Budget Notes

BN107 RESIDENCE AND DOMICILE: ANNUAL £30,000 CHARGE FOR SOME USERS OF THE REMITTANCE BASIS

Who is likely to be affected?

1. Adults who are UK residents, who have been UK residents for more than seven of the past ten years, who claim the remittance basis of taxation and who have unremitted foreign income and gains in excess of £2,000 a year.

General description of the measure

2. Legislation will be introduced in Finance Bill 2008 to ensure that adult non-domiciled, or not ordinarily resident, individuals who have been in the UK more than seven of the past ten tax years, will be able to continue to access the remittance basis of taxation on payment of an annual charge of £30,000 charged on the foreign income and gains they leave outside the UK, unless their unremitted foreign income and gains are less than £2,000.

Operative date

3. This change will have effect on and after 6 April 2008.

Current law and proposed revisions

4. Currently, UK residents who are either not domiciled or not ordinarily resident in the UK can access the remittance basis of taxation without any UK tax being charged on the foreign income and gains they leave outside the UK. So the remittance basis means that income and gains arising overseas are only taxed in the UK when they are brought into the UK.

5. On and after 6 April 2008, non-UK domiciled and / or not ordinarily resident adults who claim the remittance basis of taxation, who have been resident in the UK more than seven of the past ten tax years, will have to pay a £30,000 annual tax charge in respect of the foreign income and gains they leave outside the UK. This £30,000 charge is in addition to any tax due on UK income and gains or foreign income and gains remitted to the UK.

6. Following consultation there are 3 main changes to the draft legislation published on 18 January. These are:

•    in the draft legislation the charge did not have effect for remittance basis users who have unremitted foreign income and gains of less than £1,000 in the year of assessment. This has been raised to £2,000;

•    the charge will apply only to adults so that individuals under the age of 18 will not have to pay the £30,000 charge until the year they turn 18;

•    the tax charge will take a different form from the one set out in the draft legislation. It will be a tax charge on unremitted income and gains rather than a stand alone charge.

7. The £30,000 annual tax charge will be payable through the self assessment system. If the adult pays the £30,000 tax charge from an offshore source directly to HM Revenue & Customs (HMRC) by cheque or electronic transfer, the £30,000 will not itself be taxed as a remittance. If the £30,000 is repaid it will be taxed as a remittance at that point.

8. Individuals who have access to the remittance basis of taxation can choose each year whether they wish to claim the remittance basis of taxation or pay tax on their worldwide income and gains. Adults will not have to pay the £30,000 minimum tax charge for a particular year if they do not claim the remittance basis for that year.

9. The tax charge to be introduced from April 2008 will take a different form from the one set out in the draft legislation published on 18 January. It will be a tax charge on unremitted income and gains (or a combination of the two) rather than a stand alone charge. Individuals paying the charge will choose what foreign unremitted income or gains the £ 30,000 is paid on. As a result the tax paid will either be income tax or capital gains tax. The unremitted income or gains upon which the £ 30,000 tax has been paid will not be taxed again when and if it is eventually remitted to the UK. There will be ordering rules that determine that untaxed unremitted foreign income or gains will be treated as remitted before income or gains upon which the £ 30,000 has been paid.

10. The £30,000 charge will be income tax or capital gains tax and should be treated as such for the purposes of Double Taxation Agreements. The tax will also be available to cover Gift Aid donations.

11. Further information on the £30,000 charge, and in particular how it will be treated by the US under the UK/US double taxation agreement and applicable US domestic tax law is available on the HM Treasury website at: www.hm-treasury.gov.uk

12. For convenience, that information is reproduced as an Annex to this Budget Note.

Further advice

13. If you have any questions about this change, please email offshorepersonal.taxteam@hmrc.gsi.gov.uk or telephone 020 7147 2762. Information about Budget measures is available on the HM Revenue & Customs website at www.hmrc.gov.uk

ANNEX TO BN107: RESIDENCE AND DOMICILE: ANNUAL £30,000 CHARGE FOR SOME USERS OF THE REMITTANCE BASIS

March 11, 2008

MEMORANDUM FOR HER MAJESTY'S TREASURY

RE: UNITED STATES FEDERAL INCOME TAX

CONSEQUENCES TO UNITED STATES CITIZENS OF CERTAIN PROPOSED REVISIONS TO THE UNITED KINGDOM REMITTANCE BASIS OF TAXATION

You have requested our advice regarding certain of the United States federal income tax consequences of specific proposed revisions to the current United Kingdom remittance basis of taxation as applied to United States citizens subject to that tax. This memorandum responds to that request.

As we have discussed, Skadden has many partners and employees based in London, including many United States citizens, who would be affected by the proposed revisions. Several of these individuals have been and continue to be public in their opposition to them. In this context we want to be clear that, in accordance with our terms of engagement, our advice is limited to the United States federal income tax consequences of the proposed revisions and does not address other matters, including the merits of the policies that form the basis for the proposals, which are, of course, matters for the Chancellor of the Exchequer and not for us.

You have provided us with a brief description of the proposals as well as a copy of your instructions to counsel describing the proposals. Our understanding of the proposals is based on these materials and on our discussions with representatives of Her Majesty's Treasury and Her Majesty's Revenue & Customs. We have not reviewed draft legislation implementing the proposals. Any changes to the proposals as described herein could affect our analysis and the views we express.

