Was it a Budget for the American? Did Prime Minister Cameron’s recent love affair for President Obama shine through when the Chancellor of the Exchequer made his annual Budget announcement on 21 March?  While reducing the top rate of tax from 50 per cent to 45% per cent was welcomed by some, tax rises were signalled for others, such as the level of income from which individuals start paying tax at 40 per cent. UK tax rates remain higher than comparable income tax rates in America (although US corporate rates remain much higher than UK rates.)

Indeed, generally speaking most US citizens here in the UK have paid more UK in tax than they have owed to Uncle Sam. While US citizens continue to be required to file a host of complex annual US income tax and information tax returns, very few have ended up significant amounts of US tax each year. The 2012 Budget does not change this position.

Statutory Residence Test

The government confirmed their intention to base UK residence rules on a statutory footing from 6 April 2013. Given our familiarity with current rules and advance knowledge of the proposed changes, our view is that the coming twelve months remain an ideal time to plan towards the best outcomes for individuals leaving or coming to the UK, whether going home to America or moving on elsewhere.

Domicile

The government remains committed to increasing the remittance charge to £50,000 (from £30,000) for longer-term UK residents (those who have been UK resident for 12 or more of the previous 14 UK tax years). Any such payment would be creditable for US tax purposes.

On a more positive note, incentives will be introduced to encourage inward investment by allowing overseas income and gains to be brought to the UK for commercial investment into a qualifying UK business.

For some US persons in the UK, this will at last make it possible to remit “tainted” monies provided that the specific conditions for this relief are met.

Inheritance Tax

On a welcome note, the government intends to consult on increasing the amount that a UK domiciled individual can leave to their non-UK domiciled spouse, free of tax. This is currently limited to just £55,000.

Where this exemption is not sufficient, an election will be possible to treat the non-UK domiciled spouse as UK domiciled for IHT purposes. Both of these measures should be introduced in 2013, so overall this may be a very good year to re-visit estate planning, especially give the currently very generous $5 million “nil rate band” in the US, which is due to expire on 31 December 2012.

Enterprise Investment Scheme (EIS), Venture Capital Trust (VCT) and Seed Investment Scheme

The Chancellor announced some welcome implications and additional UK tax reliefs for these investment products. These can reduce current or future UK tax and – in the right circumstances – reduce unused “excess foreign tax credits” for Americans in the UK.

None of these are by themselves “bad things” for a US citizen investor. However, many UK investments are treated as Passive Foreign Investment Companies (PFICs) for US tax purposes.  A PFIC can result in annual US reporting and possibly high rates of US tax. Investments that are not PFICs include quoted direct shareholdings and cash. Collective investments such as UK unit trusts and VCTs are always PFICs, although some can be structured to reduce any US tax disadvantages.  Ideally US tax focussed advice should be taken before investing.

Reducing tax, saving money?

Because of the way that the changes in UK tax rates and allowances will be introduced some individuals will be better off while others will be paying more tax.

For the US person in the UK, the key to minimising the overall global tax burden is to manage “excess foreign tax credits” (put simply the difference between UK and US tax rates). Investing wisely in UK tax efficient investments can frequently help.

For example, the final date for paying pension contributions for the tax year is 5 April 2012. This is also the final date for paying contributions that use up unused “carry forward” pension relief for the 2008/09 tax year. One note of caution here, many UK pension plans may be treated as foreign grantor trusts for US tax purposes, potentially requiring additional annual US form filling forever after.  So before investing too quickly in a UK pension plan one might want balance the nuisance or costs of additional US form preparation against potential UK tax savings.

So where is the “Special Relationship”?

What seems special to us is that most Americans here in the UK will continue to pay more tax to the UK than to the US. None of this eliminates filing. None of this eliminates planning. None of this eliminates tax. Nothing is that “special”. The time to plan is now.

[Image credit: Soaring Eagle photo by Frank Kovalchek, Creative Commons Attribution]