UK: UK Budget July 2015 – Non-Doms In The Spotlight

Introduction

The July Budget 2015 was one of the most eagerly anticipated UK Budgets in recent years. It was the first Budget to be delivered by a Conservative government since 1996 and there was much speculation in the media concerning the steps the Chancellor would introduce now that he is no longer subject to the constraints of coalition government.

Following an increase in political and media attention concerning the taxation of non-UK domiciliaries in the run up to the General Election in 2015, it was expected that the Chancellor would introduce reforms to the tax regime applicable to non-UK domiciliaries ('non-doms'), which he has done. It is likely that the changes announced will be welcomed by the public at large. However, they will also mean that long-term residents of the UK who currently elect to be taxed on the remittance basis will be forced to give serious consideration to their tax position and a number may choose to leave the UK altogether.

However, the reforms are not limited to the non-dom tax regime and the Chancellor outlined significant changes to other areas of UK tax law. Below we have summarised the changes that we think will be of particular interest to clients of our Swiss offices and their advisers.

Changes to the rules concerning non-UK domiciliaries

For many of our clients, the most significant changes announced in the July Budget 2015 concern the taxation of non-doms. Two potentially very significant changes have been announced to the rules currently in place, together with a more minor change concerning the election for the remittance basis to apply:

a) Extended deemed domicile rules and restriction of the remittance basis

From 6 April 2017, individuals will become 'deemed domiciled' in the UK for all tax purposes once they have been UK resident for more than 15 out of the past 20 tax years. This means that once an individual has been resident for this period he will be unable to claim the remittance basis and will be chargeable to UK income and capital gains tax on his worldwide income and capital gains.

In addition to affecting the income tax and capital gains tax position of individuals, the change will also mean that an individual who has been resident in the UK for 15 out of 20 years will be within the UK inheritance tax net and subject to UK inheritance tax at 40% on his worldwide assets up to two years earlier than was the case under the old rules (which stipulate that an individual becomes deemed domiciled for inheritance tax purposes when he has been UK resident in 17 out of the past 20 tax years). In addition, the new rules will mean that once a non-dom who has become deemed domiciled under the 15-year rule leaves the UK, he will not lose his UK deemed domicile until he has spent more than 5 complete tax years outside the UK. There will therefore be a longer 'inheritance tax tail' for those non-doms who leave the UK than is currently the case.

One piece of good news is that it will still be possible for non-doms to create 'excluded property trusts' for as long as they are not deemed domiciled in the UK (although subject to the restriction described in (b) below). This means that it will still be possible for non-doms to shelter their assets (with the exception of UK residential property – see point 3 below) from UK inheritance tax in the event that they subsequently become deemed domiciled. Furthermore, it appears that settlors of such trusts will not be taxable on income and gains that are retained in the trust, even after they become deemed domiciled. Offshore trusts will therefore still offer very attractive tax deferral possibilities for individuals with a non-UK domicile of origin.

b) Restrictions on individuals with a UK 'domicile of origin'

The government has also announced restrictions on tax planning that can be undertaken by individuals who were UK domiciled at birth. Under the current rules, it is technically possible for an individual with a UK domicile of origin to leave the UK and to acquire a domicile of choice in another jurisdiction. Such an individual could return to the UK at a later date and elect to be taxed on the remittance basis as long as he could demonstrate that he had not lost his domicile of choice outside the UK.

In addition, a trust set up by such an individual whilst that individual was non-UK domiciled (and not deemed domiciled in the UK for inheritance tax purposes) would be an excluded property trust for UK inheritance tax purposes and would therefore remain outside the scope of UK inheritance tax even if the individual subsequently lost his domicile of choice.

Under the new rules, such an individual will not be able to benefit from the excluded property status of any trust set up by him whilst non-UK resident and non-UK domiciled if he returns to the UK and becomes UK resident. In addition, he will not be able to claim the remittance basis in relation to the trust assets or other assets held outside the trust but kept offshore.

On departure from the UK, domicile status will be lost again in the tax year after departure, as long as the individual has not been in the UK for more than 15 years and has not acquired an actual UK domicile.

c) Claim period for the remittance basis to apply

In the March 2014 Budget it was announced that the government would consult on whether to change the rules regarding the ability to claim the remittance basis on an annual basis (it was suggested that an individual would have to elect to be taxed on the remittance basis for a period of 3 years). The government has now announced that it does not intend to implement these changes. Elections for the remittance basis to apply will therefore continue to be made on an annual basis.