Our advice is principally based on the United States Internal Revenue Code of 1986, as amended (the "Code"), and regulations issued by the United States Treasury thereunder ("Treasury Regulations"), and on the Convention Between the Government of the United States of America and the Government of the United Kingdom of Great Britain and Northern Ireland for the Avoidance of Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and Capital Gains currently in force (the "Treaty"), and the United States Treasury's Technical Explanation1 of the Treaty (the "Technical Explanation"). We have met with representatives of the United States Treasury and the Internal Revenue Service ("IRS") to discuss our analysis and views, but neither agency has in any manner endorsed our analysis or the views we express.

1 Department of the Treasury, Technical Explanation of the Convention Between the Government of the United States of America and the Government of the United Kingdom of Great Britain and Northern Ireland for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and On Capital Gains.

This memorandum is divided into several parts. First, we describe the proposals establishing a Remittance-Based Minimum Charge ("RBMC"). Second, we analyze the creditability of the RBMC against United States federal income tax. Third, on the assumption the RBMC is a creditable foreign tax for United States federal income tax purposes, we analyze the potential limitations on the ability of United States citizens to utilize the RBMC as a credit against the United States federal income tax on non-United States source income under the Code, and against the United States federal income tax on United States source income under the Treaty. Finally, we provide our concluding views.

This memorandum is intended to provide you with an overview of the issues discussed herein without reference to the facts and circumstances of any particular United States taxpayer. Accordingly, it is not intended as tax advice for any taxpayer, and it was not written, and cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed under the Code.

Description of United Kingdom Treasury Proposal

In general, persons resident and domiciled in the United Kingdom are taxed on their worldwide income and capital gains as they arise. Those persons who are resident but not domiciled in the United Kingdom ("resident non-doms") may elect, alternatively, to be taxed on the remittance basis, under which non-United Kingdom source income and capital gains are subject to tax only when remitted to the United Kingdom. 2 Generally, income and capital gains are considered remitted under United Kingdom tax law when they are transmitted or brought to the United Kingdom. With respect to any remittance, taxpayers bear the burden of establishing, where appropriate, that such remittance is not out of previously unremitted income or capital gains (for example, a remittance reflecting a return of capital or pre-residency income). The tax rate applied to remittances that reflect income or capital gains depends on the character of the remittance. On or after April 6, 2008, a maximum rate of 40% 3 applies to remitted employment and other income generally, and an 18% rate applies to remitted capital gains.

Her Majesty's Treasury is proposing a number of changes to the remittance basis of taxation including an amendment that, if enacted, would cause certain resident non-doms who elect the remittance basis to pay a minimum tax (called a Remittance Basis Minimum Charge or "RBMC") on non-United Kingdom source income and capital gains not remitted to the United Kingdom in the year earned. In particular, persons who are resident for United Kingdom tax purposes in the current year, and were resident for seven of the prior nine tax years, and who elect the remittance basis for the current year, will be required to pay an RBMC of £ 30,000 on unremitted non-United Kingdom source income and capital gains. For this purpose, the taxpayer may designate whether the RBMC is levied on (i) unremitted non-United Kingdom source income, (ii) unremitted non-United Kingdom source capital gains, or (iii) a combination thereof. Further, the RBMC is levied on the amount of unremitted non-United Kingdom source income or capital gain, or combination thereof, that would give rise to a £ 30,000 liability, after taking into account any credit for source based non-United Kingdom income tax reliefs, losses and allowances.

2 Domiciliaries of the United Kingdom who, for the purposes of United Kingdom tax law, are "resident but not ordinarily resident" in the United Kingdom may also elect to be taxed on the remittance basis.

3 In general, employment and other income are subject to graduated rates of 20% and 40%. (There is also a savings rate of 10% applied to a narrow range of income.)

Resident non-doms whose net liability for United Kingdom tax on non-United Kingdom source income is less than the RBMC should choose to report their worldwide income and capital gains on an arising basis (which also provides for certain allowances not permitted to taxpayers filing on a remittance basis). Any resident non-dom initially filing on a remittance basis and paying RBMC can amend his or her filing for a period of up to one year from the date thereof to report worldwide income and capital gains on an arising basis and receive a refund of any RBMC paid in excess of net income tax liability. Otherwise the RBMC is not refundable.

The amount of income and capital gains determined to have been taxed through the RBMC will be previously "taxed" (or "franked") income if it is later remitted. For this purpose, remittances will be statutorily determined to be made first out of income and capital gains upon which RBMC has not been levied ("untaxed" income and capital gains) until all such income cumulatively arising (and not taxed on the arising basis) since the beginning of the first year of United Kingdom residency has been remitted (or, if later, since the beginning of the tax year beginning April 6, 2008). The net effect of this system is that electing resident non-dom taxpayers who remit the entirety of their cumulative non-United Kingdom source income and capital gains will pay no more than the relevant United Kingdom income tax rate[s] times their cumulative pre-foreign tax worldwide net income and capital gains, reduced by any credits for non-United Kingdom source based foreign tax. All other electing resident non-doms will pay a lesser amount of United Kingdom tax. To administer these rules, a system of pools and specific rules will track: (i) the amount of unremitted non-United Kingdom source income and capital gains upon which RBMC has been determined to have been levied, (ii) the amount and character of untaxed unremitted non-United Kingdom source income and capital gains, and (iii) the amount of source based foreign tax associated with untaxed income and capital gains. 4

We understand Her Majesty's Treasury estimates that the RBMC will generate approximately 50% of the annual revenues of the tax charged through the remittance basis on non-United Kingdom source income taking into account all proposed revisions to that basis of taxation. In addition, it is expected that a substantial number of resident non-doms who previously filed on a remittance basis will switch to filing on an arising basis.

