Following the United Kingdom’s vote to leave the European Union on 23 June, and the change of Prime Minister and to the UK Government, there was significant uncertainty regarding what would happen to the proposed ‘non-dom reforms’ and when the position would be clarified. This uncertainty ended with the publication, on 18 August, of the next stage in the consultation. It is now clear that the government intends to proceed with the reforms and to keep to the original 6 April 2017 implementation date.
This note updates our previous OTS on the proposed reforms which can be accessed here. Although the government has not yet published draft legislation for all of its proposals, and the consultation is still ongoing, it currently intends for the following provisions to take effect.
Deemed Domicile of Long-Term Residents
A new “15 year rule” will deem those non-UK domiciliaries who have been UK resident in at least 15 of the preceding 20 tax years, to be UK domiciled for all tax purposes, i.e., Inheritance Tax (IHT), Capital Gains Tax (CGT) and income tax, from the start of their 16th year of residence. This will effectively remove the ability of these individuals to claim the remittance basis and will bring forward by one year the date on which they will become deemed domiciled for IHT purposes, which is currently when they have been UK resident for 17 of the preceding 20 tax years, ending with the year in question.
Individuals who were born in the United Kingdom with a UK domicile of origin (e.g. those who were born to UK parents), will be unable to benefit from a foreign domicile of choice or dependency once they have been resident in the United Kingdom for at least one of the two previous tax years. The remittance basis will not be available in this grace period. Those individuals who are caught by these provisions can expect trusts they settled whilst non-UK domiciled to be subject to IHT, and to be taxed as if settled by a UK domiciliary for income tax and CGT purposes.
An individual’s deemed domicile will fall away for IHT purposes once he or she has been non-resident for more than four consecutive years. This broadly means that the current rules regarding IHT will be maintained for individuals who leave the United Kingdom, provided that they do not return within six tax years. This will also continue to be the IHT tail for non-UK domiciled surviving spouses who have elected to be treated as deemed domiciled. The government initially proposed that departing individuals would be deemed domiciled for six years after they leave the United Kingdom, but has since acknowledged that lengthening the time an individual is subject to IHT following his or her departure from the United Kingdom was an inadvertent outcome of the proposed legislation and not part of its policy objective.
Individuals who left the United Kingdom and then subsequently returned will not be protected from the effects of these reforms on their deemed domiciled status for IHT purposes, even if they returned to the United Kingdom before the date that the announcements were made. These individuals would need to be non-UK resident for at least six complete tax years before returning in order to reset the deemed domicile “clock” for all tax purposes.
For those individuals who leave the United Kingdom before 6 April 2017, but would become deemed domiciled on 6 April 2017 under the 15 year rule, the present rules will apply to determine whether or not they will be deemed domiciled for IHT purposes.
Individuals who will become deemed domiciled on 6 April 2017 under the 15 year rule will be able to rebase directly-held foreign assets to their market value on 5 April 2017. This means that gains that have accrued on foreign assets while the individual was non-UK domiciled will not be subject to CGT, even if part of the sales proceeds relating to the part of the gain that arose before April 2017 are remitted to the United Kingdom. This protection will be limited to those assets which were foreign situs on 8 July, the date of the Summer Budget 2015. It will only be available to those individuals who have previously claimed the remittance basis. There may be other remittance issues, however, if the foreign asset was originally funded with foreign income or gains taxable on the remittance basis.
There will be a one year window from April 2017 for foreign domiciliaries to rearrange their offshore mixed funds in order to segregate them into clean capital, foreign income and foreign gains, so they can remit the funds tax efficiently. This relief will be available regardless of when an individual will become deemed domiciled, excluding individuals born in the United Kingdom with a UK domicile of origin. This transitional rule will apply to funds held in bank accounts. Where the mixed fund is represented by an asset, however, it should be possible to sell the asset and separate out the different types of funds.
The broad policy objective is that non-domiciled settlors who have established a non-UK resident trust before they become deemed domiciled in the United Kingdom under the 15 year rule will not be taxed on trust income and gains that are retained in the trust structure, and the trust will continue to be an excluded property trust for IHT purposes. In order to achieve this objective, the latest proposals set out a number of protections that will be legislated into the existing rules without introducing an entirely new regime for offshore trusts.
