 Liechtenstein Disclosure Facility – what is it and why is it relevant?
This article was first published in Tax Journal
John Cassidy, tax investigations partner at PKF (UK) LLP, discusses the ground breaking agreement between HMRC and Liechtenstein and explains why it can be both relevant and beneficial even for those with no current connection to Liechtenstein.
Introduction
There have been various tax amnesties in recent years. They started with the Offshore Disclosure Facility in 2007. This was followed by a strikingly similar facility, the New Disclosure Opportunity, which finished earlier this year as did a programme specifically aimed at doctors, consultants and dentists. Since then there has been talk of further specific facilities aimed at other professions.
The underlying principle of all the above facilities was that a voluntary disclosure of up to 20 years or so of undeclared tax would, in most cases, lead to no questions being asked by HMRC, a relatively low penalty, and the tax affairs of the person making the disclosure being brought fully up to date.
In addition to the general amnesties, a separate facility was announced last August aimed at those with accounts or other assets held in Liechtenstein. This operates in a fundamentally different way to the other arrangements and provides a huge opportunity for legitimate tax savings in certain circumstances. The reason for this different approach is that the facility was negotiated directly between Liechtenstein and HMRC so its terms are bespoke rather than general in nature.
As is perhaps well known, Liechtenstein is a relatively small place. Its population is only 35,000 or so – to put that into context, that is less than one half percent of the population of London. What is perhaps less well known is that banking and finance is not the country’s main business sector. That honour belongs to the manufacturing industry (for example industrial fastening equipment and dental materials to name just two). According to a report by the Liechtenstein Bankers Association, 16% of workers are involved in financial services whereas 43% work in industry and manufacturing. That said, the same report shows that the financial sector accounts for about 30% of the total (value added) to the national economy; there is a mature and sophisticated banking sector with close links to both Switzerland and the EU.
Traditionally, Liechtenstein was seen as a non co-operative by the OEDC on tax matters. However, it was taken off the OEDC list of non co-operative jurisdictions in May 2009 and as recently as 5 May 2010 the Liechtenstein Government approved the creation of a new Tax Act, the aim being a simple, transparent and competitive tax law, compatible with European law. Liechtenstein also entered into a Memorandum of Understanding (MOU) with the UK in August 2009; it is this which forms the basis of the Liechtenstein Disclosure Facility (LDF) and leads to the potential opportunities now available.
Key principles of the LDF
Under the MOU, Liechtenstein banks and other financial intermediaries (for example, fiduciary and trust businesses, of which there are many in Liechtenstein) must identify ‘relevant persons’. Any of the bank’s clients who may have a tax liability in the UK, for example, if a UK address is somehow linked to the account in question, is a relevant person. Those financial institutions will be audited to verify their compliance with this requirement.
The financial institutions must then write to all relevant persons and ask them to provide a certificate to confirm that they are fully UK tax compliant. If they cannot provide such a certificate, the account holder must register for the LDF to resolve any UK tax issues, which again results in the issuing of a certificate. If the financial institution is not provided with a certificate for either route, they are obliged to close that individual’s account and cease acting for him or her.
At the time of writing, the relevant laws are passing through the Liechtenstein Parliament but most Liechtenstein financial institutions expect to begin writing to account holders with UK connections later this year.
If there is a UK tax problem
The relevant persons identified must register for the LDF and provide to the Liechtenstein bank the original of the registration certificate received from HMRC. The individual then has up to 10 months to make a full disclosure and settle the outstanding tax, interest and penalties.
If there is no UK tax problem
Some relevant persons might assert that surely no action is required if he or she is fully UK tax compliant? That is not the case and is somewhat misguided. If an LDF registration certificate is not provided, the relevant person must provide to the Liechtenstein institutions an accountant’s certificate that he or she is in fact fully UK tax compliant in relation to the Liechtenstein assets.
Provision of such certificates will not necessarily be a straightforward exercise. For example, any reporting accountant will need to consider over what period the UK tax position needs to be checked; it is unlikely to be enough to state simply that the last tax return was correct. In any case, the accountant could not do this without exploring the entries in the relevant person’s Liechtenstein account. In some cases, it may be that the UK position is relatively uncomplicated, for example, if the only item of relevance to the UK tax return is bank interest arising on a Liechtenstein account. Even so, the reporting accountant must remember that he or she is taking on an onerous task of formal certification that this is correct. He or she will, therefore, need to satisfy him or herself that this is indeed the only item of relevance so he or she will need to properly establish the source of funds going into the Liechtenstein account. If that capital comes from business profits, there is the added burden of ascertaining whether they were properly declared in (all?) prior years.