Analysis of Proposal

Article 24 of the Treaty provides that the United States shall allow United States residents and citizens a credit against United States federal income tax for certain taxes paid or accrued to the United Kingdom. 5 Section 901 of the Code6 permits United States citizens, resident aliens, and corporations to claim a credit for income, war profits and excess profits taxes ("income taxes") paid or accrued to a foreign country. 7 In addition, a tax imposed in lieu of an income tax otherwise generally imposed by a foreign country is treated as an income tax for section 901 purposes. 8 This memorandum discusses whether the RBMC as proposed is creditable under the Treaty or section 901 and, if so, the possible treatment of that credit under the credit limitation rules of section 904 and the Treaty.

4 Subcategories of the pools will track types of income, such as dividends, and the associated foreign taxes.

5 Treaty Art. 24(1); Art. 2.

6 All section references are to the Code unless indicated otherwise.

7 Section 901(a), (b)(1).

8 Section 903.

A. Whether the RBMC is creditable under the Treaty

Article 24 of the Treaty provides that the United States "shall allow to a resident or citizen of the United States as a credit against the United States tax on income the income tax paid or accrued to the United Kingdom by or on behalf of such citizen or resident." 9 The United Kingdom taxes covered by this provision (the "covered taxes") include: "(i) the income tax; (ii) the capital gains tax; (iii) the corporation tax; and (iv) the petroleum revenue tax," 10 as well as "any identical or substantially similar taxes that are imposed after the date of signature of [the Treaty] in addition to, or in place of, the existing taxes." 11

The Treaty provides that "all taxes imposed on total income, or elements of income" shall be regarded as taxes on income and on capital gains, "irrespective of the manner in which they are levied." 12 The Technical Explanation of the Treaty describes the remittance basis of taxation as imposing tax "on income from sources outside the United Kingdom . . . to the extent such income is remitted to the United Kingdom." 13 Accordingly, the United States Treasury clearly understood the remittance basis of taxation to be a tax on an element of income - income and capital gains from non-United Kingdom sources to the extent remitted. Consequently, we believe that the tax levied on the remittance basis should be viewed as a covered tax, creditable under Article 24.

The foregoing analysis should not be affected by the inclusion of the RBMC as a feature of the remittance basis of taxation for the following reasons. We understand that Her Majesty's Treasury and Her Majesty's Revenue & Customs intend to treat the RBMC as a tax covered under the Treaty as part of the remittance basis of taxation. Moreover, the remittance basis of taxation, as amended to include the RBMC, will continue to tax elements of income: remitted non-United Kingdom source income and capital gains and a portion of unremitted non-United Kingdom source income and capital gains. The RBMC merely adds as an additional element of income that is actually taxed under the remittance basis, an amount of unremitted non-United Kingdom source income and capital gains; it does not alter the character of the tax thereby imposed as a tax on elements of income. Accordingly, we believe that the remittance basis of taxation, as amended to include the RBMC, should be viewed as a covered tax, creditable under Article 24.

9 Treaty Art. 24(1).

10 Treaty Art. 2(3).

11 Treaty Art. 2(4).

12 Treaty Art. 2(1), (2).

13 Technical Explanation at 19 (emphasis added).

B. Whether the RBMC is creditable under section 901

Section 901 permits a credit for income taxes paid or accrued (or deemed paid) to a foreign country. Regulations promulgated by the United States Treasury provide detailed guidance on the criteria used to determine whether a foreign levy is an income tax for purposes of section 901.14 As a threshold matter, whether a foreign levy qualifies as an income tax is determined independently for each separate levy imposed by a foreign country. 15 In general, to be creditable, a levy must be a tax and its predominant character must be that of an income tax in the United States sense. 16 In addition, a tax imposed in lieu of an income tax otherwise generally imposed by a foreign country is treated as an income tax for section 901 purposes. 17

i. Whether the RBMC and tax charged on the remittance basis are separate levies

In order to determine whether the RBMC is creditable as an income tax under section 901, it must first be determined whether the RBMC and the remittance basis of taxation are separate levies.

Whether a single levy or separate levies are imposed by a foreign country depends on United States federal income tax principles and not on whether foreign law imposes the levy or levies in a single or separate statutes. 18 In general, levies are not separate merely because some provisions determining the base of the levy apply, by their terms or in practice, to some, but not all, persons subject to the levy. 19 A foreign taxing authority is viewed as imposing separate levies "where the base of a levy is different in kind, and not merely in degree, for different classes of persons subject to the levy." 20

As an example, the Treasury Regulations provide that a foreign levy identical to the tax imposed by section 871(b) (tax on nonresident alien individuals engaged in a trade or business within the United States) is a separate levy from a foreign levy identical to the tax imposed by section 1 (tax on United States citizens and resident aliens), as it applies to persons other than those described in 871(b). 21 Similarly, foreign levies identical to the taxes imposed by section 11 (tax on income of corporations), section 541 (tax on undistributed personal holding company income), section 881 (tax on income of foreign corporations not effectively connected with the conduct of a trade or business in the United States), section 882 (tax on income of foreign corporations engaged in a trade or business in the United States), section 1491 (excise tax on certain transfers of property, repealed in 1997), and section 3111 (tax on employers) are each separate levies because the base of each of those levies "differs in kind, and not merely in degree, from the base of each of the others." 22

