British Tax Plan Could Slam Expats

New proposals would raise taxes for sales of business assets and on long-term foreign nationals. Critics ask, is it time to rein in investment?

Nothing provokes anger from the business community like the prospect of new taxes. It's no surprise then that investors and businessmen in Britain are up in arms over proposed laws that would raise taxes 80% on sales of business assets and require long-term foreign nationals living in Britain to pay taxes on their global income, or a $60,000 a year flat charge.

Speaking to the House of Commons on Oct. 9, Chancellor of the Exchequer Alistair Darling said the current system, which allows investors to pay only 10% tax when selling stakes in companies they have held for at least two years, will be replaced by a flat 18% tax on all capital gains.

Similarly, so-called nondomiciled residents—foreign nationals who have lived in Britain for at least seven of the last 10 years—must either fork over a yearly $60,000 fee or pay tax on their worldwide earnings and assets.

Right Time for a Tax Increase?

Though the measures could raise billions, they also run the risk of driving away foreign investors and workers who have added mightily to the British economy in recent years. That's the last thing Britain needs now, with financial markets still jittery from the U.S. subprime crisis and signs of slowing growth (, 10/9/07). Goldman Sachs (GS) already has downgraded its estimate of 2008 gross domestic product growth from 2.4% to 1.9%. And the latest government inflation numbers also show raw material costs for manufacturers grew in September at their highest rate in more than two years, rising 6.4% in September from 12 months earlier.

Experts thus question whether this is the right time to increase the tax burden on business. "These changes will result in a significantly higher tax bill for businesses and investors in Britain," says Bernard Sweet, director of corporate tax at London tax adviser Chiltern. "They will also complicate the tax system for both U.K. citizens and people looking to invest from overseas."

The government definitely didn't have that in mind when it hastily outlined the new tax proposals. The proposed change in the law was principally targeted at private equity firms, such as Kohlberg Kravis Roberts (KKR) and CVC Capital Partners, and at high-profile billionaires like Indian steel magnate Lakshmi Mittal and Russian energy and mining oligarch Roman Abramovich, who are rumored to have saved millions in taxes by exploiting loopholes in Britain's code.

Measures Discourage Startups

The proposed laws will affect far more than the very rich, though. Mid-tier financial professionals and investors, as well as entrepreneurs and small business owners, could be forced to pay out much more to the taxman, says Tanya Hine, president of the British Association of Women Entrepreneurs. Her members, she says, will be "taxed out of all proportion" under the new scheme, which will discourage investors from backing startups.

"More people are saying enough's enough and are bailing out," Hine says. "These measures are another blow to entrepreneurship when taxes are already too high."

According to accounting firm Ernst & Young, Britain is currently the most popular destination for foreign direct investment in Europe. During 2006, the number of projects rose 20% from 559 to 686, compared to an overall 15% increase for the European Union. But if the proposed 18% capital-gains rate gets the go-ahead, Britain's tax level will rise above those of the U.S., France, and Switzerland, where rates are 15%, 16%, and 0%, respectively.

Closing the Non-Dom Loophole

That spells bad news for private equity firms and venture capitalists looking to maximize their profits from British investments. "It hits investors in startups and small businesses massively in the pocket," says Richard Garrod, partner in international accounting and consultancy group Mazars. "It places a heavy burden on people with long-term investments, which will not encourage business development."

Adding to the woes is the possible new tax regime for nondomiciled residents. Under the current system, "non-doms" pay tax only on assets and revenue generated in Britain, not on their worldwide income. The proposed changes are designed to crack down on non-doms who locate assets in their home countries as a means of avoiding paying taxes while they live in Britain. Like the changes to capital gains, however, this has far-reaching consequences.

This is particularly true for U.S. citizens, who may have to decide whether to shell out the $60,000 charge or pay taxes on their worldwide earnings and assets. According to Anna Chapman, a senior tax consultant at Ernst & Young, the fact that Americans already pay taxes on their worldwide income would make any change in the British tax system extremely complicated.

"There are issues with different tax years and what would be seen as a [foreign] tax credit in America," she says. "It's far from clear whether the $60,000 could be used as a tax credit, or whether the U.S. authorities would view it as a fixed charge," thus rendering it nondeductible. That could mean Americans would fork out $60,000 each year on top of their tax obligations—a prospect that would disproportionately hit mid-tier professionals over highly paid private equity bosses or hedge fund managers.

Silver Lining for Shrewd Investors

While the rising tax burden could throttle foreign investment in Britain, there could be a silver lining for shrewd investors willing to exploit the changes to their own advantage. As the date for the capital-gains switch-over approaches, firms could force discounts out of investors looking to offload their assets before the higher tax rate kicks in.

Similarly, the investment industry could see its tax burden fall by 22 percentage points by moving assets from cash deposits, whose earnings are treated as ordinary income and subject to taxes of up to 40%, into capital gains investments that pay only 18% tax, says Mazars partner Paul Willans. "Canny investors need never pay more than 18% tax on their investment portfolios," he says.

Whether the British government will let that happen depends on the details of the new tax regime to be outlined in December. Until then, the business community will be left in limbo while politicians decide its fate. At a time of global economic uncertainty, such a delay will only exacerbate the current instability.

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