The protected status of a trust settled by an individual before becoming deemed domiciled will be lost if any assets are added to the settlement after the settlor becomes deemed domiciled. The consultation document is unclear whether or not this includes the IHT protection of an “excluded property trust”, or whether it only refers to the income tax and CGT protections discussed further below. In any event, this tainting will have effect for the tax year of the addition and all future tax years, and will apply if assets are added to a protected trust at any time after the settlor first becomes deemed domiciled, whether or not he or she subsequently loses that status. It will be crucial for deemed domiciled individuals to get professional advice before making any transfers that could potentially taint the whole settlement and result in the underlying income and gains being attributed to the settlor.
Capital gains arising in the trust structure can be attributed to a UK resident and deemed domiciled settlor and taxed on the arising basis. The trust is protected from this treatment provided that:
The trust was settled before the date the settlor became UK deemed domiciled;
No property has been added to the trust after that date; and
No benefits are received after that date by the settlor, their spouse and minor children. This last proviso is likely to be the most challenging and will lead, in many cases, to a complete loss of protected status for capital gains.
For income tax purposes, similar protections will apply to prevent all non-UK source income being taxed in the hands of the deemed domiciled settlor on an arising basis. Instead, tax will be charged on the basis of benefits received by the settlor, their spouse or children. The income tax rule will be slightly less draconian: where benefits are enjoyed, the trust will retain its protected status, but the distribution will be taxed on the settlor to the extent it can be “matched” with income arising within the trust.
Tax on benefits received from offshore trusts will continue to be calculated by reference to the income and gains within the trust. The government initially proposed that a new, “dry” benefits charging regime should be introduced. During the consultation process, however, many advisors objected to the potential unfairness of introducing a regime that could result in tax liabilities arising in relation to trusts that have never generated any income or gains, such as those holding property. The government has acknowledged that introducing a charge that could, in some circumstances, have a punitive effect on non-UK domiciliaries compared to UK domiciliaries, was not its intention.
It is clear, therefore, that the proposed rules for non UK-resident trusts will have a greater impact on trusts where the settlor is living, and is both resident and deemed domiciled in the United Kingdom. While some protections are available, these come at a price and may be irrevocably lost, leading to significant UK tax consequences.
IHT Treatment of Residential Property
The current definition of “excluded property” in the IHT legislation will be amended so that shares in offshore close companies and similar entities will be within the scope of IHT if, and to the extent that, the value of any interest in the entity is derived from UK residential property.
The government does not intend to offer any relief from potential CGT and Stamp Duty Land Tax charges which may arise as a result of “de-enveloping” properties held by entities subject to the Annual Tax on Enveloped Dwellings.
There will be no minimum value threshold and properties will be within the charge if they have been used as a “dwelling” at any time within the two years preceding a transfer.
Debts will be taken into account when determining the value of the UK residential property at the time of the chargeable event, but only to the extent that they relate “exclusively to the property”, such as amounts outstanding on a mortgage used to acquire the property. Any loans made between connected parties will be disregarded for valuation purposes.
A targeted anti-avoidance rule will be introduced, the effect of which will be to disregard any arrangements where their whole or main purpose is to avoid or mitigate a charge to IHT on UK residential property.
What should those affected by the reforms be doing?
All those affected by the reforms should get in touch with their advisors to consider how the rules will apply to their circumstances. Although the full details of all the rules are not yet available, it is possible to begin considering available options for planning ahead of their introduction. In particular:
Individuals with UK residential property structures should consider whether there are any benefits to retaining their structures or whether it will be most tax and cost-efficient to hold residential property directly, with the protection of life insurance, if appropriate. Existing loans should be reviewed to determine whether or not they would be deductible.
Long-term resident foreign domiciliaries and trustees of trusts settled by those individuals will need to plan carefully to maximise the protections that the government has committed to and to ensure they are familiar with the rules in advance of their introduction. This planning might include one or more of the following in the period before 6 April 2017:
Creating new trusts or dividing existing family structures into trusts that will retain full protected status and those that will make distributions.
Up-basing assets held in distributing trusts in order to minimise gains chargeable on the settlor.
Making significant distributions to fund beneficiaries for anticipated expenditure over an extended period, in order to prolong full protected status.
Considering making use of Business Investment Relief, which encourages individuals taxed on the remittance basis to remit foreign income and gains to the UK tax-free in order to invest in certain UK businesses. The government is also consulting on how to improve this relief.
Careful consideration will need to be given to assets that can be rebased and to any mixed funds that can be unmixed in the period provided.