14 Treas. Reg. § 1.901-2.

15 Treas. Reg. § 1.901-2(a)(1) and (d).

16 Treas. Reg. § 1.901-2(a)(1).

17 Section 903.

18 Treas. Reg. § 1.901-2(d)(1).

19 Id.

20 Id.

21 Id.

22 Id.

The base of the remittance basis of taxation, as currently enacted, is the non-United Kingdom source income and capital gains of resident non-doms who elect to file on a remittance basis. The base of the RBMC, as proposed, is the non-United Kingdom source income and capital gains of resident non-doms who elect to file on a remittance basis and who have been resident for United Kingdom tax purposes in the United Kingdom for seven of the nine tax years prior to making that election. The fact that the RBMC is imposed only on a subset of taxpayers who file on a remittance basis and only on a portion of the income and capital gains which could ultimately be taxed under the remittance basis of taxation does not mean that the levies are separate. The Treasury Regulations state that levies are not separate merely because some provisions determining the base of the levy apply, by their terms or in practice, to some, but not all, persons subject to the levy. 23 In addition, there is no difference in tax rates between the RBMC and the tax that would be collected under the remittance basis of taxation. The RBMC and tax charged on the remittance basis are not different in kind like the separate levies listed in the Treasury Regulations; instead, the RBMC is analogous to a minimum inclusion provision of the remittance basis regime. Notably, the Treasury Regulations do not list the Alternative Minimum Tax imposed under section 55 as a separate levy from the taxes imposed under either section 1 or section 11. Accordingly, we believe that the RBMC as proposed and tax charged on the remittance basis should be viewed as part of the same levy.

ii. Whether the remittance basis of taxation, as amended to include the RBMC, gives rise to an income tax or a tax in lieu of an income tax for United States purposes

A foreign levy is an income tax if and only if (i) it is a tax, and (ii) the predominant character of that tax is that of an income tax in the United States sense. 24 A foreign levy is a tax in lieu of an income tax only if (i) it is a tax, and (ii) it is in substitution for an income tax. Whether tax charged on the remittance basis, as amended to include the RBMC, meets either of these sets of requirements is addressed below.

23 Id.

24 Treas. Reg. § 1.901-2(a)(1).

(a) Whether tax charged on the remittance basis, as amended to include the RBMC, is a tax

A foreign levy is a tax if it requires a compulsory payment pursuant to the authority of a foreign country to levy taxes. 25 Whether a foreign levy requires a compulsory payment pursuant to a foreign country's authority to levy taxes is determined by principles of United States federal income tax law and not by principles of law of the foreign country. 26 Notwithstanding any assertion of a foreign country to the contrary, a foreign levy is not pursuant to a foreign country's authority to levy taxes, and thus is not a tax, to the extent a person subject to the levy receives (or will receive), directly or indirectly, a specific economic benefit from the foreign country in exchange for payment of the levy. 27 For this purpose, a "specific economic benefit" is an economic benefit that is not made available on substantially the same terms to substantially all persons who are subject to the income tax that is generally imposed by the foreign country. 28 An economic benefit includes property, a service, a fee or other payment, a right to use, acquire or extract resources, patents, or other property that a foreign country owns or controls, or a reduction or discharge of a contractual obligation.

Tax charged on the remittance basis, as amended to include the RBMC, will be levied by the United Kingdom government pursuant to its authority to levy taxes. For those who are subject to the remittance basis of taxation (i.e., those who elect to file on a remittance basis), payment is compulsory. The fact that a taxpayer may elect between one of two levies does not mean that either of the levies is not compulsory for this purpose. For example, in Rev. Rul. 73-588,29 the IRS ruled that a certain Greek tax was a tax in lieu of an income tax under section 903. The taxpayer had elected to be subject to the tax in question rather than the otherwise generally applicable income tax. As described below, to be a tax in lieu of an income tax, a levy must be a "tax" under Treas. Reg. § 1.901-2(a)(2)(i). Accordingly, implicit in this ruling is that a levy is no less compulsory because a taxpayer elects to pay it in lieu of another tax.

In addition, tax charged on the remittance basis is not imposed in exchange for a "specific economic benefit" of the type listed in the Treasury Regulations; the only economic benefit that may inure to a remittance basis taxpayer is a potentially reduced tax liability compared to filing on an arising basis. Clearly, a reduction in tax liability is not property, a service, a fee or other payment, a right to use, acquire or extract resources, patents, or other property that a foreign country owns or controls, or a reduction or discharge of a contractual obligation. Accordingly, we believe the remittance basis of taxation, as amended to include the RBMC, should be viewed as requiring "a compulsory payment pursuant to the authority of a foreign country to levy taxes" and thus as a tax.

25 Treas. Reg. § 1.901-2(a)(2)(i).

26 Id.

27 Id.

28 Treas. Reg. § 1.901-2(a)(ii)(B).

29 1973-2 C.B. 268.

(b) Whether the predominant character of tax charged on the remittance basis, as amended to include the RBMC, is that of an income tax in the United States sense

If a levy is a tax, it is creditable if it has the predominant character of an income tax in the United States sense. 30 The predominant character of a foreign tax is that of an income tax in the United States sense if it is likely to reach net gain in the normal circumstances in which it applies, and liability for the tax is not dependent on the availability of a credit for the tax against income tax liability to another country. 31 Liability for tax charged on the remittance basis, as amended to include the RBMC, is not dependent on the availability of a credit for the tax against income tax liability to another country. Accordingly, whether tax charged on the remittance basis, as amended to include the RBMC, has the predominant character of an income tax in the United States sense depends on whether it is likely to reach net gain in the normal circumstances in which it applies.

