The hidden dangers in going overseas to avoid capital gains tax

Essential reading for anyone planning to leave the UK to avoid capital gains tax.

Many people think it's a simply a case of leaving the UK, and selling up free of capital gains tax. This article looks at why it's not as straightforward as this, and what pitfalls there are for the unwary.

General rule for capital gains tax

Only people that are UK resident or ordinarily resident are subject to UK capital gains tax. This means that if you can lose your UK residence and ordinary residence status you should be able to sell your assets free of capital gains tax.

This applies to your assets wherever they are situated, so whether they're in the UK or overseas is effectively irrelevant.

This is a nice tax relief, as many tax authorities like to take a slice of the gain that has arisen whilst you've been in their country or on assets in their country. So you'll find that many countries eg in other EU countries they'll tax non residents for gains that arise on assets in that country. Other countries such as Australia which although can provide an exemption for non residents, will treat you as selling your local assets when you leave Australia (and thereby crystallising any capital gain then).

As you'd expect though moving out of the UK to avoid paying capital gains tax could lead to a relatively easy route to avoid UK tax, especially if the tax is substantial which may make a year or two in the sun worthwhile.

When capital gains tax can still be charged even if you're non resident and non ordinary resident

Five year rule

In 1998 to prevent people doing just that, and going abroad for a year or two to avoid capital gains tax, the government brought in new anti avoidance rules.

These state that for anyone becoming non UK resident after 17 March 1998 they will usually need to remain non UK resident for five complete tax years to avoid capital gains tax. This is in addition to the requirement to actually be non UK resident /ordinarily resident in the tax year of departure.

This means that to avoid capital gains tax you'll need to go abroad, become non UK resident/ordinarily resident, sell the asset and ensure that you remain non UK resident and ordinarily resident for five complete tax years. If you were to become non UK resident within the five tax years the capital gain is then disclosed in your tax return in the year of your return and you'll need to pay the appropriate UK capital gains tax.

Note though that the five year rule does not apply to all disposals. In particular if you are selling assets that you bought after you left the UK, there will be no five year rule. In this case you'll just have to remain non resident for the tax year of the disposal.

It also does not apply unless you have been resident in the UK for some part of at least four of the seven tax years before the tax year of your departure. It used to be possible to get around this five year rule by using double tax treaties, but this is now no longer possible.

Establishing non UK residence and non UK ordinary residence

We've seen above that it's a prerequisite to avoiding capital gains tax that you can establish non UK residence and non UK ordinary residence. Just how do you achieve that?

Well the two best routes are either:

• Move overseas permanently which means for a period of at least three years, or
• Go overseas under a full time contract of employment which lasts for at least a complete tax year

In either case you should be classed as non resident and non ordinarily resident from the date of your departure to the date of your return.

Timing

This leads onto the timing. Although you can be classed as non resident from the date of your departure (as above) this is mainly of use for income tax purposes. For example overseas income after the date you leave will be exempt from UK income tax, but overseas income received before you leave is likely to be charged to UK income tax.

This does not though apply for capital gains tax purposes. Unless you've spent at least four of the seven years before you leave the UK as a non resident you'll be charged to capital gains tax for any gains realised in the whole tax year.

So, for most UK expats they should look to ensure that they sell any assets in a new tax year after the tax year that they leave the UK. This would then allow the capital gains tax exemption to apply.

Business assets

Any assets that are used in a UK trade will remain subject to capital gains tax, even if you're non UK resident and ordinarily resident. The main application of this will be non residents selling sole trader or partnership businesses after they leave the UK. It could also apply if they're selling property that has been used by their UK business (eg a property used as a hotel or guest house).

To soften the blow, the UK does provide for generous tax reliefs on the disposal of such assets. This means that although you'll be subject to some capital gains tax, you may be able to reduce this to a rate of less than 10% by claiming business asset taper relief.

Trading stock

When looking at the capital gains tax exemption above I've been careful to refer to 'assets', as it is only assets that can qualify for the exemption. Anything held as trading stock won't be subject to capital gains tax, and therefore won't qualify for the capital gain tax exemption for non residents. One of the main applications of this will be to anyone who is a property developer. They will not be able to leave the UK and sell their properties free of UK tax, as they would be subject to income tax on properties that they acquired for resale.

S776

One area that may need to be considered is to ensure that S776 does not apply. This is an anti avoidance provision that can tax non residents dealing in land when the charge arises under capital gains tax, as opposed to income tax.

In order for S776 to apply a number of conditions have to be satisfied.

• There must be an avoidance of tax and
• Land be acquired with the sole or main object of realising a gain from its disposal, or
• land must be held as trading stock, or
• land must be developed with the sole or main object of realising a gain from disposing of the land when developed, and
• there is a disposal of the land from which a capital gain arises

If these apply, the 'gain' is charged to income tax, and the fact you are non UK resident would not avoid the UK tax charge.

There is a formal clearance procedure to obtain advance clearance, however I would not expect it to apply in a straightforward acquisition/ disposal where the activity is not classed as trading on general principles. It should however be considered in detail if you're selling UK land, especially if there are any options in place. Double tax treaty

Double tax treaties can effect the charge to capital gains tax, but as stated above they won't now prevent the five year requirement from applying.

The main cases where a double tax treaty will now apply is in relation to UK business disposals. The immovable property article (which applies to most land) in most agreements will ensure both the UK and the overseas can tax the gain. The typical capital gains tax article will also state that assets that are moveable property (eg machinery) will just be charged to capital gains tax in the country where you are resident. The exception to this is if they are used for the purposes of a UK permanent establishment.

In this case they could be charged to both UK and overseas tax. UK tax would only be an issue here is you were to return to the UK within five tax years. Therefore the definition of permanent establishment is crucial in this case as if there is no UK trade/permanent establishment under the UK domestic law there would be no UK gain, but if there was a permanent establishment under the treaty there could be a UK UK capital gains tax charge. As stated above though this is only an issue for moveable property, and would in many cases be exempt from capital gains tax in the UK if it had a value of less than £6,000.