To stem the flow of pension funds to overseas locations, where HMRC cannot tax them, it is inventing new rules.
Invest for the long term, unless you don't have one
It has been a momentous week for investors seeking to stem the decline in their portfolios, for UK pension holders looking to transfer their pensions overseas and for UK expatriates, in general, hoping to avoid paying UK income tax on their hard-earned overseas earnings. In fact, for financial advisers like me, the whole year has been momentous.
Bond markets in Europe have suffered enormously over the past six months as European leaders - namely Angela Merkel, the chancellor of Germany, and Nicholas Sarkozy, the president of France - have failed to find a proven formula that allows Portugal, Ireland, Greece and Spain (the so-called PIGS countries) and, more recently, Italy, to get their acts together and spend less than they earn.
Nobody wants to lend them money until the European Union or the European Central Bank provides a guarantee that the loan will be paid back. Not surprisingly, Mrs Merkel is not too keen on funding these profligate economies and, as a result, Italy is having to pay more to borrow euros than it has ever done since the creation of the euro 14 years ago.
And just when we thought that a solution might be imminent, David Cameron, the British prime minister, throws a spanner in the works and refuses to endorse the plan that 26 other members of the EU thought was fine.
Mrs Merkel and Mr Sarkozy have now settled for a compromise solution that the financial community, especially in the UK, is not impressed with. The consensus among most economists is that the compromise does not go far enough to create fiscal union and neither does it help the PIGS countries to balance their budgets. Until these issues are addressed properly, uncertainty will prevail and, therefore, so will volatility in financial markets.
Since Greece has such a small economy, one might ask why its departure from the EU would be so disastrous. But if this were to happen, and it defaulted on its loan repayments, several of Europe's major banks would be in serious financial trouble. One banker who, on the basis of this witticism, must surely be worth his exorbitant annual bonus, compared Greece to a plug in a bath filled with water - small but, nonetheless, essential to keeping the bath functional.
What should the average investor make of all this? One of my favourite sources for economic forecasting is Barclays Wealth. It advises its clients to take a balanced strategic view based on two key assumptions:
Ÿ The euro and the European banking system is not about to implode;
Ÿ The US economy is not shifting into reverse gear.
It believes there is just a small chance of a PIGS country being forced to leave the EU and an even smaller chance of the euro disappearing. If you believe this, as I do, then hold on to your equities and euro-denominated assets - we are not heading towards another Great Depression.
So much for investors. But what of pension holders planning to transfer their UK pension pots into a Qualifying Regulated Overseas Pension Scheme (QROPS)? These schemes offer significant benefits over UK onshore pensions for people who are planning to retire overseas, including access, at age 55, to 30 per cent of the transfer value plus (in certain schemes) 100 per cent of the growth; a tax-free pension income; no liability to UK tax on death (this is levied by HM Revenue & Customs (HMRC) at 55 per cent on onshore UK pensions); the ability to control the choice of investment assets; and greater freedom on income draw down than is available with UK onshore pensions.
To stem the flow of pension funds to overseas locations, where HMRC cannot tax them, it is inventing new rules. Some of these are appropriate and will stop "pension busting", in which funds are transferred out of the UK for the sole benefit of allowing the owner to get his hands on all the cash.
This is against the spirit of pension planning and, quite reasonably, will incur the wrath of HMRC. The owner will face some hefty penalties if found out.
But one of HMRC's proposed changes, in particular, will cause a great deal of concern to Guernsey and the Isle of Man, which are major players in the QROPS marketplace. Under existing rules, they are allowed to offer pension schemes to non-residents where the tax levied on pension income is different from that which is levied on their own nationals.
The tax rate applied on a QROPS pension income is currently zero. But from April 2012, HMRC requires them to tax QROPS pension income at 20 per cent - the same as they do for their own nationals.
HMRC has offered a consultation period until January 31, 2012, when interested parties can make their concerns known. But since its staff will be on holiday for most of this period, it is clear they will not be available for much consultation.
If HMRC gets its way, the new legislation will take effect on April 6, 2012. This gives you just over three months to get your QROPS application in place. It will be interesting to see what happens because these two offshore banking islands have been hugely influential in developing this market and have done so in a professional way.
If they fail to persuade HMRC to change its rules or are unable to persuade their own governments to reduce tax on domestic pension income, then they will lose a lot of business in favour of other jurisdictions, such as New Zealand, where tax on pension income is already at zero per cent.
And lastly, what about the UK expatriate who is desperate to avoid paying UK income tax on his overseas earnings? This is achievable providing you can meet HMRC's requirements for non-UK residency status. The rules for non-residency have never been abundantly clear, so HMRC put forward proposals this summer for a more clear definition.
Essentially, if you are fully employed overseas, spend no more that 90 days in the UK and, while there, work no more than 20 days, you are a non-UK resident. If you do not meet these conditions, then other factors come into play relating to your UK-centric lifestyle.
But do not worry yet, HMRC has just advised that the introduction of the new rules will be delayed another 12 months until April 6, 2013. So until then, the familiar, but ill-defined, existing rules will apply.
Bill Davey is a wealth manager at Mondial-Financial Partners in Dubai. Contact him at email@example.com