A foreign tax is likely to reach net gain in the normal circumstances in which it applies if and only if the tax, judged on the basis of its predominant character, satisfies each of three requirements: the realization, gross receipts, and net income requirements. 32

A foreign tax satisfies the realization requirement if, judged on the basis of its predominant character, it is imposed upon or subsequent to the occurrence of events ("realization events") that would result in the realization of income under the income tax provisions of the Code. 33 In addition, a foreign tax may satisfy the realization requirement if it is imposed upon the occurrence of an event prior to a realization event and certain other requirements are met. 34 Tax charged on the remittance basis, as amended to include the RBMC, is imposed only at or after the time income or capital gains arise: when remitted or, in the case of the RBMC, prior to remittance but still at or after the time the income or capital gains arise. We understand that the predominant character of the concept of income and capital gains arising in the United Kingdom is equivalent to the concept of income and capital gains earned by or accrued to a taxpayer in the United States sense. Accordingly, because the remittance basis of taxation as amended to include the RBMC is imposed only at or after the time income or capital gains arise, we believe it should meet the realization requirement.

A foreign tax satisfies the gross receipts requirement if, judged on the basis of its predominant character, it is imposed on the basis of gross receipts or gross receipts computed under a method that is likely to produce an amount that is not greater than fair market value. 35 Tax charged on the remittance basis, as amended to include the RBMC, will be levied on non-United Kingdom source income and capital gains remitted to the United Kingdom and that amount of unremitted non-United Kingdom source income and capital gains of individuals resident for seven of the nine prior tax years that, if remitted, would produce a £ 30,000 tax liability. This computation is "likely to produce an amount that is not greater than fair market value." Only remittances of receipts less expenses paid and net capital gains are subject to tax charged on the remittance basis, and, accordingly, the tax thus charged is levied on an amount likely to be not greater than a taxpayer's gross receipts. Additionally, taxpayers can establish that remittances are not out of gross receipts by showing, for example, that any particular remittance is attributable to a return of capital or to earnings prior to the beginning of United Kingdom residency. Accordingly, we believe the remittance basis of taxation, as amended to include the RBMC, should be viewed as predominantly imposed on the basis of gross receipts calculated in a manner likely to produce an amount that is not greater than fair market value.

30 Treas. Reg. § 1.901-2(a)(1)(ii).

31 Treas. Reg. § 1.901-2(a)(3).

32 Treas. Reg. § 1.901-2(b)(1).

33 Treas. Reg. § 1.901-2(b)(2)(i)(A).

34 Treas. Reg. § 1.901-2(b)(2)(i)(B), (C)

35
Treas. Reg. § 1.901-2(b)(3).

A foreign tax satisfies the net income requirement if, judged on the basis of its predominant character, the base of the tax is computed by reducing gross receipts to permit recovery of either (i) the significant costs and expenses (including significant capital expenditures) attributable, under reasonable principles, to such gross receipts, or (ii) such significant costs and expenses computed under a method that is likely to produce an amount that approximates, or is greater than, recovery of such significant costs and expenses. 36 The remittance basis of taxation generally allows the same deductions and credits for particular types of income and capital gains as those allowable under the arising basis of taxation. 37 For example, remittances of business profits are taxed after a deduction of allowable expenses. Similarly, the RBMC will be levied on income and capital gains after allowing those credits and deductions that would be allowable had such income and capital gains been taxed on the arising basis. Accordingly, we believe the remittance basis of taxation, as amended to include the RBMC, should satisfy the net income requirement and therefore should be viewed as having the predominant character of an income tax in the United States sense.

(c) Whether the remittance basis of taxation, as amended to include the RBMC, is a tax in lieu of an income tax

Even if tax charged on the remittance basis, as amended to include the RBMC, is not treated as a tax the predominant character of which is an income tax in the United States sense, it will still be creditable under section 901 if it is determined to be a tax imposed in lieu of an income tax under section 903. Section 903 treats a tax imposed in lieu of an income tax otherwise generally imposed by a foreign country as an income tax for section 901 purposes. 38 To qualify as a tax "in lieu of" an income tax, the foreign levy must be a tax and must be "imposed in substitution for, and not in addition to, an income tax or series of income taxes otherwise generally imposed." 39 As discussed in Part B.ii.a) of this memorandum, tax charged on the remittance basis, as amended to include the RBMC, should be treated as a tax. Accordingly, whether tax charged on the remittance basis, as amended to include the RBMC, is a tax in lieu of an income tax depends on whether that tax is imposed in substitution for an otherwise generally imposed income tax.

36 Treas. Reg. § 1.901-2(b)(4).

37 Taxpayers who file on the remittance basis are not entitled to certain income tax personal allowances or the annual exemption for chargeable capital gains which are available to United Kingdom resident taxpayers who file on an arising basis.

38 Section 903.

39 Treas. Reg. §1.903-1(a), (b).

In determining whether tax charged on the remittance basis, as amended to include the RBMC, is a tax in lieu of an income tax, the relevant "otherwise generally imposed" income tax is tax charged on the arising basis. The remittance basis of taxation, as amended to include the RBMC, and the arising basis of taxation are alternative bases of taxation and do not apply to tax the same items of income and gain. In particular, the remittance basis of taxation cannot give rise to tax on funds that have been previously taxed on the arising basis. Similarly, the arising basis of taxation cannot tax items of income or capital gains that have been taxed on a remittance basis. In addition, all income and capital gains taxed on the remittance basis are income and capital gains that would alternatively have been subject to tax on an arising basis. Thus, the remittance basis of taxation does not add to the tax that would have been collected on an arising basis, but instead is an entirely alternative basis of taxation. Accordingly, if tax charged on the remittance basis, as amended to include the RBMC, is not treated as having the predominant character of an income tax in the United States sense, we believe it should be viewed as tax imposed in substitution for income tax collected on an arising basis and therefore as a tax paid in lieu of an income tax.

iii. Whether the RBMC, if treated as a separate levy from the tax charged on a remittance basis, is an income tax

As described in Part B.ii. of this memorandum, a foreign levy is an income tax if and only if (i) it is a tax, and (ii) the predominant character of that tax is that of an income tax in the United States sense. A foreign levy is a tax in lieu of an income tax only if it (i) is a tax and (ii) is in substitution for an income tax. Whether the RBMC, if treated as a separate levy from tax charged on the remittance basis, meets either of these sets of requirements is addressed below.

