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April 22, 2020updated 23 Apr 2020 12:52pm

A tax expert asks: Why did Harry and Meghan move to LA?

By Spear's

The Sussex’s short period of residence in Canada was potentially tax-motivated, writes Matthew Pannell

So far, 2020 has turned out to be quite a rollercoaster ride for the Duke and Duchess of Sussex. In January, after months of media scrutiny, the Royal couple resolved to step away from the traditional model for working Royals and ‘carve out a progressive new role’ within the centuries-old establishment.

Their controversial plan culminated in a mid-January meeting with the Queen and other senior Royals in which it was agreed that the couple would no longer represent the Monarch in a formal capacity.

Public funding for the couple would cease but in return, the couple would be free to pursue their own commercial endeavours – activities that would otherwise be prohibited for working Royals.

This transition was accompanied by a physical relocation, with the Royals announcing they would split their time between Canada and the United Kingdom.

Much was written at the time about the tax issues that the couple would face given their international profile. The Duchess, as a US Citizen, remains liable for US taxes and is required to continue filing US tax returns irrespective of whether she resides overseas.

The US tax system includes complex anti-avoidance provisions aimed at preventing Americans from avoiding their taxes by exploiting offshore structures and arrangements. This legal and accounting minefield can be exceptionally difficult to navigate for internationally mobile Americans for whom foreign bank accounts, foreign income streams and foreign legal structures are absolutely necessary.

Combine this with Harry’s profile as the heir to a wealthy and sophisticated British estate and the complexities are magnified tenfold. Much of the Royal family’s private wealth will be protected in complex legal structures, including trusts and estates, which will have been formed without regard to US tax.

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It is rumoured that as much as 95 per cent of the Sussex’s financial support will be funded by the Duchy of Cornwall; Prince Charles’s private estate. If subject to US tax rules Harry would be liable to many complex US reporting requirements.

It has been suggested that the tax complexities involved in navigating three tax systems (US, UK and Canada), with the increased risk of double was a significant motivating factor behind the Sussex’s ‘sudden’ decision to relocate to Los Angeles.

In late March 2020, fewer than three months after announcing a move to Canada the Royals moved again to LA.  The relocation has been widely reported as permanent.

To many, their decision to move so soon after arrival in Canada seems sudden and was potentially a knee-jerk reaction to the financial complexity that the Duchess faced as an American living overseas.  But is this move quite so inexplicable?

Certainly, the press focus on the scale of the double tax issue was much overstated. Almost all major western nations, including the US, have agreed comprehensive networks of double taxation agreements. In the large part, these agreements operate to prevent a taxpayer from suffering more than one tax on any particular income source.

Ordinarily, the subject of a tax treaty will find themselves paying the higher of the two taxes to which they are exposed – but rarely both.  There can be occasions where certain unusual circumstances highlight shortcomings in the drafting of these treaty agreements but generally these issues can be avoided by working with the right advisors – a resource that the Royals would be expected to have available in abundance.

It is true, however, that the couple’s tax position will be inordinately complex, and that the genesis of this complexity is the family’s international profile.

By abandoning their Canadian footprint, prior to establishing tax residency, it is certainly possible that some of this complexity may have fallen away.

While Meghan’s exposure to the minefield of US anti-avoidance rules might well be reduced most of the complexity relates to the Duke’s beneficial interest in the various Royal estates.

In fact, by relocating to the US the family’s overall exposure to complex US tax provisions associated with foreign financial structures will almost certainly have increased.

Furthermore, the Duke & Duchess have chosen to base themselves in the highest taxing state within the USA.  For wealthy Californian residents state income taxes add an additional 13.3 per cent to the 37 per cent Federal tax rate (40.8 per cent for certain investment returns) producing a total combined potential marginal tax rate of 54.1 per cent.

Aside from Californian Income taxes the State operates the highest Sales tax rate in the US – on top of which additional local/city rates can apply.  Property taxes too will add a substantial cost to life in the US.

The Los Angeles real estate market is one of the most expensive in the world.  With property taxes assessed as a percentage of a property’s value, costs will be considerable.  There are lots of good reasons that well known, wealthy individuals might choose LA as a base – but a favourable tax regime is certainly not one of them!

What then prompted this relocation and why so soon after their decision to move to Canada? LA is, of course, famous for its entertainment & media industry and with the Royal couple looking to become financially independent they are sure to want to exploit their celebrity status.  But this doesn’t explain the couple’s sudden departure from Canada.

No doubt the Covid-19 pandemic, the threat of grounded flights and international lockdowns accelerated this relocation to some degree, but some sources close to the couple indicate that the move had been in the planning for some time.

Given the complexity attached to US tax residency the Duke’s decision to relocate to the US will, indeed, need to have been carefully planned. Assets will have been restructured, trust deeds redrafted, and income streams carefully reviewed.

Such a decision therefore simply cannot have been taken on ‘a whim’. The couple will have had a team of advisors working meticulously through their financial affairs looking to optimise and streamline matters ahead of Harry’s US arrival. Even for the most experienced advisors this operation will have taken months.

It seems likely that Canada was only ever intended as a short-term step within a wider plan for long term relocation to the US.  Practically Canada provides a suitable intermediate option – closer from a geographical and time zone perspective to their target destination whilst providing an opportunity to break fiscal residence in the UK and implement tax planning – while away from the prying eyes of the British Press.

Utilising the UK ‘split year’ tax rules a short period as a ‘fiscal nomad’ (resident in no country) might have given Harry an opportunity to tax efficiently restructure his affairs in preparation for a move to the US without regard to potential adverse UK tax issues.

A ‘stop off’ in Canada no doubt appearing less provocative that a temporary residence in an Island tax haven while nevertheless achieving the same goal.

A reappraisal of the facts suggests that the Sussex’s never intended to reside permanently in Canada, and while the move to LA which was not tax motivated their short period of residence in Canada might well have been!

Matthew Pannell is an associate director at Frank Hirth

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