Significant reforms to the taxation of non-UK domiciled, longer term residents of the UK were proposed in the first UK Budget since the May 2015 General Election. The proposals are still being formulated, with consultation completed on 11 November 2015 and expected draft legislation later in 2015. The changes will impact individuals who have been resident in the UK for 15 or more tax years in the last 20 years.
The availability of the remittance basis of taxation for non-UK domiciled individuals who have not yet become resident, or who have been resident for fewer than 15 years, will continue. The availability of the remittance basis allows for some interesting tax planning opportunities.
The proposed reforms highlight the need to consider trusts as these retain some significant longer term benefits in relation to inheritance, income and capital gains taxes.
The Implications of the Proposed "15 Year Rule" Reform
The current position for UK tax resident, non-domiciled individuals ("non-doms") is that they can elect to pay UK income and capital gains tax on foreign source income and gains in the event that those monies are remitted to the UK. If they are not, no UK income or capital gains taxes are payable on this income.
Since 2008 non-doms resident for 7 or more tax years have had to pay an annual charge for the use of the remittance basis. As long as the annual charge has been paid, the remittance basis has remained available.
- It is proposed that, from April 2017, anyone who has been tax resident in the UK for 15 of the previous 20 tax years will become "deemed domiciled" for tax purposes. This will mean that the non-dom individual will no longer have the option to use the remittance basis of taxation and will be taxed on a worldwide basis.
- Becoming deemed domiciled will also impact on inheritance taxes payable on the estates of non-doms. For non-doms only UK situs assets are subject to UK inheritance tax, which is charged at a rate of 40%. However, the full worldwide estate of a "deemed domiciled" individual will be subject to UK inheritance tax.
In relation to income, capital gains and inheritance tax it is therefore very important to consider planning opportunities as far ahead of April 2017 as possible.
Deemed Domiciled and Inheritance Tax
In relation to inheritance tax only, a similar "deemed domiciled" rule already exists. The current rule is that an individual is deemed domiciled for inheritance tax purposes when tax resident in the UK for 17 of the previous 20 tax years.
The concept of "deemed domiciled" for tax purposes therefore already exists and anyone falling within the current law, prior to April 2017, should also consider taking advantage of inheritance planning opportunities.
Trust Tax Planning – Excluded Property Trusts
- Inheritance tax
Under the current "deemed domicile" rules for inheritance tax (it is understood these will not change under the current reform proposals), any non-UK assets settled into a non-UK resident trust by a UK resident non-dom will be permanently excluded from his inheritance tax estate as long as the trust (so called an "excluded property trust") is settled prior to him becoming deemed domiciled.
The exception to this is residential property, where inheritance tax will be payable on UK residential property owned by non-doms, even if held through an offshore structure.
- Income, gains and capital
The proposed reforms expressly state that the UK Government does not intend that non-doms who become deemed-UK domiciled will have to pay UK tax on income and gains in excluded property trusts established before they became deemed domiciled.
However, it is proposed that, from April 2017, any benefits received, without reference to the source of the monies being distributed, will be fully taxable on the value of the distribution. The present position is that the nature of the monies being distributed (i.e. income, gains or capital) is considered and taxed accordingly, with capital not being taxed, even if remitted to the UK.
All distributions being fully taxable will have a substantial and negative effect on the tax liability. Representations are being made to the UK Treasury and this is an area currently being given further consideration by the UK Government.
If the changes go ahead they will remove the necessity to retain and account for capital and income separately, and this will reduce the associated additional time and cost that this has generated.
- Planning opportunities
The retention of significant inheritance tax benefits means that excluded property trusts remain an interesting planning structure for an individual prior to them becoming deemed domiciled (under either the current rules or the proposed reforms). With a UK inheritance tax rate of 40% a non-dom might consider settling a significant portion of his non-UK estate into an excluded property trust in order that the value of those assets remain permanently outside their estate for inheritance tax purposes.
It is however important to carefully consider the future objectives regarding the assets and/or the income generated from them. Until the precise legislation is announced, the detail of the taxation on distributions is unknown. The proposals suggest however, that if a UK tax resident beneficiary receives a distribution or benefit from a trust he will be taxed in the UK on the full value of that distribution.
Prudent planning would therefore suggest, that assets should only be settled into a trust if there is no likelihood of them being required by a UK resident family member now or in the future.
Trust Tax Planning – Pre-April 2017 Distributions
The opportunity to use excluded property trusts for inheritance tax planning has been available for a number of years. It is therefore probable that many such trusts have already been settled.
In the event that an individual who is already deemed domiciled is expected to be receiving a distribution from such a trust, the trustees should consider making that distribution prior to April 2017 if the proposals covering the taxation of income, gains and capital are enacted, as currently envisaged.
Other Tax Planning Opportunities
The proposed new "deemed domicile" 15 year rule is dependent on the tax residence of the individual non-dom. Individuals might wish to reconsider their tax residence position to endeavour to change their UK tax residence status and also potentially their deemed domicile status.
As detailed above, the proposed rule is that an individual will be deemed domiciled if tax resident in the UK in 15 of the previous 20 tax years. With correct planning, ceasing to be UK tax resident for 6 years will mean that individuals will lose their deemed domicile status. Should they subsequently choose to return and become UK tax resident, they will have re-set the year count in relation to the deemed domicile test.
For more information about the UK statutory residence test please refer to the Dixcart schedule: UK Resident/Non-Resident Test. For more information regarding alternative tax residencies please refer to IN390: A Move of Residence.
Other Proposed Reforms to Domicile
- Born in the UK
The proposed reforms are expected to include a provision that an individual born in the UK with a domicile of origin in the UK but who has adopted a domicile of choice elsewhere, will be restricted from taking advantage of being a non-dom by claiming the remittance basis at any time in the future, should they return to live in the UK.
The proposals are still being formulated (consultation completed on 11 November 2015 with expected draft legislation later in 2015). However, it is clear that the reforms will have a significant impact on the availability of the remittance basis for longer term residents of the UK.
Representations from the UK Government suggest that trusts will remain effective for certain aspects of tax planning, and in particular will enable major inheritance tax benefits to be enjoyed.
Non-dom individuals should take advice regarding their UK residence and domicile positions to organise their affairs in the most tax efficient manner possible.Originally published on 17 November 2015