(a) Whether the RBMC, if treated as a separate levy from the tax charged on the remittance basis, is a tax

As described in Part B.ii.a) of this memorandum, a foreign levy is a tax if it requires a compulsory payment pursuant to the authority of a foreign country to levy taxes. 40 The same reasoning that indicates that tax charged on the remittance basis, if determined to include the RBMC, is a tax suggests that the RBMC standing alone is also a tax. The RBMC will be levied by the United Kingdom government pursuant to its authority to levy taxes. For those who elect the remittance basis, and who have been United Kingdom tax residents for seven of the prior nine tax years, the RBMC will be compulsory. The fact that such a taxpayer elects the remittance basis does not mean that payment of the RBMC is not compulsory. Also, as previously discussed, the RBMC will not be chargeable in exchange for a specific economic benefit. Accordingly, we believe the RBMC, if treated as a separate levy from tax charged on the remittance basis, should meet the definition of a tax.

40 Treas. Reg. § 1.901-2(a)(2)(i).

(b) Whether the predominant character of the RBMC, if treated as a separate levy from the tax charged on the remittance basis, is that of an income tax in the United States sense

As described in Part B.ii.b) of this memorandum, a levy is creditable, in addition to being a tax, only if the levy has the predominant character of an income tax in the United States sense. 41 The predominant character of a foreign tax is that of an income tax in the United States sense if it is likely to reach net gain in the normal circumstances in which it applies and liability for the tax is not dependent on the availability of a credit for the tax against income tax liability to another country. 42 Liability for the RBMC, if treated as a separate levy from the tax charged on the remittance basis, is not dependent on the availability of a credit for the tax against income tax liability to another country. Accordingly, whether the RBMC, if treated as a separate levy from the tax charged on the remittance basis, has the predominant character of an income tax in the United States sense depends on whether it is likely to reach net gain in the normal circumstances in which it applies.

As described in Part B.ii.b) of this memorandum, a foreign tax is likely to reach net gain in the normal circumstances in which it applies if and only if the tax, judged on the basis of its predominant character, satisfies each of three requirements: the realization, gross receipts, and net income requirements. 43 The RBMC, if treated as a separate levy from the tax charged on the remittance basis, arguably meets the realization requirement because it is levied only at or after the time income or capital gains have arisen or accrued to the taxpayer. The RBMC, if treated as a separate levy from the tax charged on the remittance basis, arguably meets the gross receipts requirement because it is imposed on the basis of gross receipts computed in a manner likely to reach no more than fair market value in normal circumstances: taxpayers will generally not elect to file on a remittance basis and pay the RBMC where doing so would reach more than gross receipts because in such a case the arising basis would produce a lower liability. 44 Taxpayers who erroneously choose the more expensive levy will be allowed one year to change their election retroactively. Therefore, overall, the RBMC, if treated as separate from the tax charged on the remittance basis, is arguably imposed on the basis of gross receipts calculated so as likely to produce an amount that is not greater than fair market value. Finally, the RBMC, if treated as a separate levy from the tax charged on the remittance basis, arguably meets the net income requirement because, as described Part B.ii.b) of this memorandum, the RBMC will be levied on income and capital gains after allowing those credits and deductions that generally would be allowable had such income and capital gains been taxed on the arising basis. Accordingly, we believe the RBMC, if treated as a separate levy from the tax charged on the remittance basis, arguably has the predominant character of an income tax in the United States sense.

41 Treas. Reg. § 1.901-2(a)(1)(ii).

42 Treas. Reg. § 1.901-2(a)(3).

43 Treas. Reg. § 1.901-2(b)(1).

44 Under the Treasury Regulations, amounts paid in excess of a taxpayer's liability under foreign law (determined so as to reduce, over time, the taxpayer's expected liability under foreign law), are not amounts of tax paid. Treas. Reg. § 1.901-2(e)(5). Accordingly, a taxpayer who elects to file on a remittance basis for a particular year and pay the RBMC and whose tax liability for that year is, as a result, more than it would have been on an arising basis, may be treated as having paid only the amount of tax that would have been due under the arising basis.

(c) Whether the RBMC, if treated as a separate levy from the tax charged on the remittance basis, is a tax in lieu of an income tax

As discussed in Part B.iii.a) of this memorandum, the RBMC, if treated as a separate levy from tax charged on the remittance basis, is a tax. Accordingly whether the RBMC, if treated as a separate levy from the tax charged on the remittance basis, is a tax in lieu of an income tax depends on whether that tax is imposed in substitution for an otherwise generally imposed income tax or series of income taxes.

