Expats and tax: the lowdown on living the high life in Cyprus

CASE STUDY:

Retired
Personal status:
Couple in their early sixties.
Expat status:
Retired to Cyprus five years ago.
Financial status:
UK pensions income about £35,000 per annum. UK investment income £20,000 per annum. Flat in Cyprus now worth £350,000. UK family house worth £500,000. UK investment property worth £500,000 with mortgage of £300,000 and rented out.

This couple will be tax resident in Cyprus and subject to Cyprus tax on their worldwide income. The maximum tax rate in Cyprus is 35pc but there is also a "tax" of up to 20pc as a "Defence Contribution".

The UK pension income would generally be subject to withholding tax in the UK, but the UK and Cyprus have ratified a tax treaty that normally gives the taxing right only to Cyprus. Pension income accumulated from services rendered abroad is taxed at a rate of only 5pc for amounts exceeding €3,420.

Moving the pension to a qualified recognised offshore pension scheme (QROPS) would be advantageous as the special member payment charges that apply to UK-registered schemes would be avoided.

The most punitive charge is the special 55pc death charge imposed on the remaining fund after the member's death. It should also mean that the couple could drawdown a greater level of income from their pensions as the UK's drawdown limits also cease to apply.

Depending on the type, income from investments in the UK might be subject to withholding tax in the UK, but this would generally be credited against tax due on the same income in Cyprus under the tax treaty. Moving the investments offshore should avoid any UK tax. Dividend income is exempt from tax in Cyprus but is still subject to the Defence Contribution at 20pc. Capital gains on qualified securities and funds are also tax-exempt in Cyprus.

The rental income on the investment property would be liable to UK tax but all expenses of maintenance and interest on the loan could be deducted. The couple could elect to be taxed according to the non-resident landlord scheme so the rental income can be received gross. The income after expenses would be subject to UK tax at the individual rates, but the couple would still enjoy their tax-free personal allowance, so the maximum rate would probably be only 20pc. Tax paid in the UK on rental income is allowed as a credit against tax due in Cyprus.

Their main concern should be UK inheritance tax (UK IHT). If they intend to remain in Cyprus for the rest of their lives, they could be domiciled in Cyprus. If so they would not be subject to UK IHT on their worldwide estate. Contrary to popular belief, the fact that they still own UK property would not be a barrier to claiming a non-UK domicile.

Irrespective of domicile, they would still be liable to UK IHT on any UK-situated assets. They each get an allowance in the UK of approximately £325,000, so a total allowance of £650,000. The total equity (value less loans) in their UK properties is £800,000. This would still leave them with a UK IHT liability of 40pc of the balance, being about £70,000. If they were still UK domiciled, IHT would bite on the whole of their estate. This would give them a substantial IHT bill in the UK. The couple should get certainty on their domicile.

There are steps they could take to mitigate IHT. If they are not domiciled in the UK, they could turn their UK investments into non-UK investments by transferring them to offshore companies so their asset was the shares in the non-UK company rather than the UK property itself. The shares would not be subject to UK IHT. The new penal taxes on residential property held by offshore companies apply to properties worth more than £2 million, so won't affect them.

Howard Bilton is chairman of The Sovereign Group and a barrister at law.