Inheritance tax on UK properties

a) Current position

Under current rules, individuals who are not domiciled or 'deemed domiciled' in the UK (regardless of where they are resident) are only subject to inheritance tax ('IHT') on assets situated in the UK. Because IHT is only charged on directly held UK assets, it is relatively easy for a non-dom to avoid IHT by 'enveloping' such assets. i.e. owning them through a non-UK company or other non-transparent entity (either directly or via an 'excluded property trust').

In recent years the UK Government has made various attempts to discourage non-doms from enveloping UK residential real estate, including the introduction of the ATED (annual tax on enveloped dwellings) and the increased rates of SDLT (stamp duty land tax) for residential properties held through non-UK entities. However, some non-dom owners of high-value properties have taken the view that these disadvantages do not outweigh the benefit of protection from an IHT charge of 40% on their death.

b) Proposed new rules

With effect from 6 April 2017, the current IHT rules are to be amended so that individuals or trusts owning UK residential property through a non-UK 'envelope' will be subject to IHT on the value of the property, in the same way as UK domiciled individuals. The charge will be based on the existing ATED rules, but will be wider in scope as it will also apply in relation to properties which are rented out and the various ATED reliefs will not apply. Also, the IHT charge will apply regardless of the value of the property (assuming that it exceeds the normal IHT nil rate band).

IHT will be imposed on the value of UK residential property owned by the offshore holding company on the occasion of any chargeable event. This would include:

  1. the death of the individual (wherever resident) who owns the company shares,
  2. a gift of the company shares into trust,
  3. the ten-year anniversary of the creation of the trust,
  4. distribution of the company shares out of trust,
  5. the death of the donor within 7 years of having given the offshore company away to an individual, or
  6. the death of the donor/settlor where he benefits from the gifted UK property or shares within 7 years prior to his death (i.e. the IHT 'reservation of benefit' rules will be extended to apply to the shares of the offshore holding company in the same way as the rules currently apply to UK domiciliaries and directly held UK property of non-doms).

In some cases the position may be more complicated, e.g. because the offshore company has other assets as well as the UK residential property, the offshore company is held through a group or the non-dom/trust does not wholly own the company. The intention is that only the UK residential property will be caught by the new IHT charge and the government proposes to consult on the details of the proposals to ensure that this is achieved.

It is intended that the same IHT reliefs and charges will apply as if the UK property was held directly by the owner of the company. The spouse exemption will therefore be available on the non-dom's death in the normal way if he/she owned the company shares directly – but in most cases it will not apply if the property is held through a trust.

There will be targeted anti-avoidance legislation, and attempts to avoid the new charge may also be within the proposed extension of the DOTAS (disclosure of tax avoidance schemes) regulations in relation to IHT.

The UK government apparently does not intend to change the IHT treatment of other UK or non-UK assets held by non-doms or excluded property trusts.

c) Impact of new rules?

It is anticipated that the new IHT charge may prompt at least some non-doms and trusts to 'de-envelope' UK properties. The government is aware that in some cases (e.g. if the property is mortgaged or has increased in value since 2013) there may be significant costs associated in doing this and has announced that it will consult on this aspect, and any other concerns stakeholders may have, before the new rules are implemented. A consultation document is due to be published towards the end of this summer.

In the meantime, it remains to be seen what the overall impact of the changes will be in economic terms. Although they may well increase the IHT take, the yield from the ATED (which is more reliable given that an IHT charge will not always materialise, e.g. if the non-dom sells the UK property before his death) is likely to reduce, and the new charge may also affect the attractiveness of the UK property market for non-doms.

Taxation of UK dividends

The tax treatment of UK dividends is currently more complicated than it needs to be, mainly because of the dividend tax credit system (which reduces the amount of tax payable on dividends, but is disproportionately complex). The government is proposing to simplify the system from April 2016, by abolishing the dividend tax credit and replacing it by a new 'dividend tax allowance' of £5,000 and increased tax rates on dividend income. The new tax rates will be 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers and 38.1% for additional rate taxpayers.