In determining whether the RBMC, if treated as separate from the tax charged on the remittance basis, is a tax in lieu of an income tax, the relevant "otherwise generally imposed" bases of income tax are the arising basis and the remittance basis. The RBMC would not tax income or capital gains which have been taxed either under the arising basis or (if regarded as separate from the RBMC) the remittance basis. The RBMC taxes unremitted non-United Kingdom source income and capital gains; the remittance basis of taxation only applies to remitted non-United Kingdom source income and capital gains that have not previously been taxed. Similarly, income and capital gains previously taxed by the RBMC are by definition never taxed on an arising basis because the RBMC can only be incurred in situations where a taxpayer elects for remittance basis in respect of his or her income and capital gains in any tax year. In addition, all income and capital gains taxed by the RBMC are income and capital gains that would alternatively have been subject to tax on a remittance basis or on an arising basis. Accordingly, the RBMC does not add to any tax chargeable on the arising basis or remittance basis but instead partially replaces them. The RBMC therefore is arguably imposed in substitution for otherwise generally imposed income taxes and arguably meets the definition of a tax paid in lieu of an income tax.

C. Limitation on the use of credits for the RBMC under the Code and the Treaty

In general, section 904 provides that the total amount of credit allowable under section 901 shall not exceed the same proportion of the tax against which such credit is taken as the taxpayer's specified taxable income from sources without the United States (but not in excess of the taxpayer's entire taxable income) bears to his or her entire taxable income for the same taxable year. 45 The limitation is determined separately for passive category income and general category income. 46

45 Section 904(a).

46 Section 904(d)(1). In general, passive category income is any income received or accrued by any person which is of a kind which would be foreign personal holding company income as defined in section 954(c). This includes, for example, dividends, interest, rents and royalties unless derived in the active conduct of a trade or business, certain capital gains, and income from notional principal contracts. General category income is any income that is not passive category income. Section 904(d)(2)(A)(ii).

This limitation effectively caps the rate of foreign tax that can be used as a credit against either passive category income or general category income that is non-United States source income to a taxpayer's average effective rate of United States federal income tax (before foreign tax credit) on total taxable income. Because of the benefits of 15% tax rates on certain dividends and capital gains and the potential benefit of lower than 35% marginal rates on certain levels of other income, most United States individuals can only utilize foreign tax credits at a rate significantly below 35%. Given that the RBMC is imposed at an 18% rate on capital gains and a rate up to 40% on income, a United States citizen will generally not be able to take a credit against his or her United States federal income tax for the full amount of RBMC paid unless that citizen has other foreign source income in the same category taxed at a relatively low foreign tax rate. Any foreign tax, including RBMC, that cannot be taken as a credit in the year it is paid or accrued can be carried back one year and carried forward ten years for use against tax on income in the same category in that other year.

To aid in understanding the ability of United States citizens to take a credit against United States federal income tax for the RBMC, this Part C. discusses (i) the allocation and apportionment of the RBMC to categories of income; (ii) the use of the RBMC as a credit against non-United States source income under the Code;

(iii) the use of the RBMC as a credit against United States source income under the Treaty; and (iv) the effect of the difference in taxable year between the United States and the United Kingdom.

i. Allocation and apportionment of the RBMC to categories of income

In general, for United States credit purposes, the amount of foreign taxes paid or accrued with respect to a separate category of income (including United States source income) includes only those taxes that are related to income in that separate category. 47 For this purpose, taxes are related to income if the income is included in the base upon which the tax is imposed. 48 For example, if foreign law provides for a specific rate of tax with respect to a certain type of income (e.g., capital gains), or if certain expenses, deductions, or credits (including foreign tax credits) are allowed under foreign law only with respect to a particular type of income, each such type of income is a separate base for purposes of determining the amount of foreign tax imposed on such income.49 A tax imposed on a base that includes more than one separate category of income is considered to be imposed on income in all such categories, and, thus, the taxes are related to all such categories included within the foreign country's taxable income base.50 A tax related to a base that includes more than one separate category is apportioned among the separate categories in proportion to the relative amount of net income in each separate category. 51

47 Treas. Reg. § 1.904-6(a)(1)(i).

48 Id.

49 Id.

50 Id.

51 Treas. Reg. § 1.904-6(a)(1)(ii).

Under these rules, the RBMC arguably should be treated as related only to those types of income of the taxpayer (and to those amounts of each) actually designated by the taxpayer as the unremitted income or capital gains upon which the RBMC is levied. It is also possible, however, that the United States Treasury and IRS may not respect the taxpayer's designation as determinative for these purposes. In such a case, the RBMC might be allocated to each type of income in proportion to the United Kingdom tax charged on the remittance basis that would be levied on each type of income if income and capital gains were fully remitted. Alternatively, the RBMC could be simply apportioned among all categories of taxable income other than United Kingdom source income (i.e., income and capital gains that are taxed on a remittance basis only), although such an apportionment would seem inconsistent with the allocation provisions of Treas. Reg. § 1.904-6(a)(1)(i) given the differences in tax rates on capital gains and other income and the availability of foreign tax credits against RBMC with respect to some but not necessarily all income. The determination of the appropriate allocation and apportionment of the RBMC under the Treasury Regulations is important to United States citizens because of the limitations on the use of foreign tax credits discussed below, including most importantly the limitations on the use of such credits against United States source income under the Treaty.

ii. The use of the RBMC as a credit against non-United States source income under the Code