In most cases, certification will, in fact, be a difficult process. As well as the above issues, many people with accounts in Liechtenstein will not be domiciled in the UK. The accountant will, therefore, need to prove a negative, i.e. that the relevant person has not remitted taxable income or gains to the UK. Those of us that deal with wealthy non-domiciliaries on a regular basis will realise that, whilst the remittance basis is a simple principle, it is a very complicated area of tax in reality. A thorough review of transactions passing through the Liechtenstein (and probably other overseas) accounts will be required before the accountant can, with confidence, put a signature to a formal certificate stating that everything is in order. Other complications will obviously arise if the Liechtenstein presence is more than a bank account: it is not uncommon for individuals to own and invest through a Liechtenstein foundation or company.
On the positive side, the relevant person will have benefited from a thorough review undertaken by a tax adviser who has his or her best interests at heart – rather than being exposed to detailed scrutiny by an HMRC officer (which will inevitably happen at a later date) who is seeking additional tax. In addition, if the accountant identifies a tax problem, the client can then register for the LDF so that the problem is properly squared away leaving the taxpayer in a much better position moving forward. It is, of course, not uncommon to find that inadvertent remittances from a mixed account or constructive remittances have been made by an individual without him or her realising the UK tax implications.
In summary, unless the account is to be closed, even if a relevant person believes he or she is totally UK tax compliant, there is still action to be taken and that action is not necessarily straightforward.
Presence in Liechtenstein
If assets are already held in Liechtenstein there is no need to wait until contact is made by the bank. The LDF can be used immediately if a disclosure is appropriate.
On the other hand, there is no need to already have a link with Liechtenstein. Anyone who now moves offshore funds into Liechtenstein, or obtains an interest in an appropriate Liechtenstein asset can use the LDF. There are various complexities to consider before ascertaining if the beneficial terms of the LDF will be available, such as whether the original overseas bank accounts were opened locally or via a UK branch or agency. However, in principle, a Liechtenstein presence can be validly created in order to make a disclosure under the LDF. This process is underway for a number of clients and I now have access to many Liechtenstein institutions keen to facilitate the arrangements.
Potential benefits of the LDF
The MOU signed in August 2009 by the UK and Liechtenstein forms the basic building blocks of the LDF. The terms of the MOU offer some interesting options and outcomes for users and mean that significant savings can be made compared to settlements under normal disclosure routes, including previous general offshore amnesties.
Firstly, an LDF disclosure needs to cover only ten years or so from 6 April 1999 rather than up to twenty years under normal routes or the other general amnesties. Clearly this could cut the tax bill drastically. Interest on the tax liabilities could have an even more marked effect as interest rates in the early 1990’s were extremely high compared to today (at well over 10% for several years). In some instances, the interest charges for some of those early years are higher than the tax liabilities but these all drop out under the LDF as they are pre-1999. See the example in the box below.
£1m deposited twenty years ago, earning 5% interest.
LDF
From 6 April 1999 to April 2009
tax at 40% is approx. £410,000
interest is approx. £99,000
Total £509,000
Others
From c. April 1989 to April 2009
tax at 40% is approx. £660,000
interest is approx. £344,000
Total £1,004,000
Tax saved = £250,000
Interest saved = £245,000
Penalty saved = £157,000*
(*Comparing 10% and 30% penalties. Note that the penalty advantage of the LDF will be much greater when the FA 2010 penalty regime – with penalties of up to 200% – takes effect). |
I have already encountered in practice a number of other examples that illustrate the potential savings from using the LDF:
Undeclared business profits
£1m was siphoned off the profits of a UK self employment into a Swiss bank account opened in Geneva in the 1970s. This went on for many years until 1998; between 1989 and that date the amount of undeclared business profits deposited was £600,000.
Under normal disclosure routes, or indeed the offshore amnesties, the tax due is 40% of everything deposited in the Swiss account in the 20 years to 5 April 2009, i.e. tax due of £240,000 plus interest (again including high interest from the early 1990’s) and a 10% penalty.