According to the government, this change will result in a tax cut or no change for investors with modest income from shares, but taxpayers who receive significant dividend income (e.g. if they have very large shareholdings or receive significant dividends through a closed company) will pay more. The government also anticipates that the changes will reduce the incentive to incorporate and remunerate through dividends rather than through wages, and that this will reduce the cost to the Exchequer of future 'tax motivated incorporation'.

Enhanced compliance and increased criminal investigations

Also included in the Budget are measures designed to discourage tax evasion and tax avoidance and to increase compliance.

a) Tax evasion

The government has stated that it will increase funding to HM Revenue & Customs ('HMRC') by over £60m by 2020-21 to allow HMRC to step up criminal investigations into serious and complex tax crime carried out by wealthy individuals and corporations.

HMRC's powers to acquire data from online intermediaries and electronic payment providers will also be increased to catch those operating in the 'hidden economy'.

b) Tax avoidance

The government will introduce legislation to clamp down on serial tax avoiders who persistently enter into tax avoidance schemes which are defeated. The measures will include a special reporting requirement and a surcharge on those whose latest tax return is inaccurate as a result of a defeated avoidance scheme.

In addition, the government will seek to strengthen the 'General Anti-Abuse Rule', which seeks to prevent the creation of schemes which are artificial and designed solely in order to reduce tax. It will also consult on introducing a penalty for those who fall foul of the GAAR.

c) Compliance

The government will also invest additional funds to tackle non-compliance by small and mid-sized businesses, public bodies and affluent individuals.

Common Reporting Standard ('CRS')

Legislation will be introduced to require financial intermediaries (including tax advisers) to notify their customers about the CRS. The notification will also have to include information concerning the penalties for tax evasion and the opportunities available to individuals to regularise their tax affairs.

This is a welcome announcement since individuals may be unaware of the far-reaching implications of the CRS, which comes into force in some jurisdictions (including the UK) in 2016 and will result in the automatic exchange of information between jurisdictions where assets are located and where the beneficial owner of those assets is resident.

It is similarly important for advisers to make clients aware of the various disclosure facilities that are still available and which offer individuals favourable terms under which to regularise undeclared tax liabilities. These facilities, the most favourable of which is the Liechtenstein Disclosure Facility, will only remain open for new registrations until 31 December 2015. However, the government has also announced that it will introduce an additional time-limited disclosure facility in 2016 to allow non-compliant taxpayers to correct their tax affairs before HMRC start to receive data under the CRS in 2017. This facility will be on tougher terms than the facilities currently available and we recommend that taxpayers who are aware that they have outstanding tax liabilities take steps to regularise their affairs using one of the schemes currently available rather than waiting until 2016.

Other points to note

a) Capital gains tax and hedge funds

With effect from 8 July 2015, the rules on the taxation of 'carried interest' will be amended with a view to stopping investment fund managers from using tax loopholes to avoid paying the correct amount of capital gains tax on the carried interest. Individuals will normally be charged to CGT on the full amounts they receive in respect of the carried interest, regardless of the items notionally applied to satisfy the carried interest at the level of the partnership or other entity in the fund structure. Only limited deductions will be permitted, in particular for any actual consideration given by the individual for the carried interest. This measure will apply to all carried interest arising on or after 8 July 2015, regardless of when the arrangements were entered into.

The government has also issued a consultation on the circumstances in which investment managers' performance-related returns are to benefit from CGT treatment (rather than being treated as income).

b) Banking tax

From 1 January 2016, a new tax on banking sector profit set at a permanent rate of 8% will be introduced. There will also be a phased reduction of the bank levy rate from 0.21% to 0.10% by 1 January 2021. In addition, the scope of the bank levy will be changed so that from 1 January 2012 UK headquartered banks are charged on their UK balance sheet liabilities.

c) Pension tax

From April 2016 the government will reduce the amount of money individuals with an annual income of more than £150,000 (including their own and their employer's pension contributions) can pay into a pension scheme free of tax. The reduction will take the form of a taper to the annual allowance. For every £2 of income over £150,000, the limit on the amount of tax relieved pension saving will be reduced by £1 down to a minimum of £10,000 (the limit is currently £40,000).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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