Any RBMC allocated or apportioned to general category income for United States purposes will be allowed as a credit up to the average effective rate of United States federal income tax on all income within the general category and taking into account all foreign taxes attributed or apportioned to that income. With respect to passive category income, the Code and the applicable Treasury Regulations provide a special rule under which income received or accrued by a United States person that would otherwise be passive category income is treated as general category income if the income is determined to be high-taxed income. 52 In general, income of a United States person is considered to be high-taxed income if, after allocating expenses, losses and other deductions of the United States person to the income, the sum of the foreign income taxes paid or accrued by the United States person with respect to the income exceeds the highest rate of tax specified in section 1 (applicable to individuals) or section 11 (applicable to corporations), whichever applies, multiplied by the amount of such income. 53 To make this determination, items of income are assigned to one of four groups: (i) all passive income that is subject to a withholding tax of fifteen percent or greater, (ii) all passive income that is subject to a withholding tax of less than fifteen percent (but greater than zero); (iii) all passive income that is subject to no withholding tax or other foreign tax; and (iv) all passive income that is subject to no withholding tax but is subject to a foreign tax other than a withholding tax. 54 RBMC that is treated as levied on passive income not subject to withholding will be allocated to this fourth group; such income will likely constitute high-taxed income to the extent the RBMC rate of tax exceeds the highest marginal rate of tax imposed by the United States on United States citizens. Passive income that is subject to withholding will be allocated to one of the first two groups, regardless of whether the RBMC has been levied on it. Whether that income will be treated as high-taxed income will depend on what other income is included in that group and the amount of foreign tax allocated or apportioned to that other income.

52 Section 904(d)(2)(F); Treas. Reg. § 1.904-4(c)(1).

53 Id.

54 Treas. Reg. § 1.904-4T(c)(3).

iii. The use of the RBMC as a credit against United States source income under the Treaty

Paragraph 6 of Article 24 of the Treaty provides special rules for the taxation of certain types of income derived from United States sources by United States citizens who are residents of the United Kingdom. 55 The practical effect of paragraph 6 is that United States citizens resident in the United Kingdom are taxed on income from United States sources as follows. First, the United States is entitled to tax the taxpayer's income from United States sources to the extent the United States would have imposed tax had the income been paid to or earned by a resident of the United Kingdom, taking into account any reduced rates of taxation available under the Treaty to such United Kingdom residents (the "United States source-based tax"). Second, the United Kingdom is entitled to tax the taxpayer's United States source income but must give a credit for the United States source-based tax (the "United Kingdom residency-based tax"). Third, the United States is entitled to tax the taxpayer's United States source income but the incremental United States federal income tax liability on such income is reduced by the amount of United States sourcebased tax on such income as considered above (the "United States citizenship-based tax"). The United States then provides a credit against this United States citizenshipbased tax for the United Kingdom residency-based tax, but only to the extent such United Kingdom tax does not exceed the United States citizenship-based tax. Finally, United States source income is re-sourced as United Kingdom source income to the extent the United States provides a credit for the United Kingdom residency based tax.

Applying these rules, United States taxpayers will generally credit the RBMC against United States citizenship-based tax to the extent the RBMC may be allocated to certain United States source investment income and capital gains, because there is no or relatively low United States source-based tax on such income and capital gain. 56 The credit, however, will often be limited to an amount less than the RBMC because the United Kingdom rates of tax on these types of income currently exceed the average United States effective tax rates at which foreign tax credits are allowed. Moreover, to the extent the United States treats the RBMC as allocable to United States source business profits attributable to a permanent establishment in the United States or to gain on the sale of real estate located in the United States, no credit will likely be allowed, because the United States federal income tax on such income is levied on the basis of source and not citizenship.

55 The United Kingdom is not bound to provide a credit for United States federal income taxes with respect to income from sources without the United States, as determined under United Kingdom law. Treaty Art. 24(6)a).

56 It may not be possible to credit the RBMC against United States source dividend income of United States citizens who are eligible to be taxed at a 15% rate under section 1(h)(11).

iv. The effect of the difference in taxable year between the United States and the United Kingdom

The taxable years of individuals in the United States and United Kingdom are different: in the United States it is the calendar year (that is, January 1 through December 31); in the United Kingdom it is April 6 through April 5. Because the RBMC may not be due until approximately nine months after the end of the United Kingdom tax year, it is possible that it will not be paid until the second tax year (for United States federal income tax purposes) following the tax year in which a portion of the taxed income was earned for United States federal income tax purposes. The Treasury Regulations provide that, in allocating taxes between passive category income and general category income, the nature of the income taxed determines the allocation even if the income was taxed in a different period. 57 Although the Treaty is silent on this issue with respect to re-sourcing under paragraph 6 of Article 24, parallel concepts could be applied. Thus, the re-sourcing rule in the Treaty could resource the unremitted income upon which the RBMC has been levied even if it is earned in an earlier tax year (for United States federal income tax purposes) than the year in which the RBMC is paid or accrues. With respect to non-United States source income and particularly with respect to United States source income that is re-sourced under the Treaty, United States taxpayers who claim foreign tax credits on a paid basis will need to manage tax payments to make sure that when the RBMC is paid it can be carried back to the year in which the income to which it is attributed for United States federal income tax purposes was earned.

Concluding Views

We expect that the United States Treasury and IRS will in due course provide authoritative guidance on some or all of the issues analyzed above, which guidance may well have retroactive effect. Based on our analysis and subject to the limitations on the use of credits described herein, it is our view that under current United States law (including the Treaty), and in the absence of such guidance, the RBMC should be treated, for United States federal income tax purposes, as a foreign tax creditable against United States federal income tax. However, given the limitations on the use of foreign tax credits against United States federal income tax provided in the Code and the Treaty, and, more importantly, given that the rates at which the RBMC will be generally imposed is currently higher than the average effective United States federal income tax rate of individuals, most United States citizens will not be able to credit against their United States federal income tax all of the RBMC they pay. The portion of RBMC that cannot be used as a credit will vary depending on a number of factors, including the amount and character of the income of any particular United States citizen and on the resolution of various interpretative issues under Treasury Regulations and the Treaty described above.

SKADDEN, ARPS, SLATE, MEAGHER & FLOM LLP

57 Treas. Reg. § 1.904-6(a)(1)(iv).