Under the LDF the tax due is nothing. All of the undeclared business profits escape tax forever. Interest and penalties on that tax are also saved.
I should add for the benefit of those who might suggest that the LDF cannot be used to make a nil disclosure; the Swiss account also earned interest, which is taxable under the LDF post 1999. I have not referred to the liability this triggered in order to keep the illustration of the principle simple.
Undeclared inheritance tax 1
Under normal circumstances HMRC is usually restricted to looking back around 20 years (only six years in cases of failure to take reasonable care following changes to time limits with effect form the end of March this year). However, there is no such limit for inheritance tax (IHT). Hence HMRC can still collect undeclared IHT if the death occurred in, say, 1986. In one case, the taxable estate included a Swiss account with £1m in it; no IHT was paid on that asset. Again there may also be issues with bank interest earned pre-death and post distribution of the estate, but I want to keep this example simple.
Normally, £400,000 of IHT would be due plus interest (which will be huge since 1986) and penalties.
Under the LDF the tax due is again nil. The MOU with Liechtenstein removes everything, even IHT, pre- April 1999 so £400,000 plus interest and penalties is saved forever.
Undeclared inheritance tax 2
For simplicity, I will assume the facts are as in IHT example 1 but with a death post April 1999, say in 2008. On the face of it, tax due under the LDF is just the same as under any other route, i.e. £400,000.
Under the LDF, however, the person making the disclosure can opt to use the “composite rate”. This means that there is no need to calculate the accurate amount due in respect of specific taxes in the normal way. Instead, a flat rate of 40% is used to work out a figure that is then deemed to stand in the shoes of all taxes that are theoretically due. The question is, what figure to apply the composite rate to? HMRC agrees that the composite rate in these circumstances is applied to all income and gains – i.e. not to the estate assets - in the six years prior to death (being the longest period HMRC can look back under section 40 TMA 1970). Clearly this is another potentially sizeable saving.
Diverted company profits
The composite rate can also be useful in cases concerning a participator in a close company who has diverted profits into his or her personal bank account. In this common scenario, there is potentially corporation tax, VAT, section 419 tax (now section 455 CTA 2010) on an overdrawn participator’s loan account and a beneficial loan to think about. That is in addition to any national insurance contributions issue that may be apparent. The total tax could easily be more than 40%.
Consider an example of £1m diverted from a VAT registered company to a director/shareholder. The tax due is:
- Corporation tax at 28% on the net of VAT amount £238,000
- VAT at 17.5% £149,000
- s.455 on participator’s loan account (assuming it started at nil) £250,000
- Total tax due £637,000
Under the composite rate arrangement the total tax due is 40% of undeclared income, i.e. £400,000, a saving of £237,000 before interest and penalties (and NIC) are considered.
Conclusions
There are three possible scenarios relevant to the agreement with Liechtenstein:
- If there is already a presence in Liechtenstein, the LDF can be used if appropriate (i.e. if there is a UK tax problem).
- If there is already a presence in Liechtenstein but there is full UK tax compliance, action still needs to be taken by the account holder to obtain an accountant’s certification of the position.
- If there is no current link with Liechtenstein, one can now be validly created and the LDF used if appropriate.
Overall, the LDF is good for both HMRC and the individual. The client makes potentially large savings from using the LDF as opposed to any other route of making a disclosure and HMRC gets some additional tax. HMRC is well aware of the potential for the scale of savings explained in this article but, at the same time, is keen to reap the additional tax receipts that it could not otherwise obtain.
It is clear that further Liechtenstein-type arrangements may be on the agenda. However, in my view, it is misguided to wait for these to come along as we do not know what the terms of future arrangements negotiated with specific jurisdictions will be. Given that the potential penalties on offshore accounts have increased to up to 200% in schedule 10, Finance Act 2010, it is unlikely that any future bilateral agreement will be as favourable as the LDF.
It is incumbent on advisers to act in their clients’ best interests by considering the potential savings to be made if their circumstances fit any amnesty on offer: it would be unfortunate to say the least if suitable clients missed the opportunity to use the LDF. I realise it can be a delicate issue to raise the topic of tax amnesties with clients but, if only to protect ourselves, the message that the LDF can save clients money should be spread as widely as possible.
John Cassidy can be contacted at john.cassidy@uk.pkf.com
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