Cleansing Mixed Fund Accounts
On 6 April 2017 a major regime change came into force affecting the way that UK resident non-domiciles are taxed. The impact of the changes meant that some non-domiciled individuals became deemed domiciled on 6 April 2017.
To ease the impact of the deemed domiciled status and to encourage deemed domiciled and non-domiciled individuals to bring funds into the UK, “cleansing relief” was introduced to enable mixed fund accounts to be segregated within a two-year window which will expire on 6 April 2019.
What is a mixed fund?
Where a single overseas bank account contains a mixture of capital, foreign income and foreign gains, this account is deemed to be tainted for tax purposes and any remittances from that bank account into the UK will fall within the ‘ordering rules’ with an unfavourable tax treatment which determines how the funds are classified for tax purposes. For example, under the mixed fund rules foreign capital gains arising from a share sale can be treated as ‘employment income’ when remitted to the UK and taxed at income tax rates of up to 45% rather than 10% or 20%.
As a result, many non-domiciled individuals who have not set up separate offshore accounts to hold different categories of overseas funds simply do not remit their overseas funds into the UK, even after they become deemed domiciled. By utilising cleansing relief non-domiciles with mixed funds will be able to seperate their foreign income and foreign gains from their clean capital and then enjoy the flexibility bringing their cleansed clean capital into the UK.
Broadly any non-domiciled individual, including those who became deemed-domiciled on 6 April 2017 will qualify for the relief provided that the nominated transfers are carried out correctly.
The cleansing process must be completed within the two-year window; if any transfers in relation to the overseas accounts take place outside of the cleansing window the transfer will not qualify.
The cleansing process involves analysing the ‘mixed fund’ accounts and separating the capital, income, and gains. The analysis can be time consuming and complex as old bank account statements and financial records will be required to identify the source of the funds in each account. Fortunately, the analysis does not need to scrutinise every component of the original transaction. It is sufficient, for example, to show that the gains were derived from the sale of shares provided that the supporting information is available.
Once the funds have been identified the taxpayer is likely to need to set up additional offshore bank accounts to make the nominated transfers into the new nominated accounts. Usually this exercise will require three overseas bank accounts to segregate the capital, income and gains.
The funds need to be grouped by their class rather than the specific origin, therefore capital gains derived from property sales and security sales can be placed into the same account.
If more than one mixed fund account exists, in more than one or multiple countries, it is possible to select which accounts to cleanse; there is no requirement to cleanse all mixed fund accounts. However, any account that remains uncleansed or partially cleansed will be subject to the normal mixed fund rules.
The transfers must be ‘nominated’ this means that there must be an express intention to cleanse that account and it should be clear from the bank instructions that the transfer is a nomination. The records of how the mixed funds were segregated and how the balance was calculated should be kept for evidence in the event that the information is requested by HMRC. HMRC does not require a formal report of the nominations made, nevertheless it is essential to keep a formal log of the nominated transfers.
The nominated accounts with clear capital should be then kept clean. A nominated account with clean capital can be interest bearing but it should be set up so that the interest is paid into a separate account.
If there is not enough evidence to support the class or origin of the funds the transfer will be invalid, it will be treated as income and there is a risk of invalidating all the previous or subsequent transfers into that account.
In some cases, a mixed fund account will contain funds that are classified as income in the UK and as gains in the country where they originated or vice versa. In these special cases advice would need to be sought.
Practical and Effective
The mixed fund cleansing relief is a rare opportunity to segregate mixed fund accounts and release funds that are currently kept offshore solely to avoid the unpleasant tax treatment of the ordering rules.
If you have non-domiciled status, the cleansing relief should be considered if you would like the flexibility to bring offshore funds into the UK in the future and you have the supporting records to segregate the accounts.
The cleansing analysis process is complicated so it is advisable to seek advice before taking any action.