Offshore tax penalties: case study

Former Chancellor of the Exchequer, Minister Nadhim Zahawi, has made a large tax settlement involving tax penalties with HMRC, according to the press. It probably relates to the undeclared capital gains on the sale of shares in one of his business interests. How did HMRC calculate his penalties? With the benefit of hindsight, what might he have done to mitigate the penalties?

We have made his case into a Case study for offshore penalties. 

• A non-UK domiciled but UK resident individual, Mr Z, had set up an Offshore trust in Gibraltar for the benefit of himself and his family.
• He arranged for Shares issued by a start-up company to him in return for his work, to be issued to the trust instead of him.
• The shares were later sold for £20 million. No UK Capital Gains Tax (CGT) was paid on the sale and no tax was paid in respect of the share issue.
• Mr Z and his wife then took interest-free loans from the trust of £10 million each. Again no UK tax was paid.

Mr Z had filed a Self Assessment return for the year in which the shares were sold, on time, but it did not mention any of the above or declare any capital gains.

Although a high-wealth individual, he claimed not to have sought any specific tax advice about the share disposal when he prepared his return, simply assuming that he did not have any tax liability in respect of the sale and did not have to disclose it.

Following a tip-off, HMRC looked into his tax affairs and determined that:

• CGT of £4m should have been paid on the sale of the shares.
• An incorrect Self Assessment return had been filed for the year the shares were disposed of and this related to an offshore capital gain so increased penalties applied.
• Mr Z had been careless when he prepared the relevant tax return.
• Although the potential lost tax exceeded £25,000 asset-based penalties did not apply as Mr Z’s behaviour was not deliberate.

What penalties can HMRC charge Mr Z?

Enhanced Tax-geared penalties apply in a case involving offshore income or capital gains. 

Gibraltar is not a named 'category country' according to the legislation which makes it a Category 2 case, and the maximum penalty is therefore 150% of the tax due.

 
The onus was on Mr Z’s to prove that his behaviour in failing to declare a transfer of shares into an offshore trust, or the later gain made by the trust was 'careless' and not 'deliberate.'

Mr Z explains to HMRC that he had a reasonable excuse for his failure to disclose the proceeds of the share sale: he relied on the advice of his accountants. As a non-tax expert, he had selected, he thought, suitably qualified advisers and had expected them to provide him with the correct advice, he protests that he was unaware of the fact that the loans reveal that he was a settlor of a settlor-interested offshore trust.

HMRC did not accept this excuse maintaining that as Mr Z and his wife had taken such large loans from the trust they clearly should have taken more care with their tax affairs. HMRC decided that his behaviour was careless.

Mr Z failed to spot the error and so he was unable to tell HMRC about it before HMRC found out of their own accord. This makes his disclosure 'prompted'. From the table, the maximum penalty which can be charged for a careless error is 45% of the tax due and the minimum 22.5% depending on 'the quality' of the disclosure once the error was discovered.

HMRC makes reductions to the maximum penalty according to the quality of the disclosure, say as follows:
(1) For 'telling', a reduction of 15% out of a possible 30%, some information was provided about the transactions but there were big gaps in the information with crucial details being left out.
(2) For 'helping', 20% out of a possible 40%, Mr Z had allowed the inspection of certain records and attended some meetings, but was not proactive in offering information about the transactions waiting in the large part for HMRC to specifically ask for it.
(3) For 'giving', 10% out of a possible 30%, because Mr Z had been very slow in responding to requests for information and documents requiring several reminders.

HMRC made a reduction of 45% to the maximum penalty of 45%, resulting in a fine of 24.75% or £990,000.

Mitigation: all with the benefit of hindsight

• Had Mr Z taken the advice of a suitably qualified tax adviser, he could have put up the defence of making a 'reasonable excuse' of reliance on an adviser and avoided the allegation of carelessness. In our example, we note that he most definitely had advisers but it looks as if he failed to take reasonable care to ensure that they were suitable for his needs.
• If he had told HMRC about the error before they found it, it would have been 'unprompted': he also may not have had any penalties.
• A non-domiciled potentially UK resident should always take tax advice before acquiring UK residence. If you can live off 'clean capital', you may well be able to avoid UK taxes for some time. 
• As a non-domiciled individual, if you want to invest in a UK start-up company and you want to avoid making a taxable remittance into the UK you can consider a claim for Business Investment Relief to remit to the UK, tax-free, their offshore income and gains in order to invest in qualifying UK companies.

Useful guides on this topic

Tax penalties: undeclared offshore income or gains
What penalties apply for errors and failures relating to offshore Income and Capital Gains Tax (CGT)?

Acting for a trust: start here
This is an essential guide for advisers and trustees on how to manage the tax affairs of a UK trust and how to avoid common pitfalls.

Non-domcile status
Who is non-UK domiciled? What does this mean for UK Income Tax, Capital Gains Tax and Inheritance Tax? What reliefs are available to non-doms?

The Remittance Basis
What is the remittance basis of taxation? Who can claim it and when? What are the advantages of claiming the remittance basis, how much is the remittance basis charge?

What is a Remittance?
Can a non-domiciled individual avoid UK taxes? What counts as a remittance?

A closer look at the Chancellor's unusual share allotment
The former Chancellor of the Exchequer, Nadhim Zahawi, has been under pressure to explain whether £26m in unsecured loans received by himself and his wife from a family trust are, in fact, capital receipts that he should have declared for UK Capital Gains Tax, or taxable as income under the Transfer of Assets Abroad rules.