To Correct (“RTC”) regime, see Requirement to Correct tax due on offshore assets - GOV.UK (www.gov.uk). Individuals who failed to correct (known as a “Failure to Correct”) their UK tax position and are approached by HMRC in respect of undisclosed overseas income, for example linked to India, could be subject to penalties of at least 150%.
For a no obligation discussion in regards of your worldwide income and your UK tax liability, feel free to contact us.
This article was written by Tax Dispute Resolutions Senior Manager, Piyush Patel. For more information contact Piyush.