A tax holiday that’s hard to justify

The Labour party call for stripping non-domiciled UK residents of tax privileges has gone down well with people at large

April 15, 2015: In January 1799, British Prime Minister William Pitt the Younger brought in a 10 per cent tax on income for Britons for the first time, as part of efforts to help the indebted nation continue to fund the war against Napoleon. Income earned abroad was excluded, however, as long as it wasn’t brought into the UK, to continue to promote investment into the colonies.

The government also introduced the concept of “domicile” — a notion that was separate to that of residency and helped Britons abroad “identify themselves in the empire where they lived,” writes Nicholas Shaxson, in Treasure Islands: Tax havens and the men who stole the world. It meant, quite simply, he says, that “While English administrators could be resident in India and domiciled in England, Indians in London would remain domiciled in India, and never fully British.”

Centuries later, in 1914, however, again triggered by revenue needs to pay for the World War, foreign assets began to be taxed with one exception — those deemed to be “domiciled” abroad remained exempt, thereby creating Briton’s controversial and archaic ‘non-dom’ tax status, which remains in place to this date. It’s not known how many Indian-origin business people claim that status, though Lakshmi Mittal is certainly among them.

All that could change, however, after the general election set to take place at the start of May — Ed Miliband, the leader of the Labour party has pledged to scrap the tax describing it as “indefensible” and an “outdated” idea whose time had passed. “We don’t compete in the world by offering tax advantages that we don’t give to all our citizens.”

Differential treatment
It’s a move welcomed by social justice campaigners in the UK, who’ve long argued that it created a two-tier system, which enabled some of the world’s wealthiest people with strong links abroad to afford advantages not available to the rest of British society (an irony, given that the status was initially created to discriminate against foreigners).

“I’m not surprised people think there is one set of rules for rich people and one set of rules for everyone else,” said Richard Bacon, a Conservative MP during a recent parliamentary committee meeting that was shared widely online.

The Labour proposal has also elicited a predictable response from others; the right-of-centre Daily Telegraph lambasted the proposal as “cataclysmic” for the economy, quoting a tax lawyer who warned that it would lead to an “enormous flight” of wealth investors and business people from the country.

However, it’s notable that by and large critics are in the minority — financial publications such as the Financial Times and The Economist have supported the Labour proposal, noting that the prized non-dom status was not the deciding factor for the vast majority who came to the UK for a variety of different reasons — cultural, financial and social. It was merely an added advantage.

“In many ways the non-dom status was a golden hello for high net-worth foreigners coming to the UK — sending the message that it is a welcoming place both to live and from a financial perspective,” says Saionton Basu, a partner at law firm Duane Morris, who argues the proposal is unlikely to drive most away, given that it merely puts Britain on a par with most other jurisdictions.

“The Labour proposal would essentially make a person’s global income taxable — and ensure that they wouldn’t be able to circumvent or ring fence a part of it — India, the US, and many other countries tax you on your global income subject to obtaining a double tax treaty relief.”

Many variables
In any case, only a small proportion of those who claim non-dom status use the option to avoid tax on foreign income and capital gains. In 2008, the then Labour government introduced a rule that limited the period that a non-dom could avoid tax on offshore income not remitted into the UK to seven years (significantly longer, it should be noted, than most countries). After that period, to keep that privilege, a person would have to pay an annual fee of between £30,000 to £90,000 depending on the period of time they had resided in the UK. According to estimates by the Institute of Fiscal Studies, just under half of the over 110,000 people who have non-dom status claimed the remittance basis. And with just over 5,000 people paying the annual fee, it can be assumed the vast majority have been in the country for less than seven years.

However, setting aside the question of revenues, estimates on how much additional revenue could be brought in by scrapping the non-dom status vary widely, given the large number of variables — the non-dom status has other major problems with it. For one, given its arcane background, it remains inherently sexist — the status can be passed on via fathers and grandfathers only, while the concept of domicile remains open to generous interpretation — a person could live and work in the UK with little link to their country of origin but still reap the tax benefits accorded by it.

Global relevance
But perhaps the most significant and harmful impact of the tax is on the global fight against tax avoidance and evasion. In February, the Guardian, which revealed the numerous ways in which HSBC’s Swiss private bank had enabled clients to evade and avoid tax, unveiled details of how the bank encouraged individuals to use their non-dom status to pay tax neither in the UK nor in other countries they had strong links to, putting funds into a private Swiss account, shrouded in secrecy.

In addition, should the changes be brought in, British tax authorities ability to gather information on the foreign earnings of some of its wealthiest residents could also help tax authorities in India and other parts of the world ensure against abuse of tax regualtions, particularly with the automatic exchange of data set to be introduced

“Yes it goes without saying that this change could help India with its tax collection, assuming we have developments such as the automatic exchange of information,” says Basu. “This is a much more mature tax administrative system, where processing of tax happens at a far more efficient, effective and automated level.”