The tax treatment of non-domiciled individuals is changing again from April 2017. The changes were first announced in the 2015 Summer Budget, and a Consultation document was issued in September 2015 setting out further details.
The proposed changes target three key areas:
- The taxation of non-domiciled individuals who have been resident in the UK for 15 years
- Individuals owning UK residential property indirectly, e.g. through an overseas company and/or trust
- UK domiciled individuals born in the UK who leave the UK and acquire a non-UK domicile of choice and then later return to the UK
This briefing note focuses on the changes that will affect non-domiciled individuals who been living in the UK for more than 15 years.
The permanency of the remittance basis regime has been criticised as being unfair, particularly for individuals who have been living in the UK on a long-term basis. The aim of the proposed changes is to restrict indefinite access to the remittance basis regime by treating non-domiciled individuals who have been living in the UK for 15 years or more as deemed domiciled so that they pay tax on the same basis as UK domiciles. From 6 April 2017, such individuals will no longer be able to access the remittance basis; UK tax will be charged on their worldwide income and gains on an arising basis.
However, important and valuable protection is to be offered for overseas income and gains arising in offshore trusts settled before an individual becomes deemed domiciled, provided that no benefit is received from the trust by the individual, their spouse or children.
Individuals who are UK resident but non-UK domiciled enjoy a favoured tax regime in the UK. They are liable to UK tax on UK source income and gains, and can opt for overseas income and gains to be taxed on the remittance basis, whereby UK tax is payable only on any overseas income or gains that are remitted to the UK. Overseas income and gains not remitted to the UK are not subject to UK tax.
Longer term UK resident non-domiciled individuals are required to pay an annual charge to access the remittance basis (the Remittance Basis Charge). The charge increases the longer the individual has been resident in the UK, as follows:
Number of tax years resident in the UK
Annual Remittance Basis Charge
At least 7 of the past 9
At least 12 of the past 14
At least 17 of the past 20
For UK inheritance tax (IHT) purposes, non-domiciled individuals are only subject to IHT on their UK assets. However, once an individual has been UK resident for at least 17 out of the past 20 tax years, he will be deemed to be UK domiciled for inheritance tax purposes, so that his worldwide assets are subject to IHT.
Where a non-domiciled individual settles an offshore trust that holds non-UK property, the trust is known as an 'excluded property trust' and the assets within the trust (provided they are all non-UK situs) are outside the scope of IHT even after the individual becomes deemed domiciled for IHT purposes.
Trusts therefore provide a unique mechanism to protect the individual's non-UK assets from UK IHT on a permanent basis.
Under current anti-avoidance rules, income and gains arising in an offshore trust settled by a non-domiciled individual who is also a beneficiary of the trust are taxable on the settlor, although the remittance basis can apply where the income and gains are foreign source.
From April 2017, non-domiciled individuals who have been resident in the UK for more than 15 out of the previous 20 tax years will be regarded as deemed domiciled in the UK for all UK tax purposes, and will no longer be able to claim the remittance basis. Such individuals will therefore pay tax in the UK on their worldwide income and gains on an arising basis. Their worldwide assets will be subject to inheritance tax, with the exception of assets held in an excluded property trust settled by the individual before he became UK domiciled or deemed domiciled.
Part-years of UK tax residence count for the 15 year rule, so an individual who became UK resident during 2002/03 will become deemed domiciled from 6th April 2017.
The 15 year rule will not affect an individual's domicile position under general law, or a child's domicile position which will be tested independently.
The £90,000 annual Remittance Basis Charge for individuals who have been in the UK for 17 years will be redundant as such individuals will no longer be able to use the remittance basis.
Individuals who will become deemed domiciled from April 2017 as a result of these proposals and those who anticipate longer term UK residence are advised to take action now to protect their overseas income and gains from UK taxation and their overseas assets from IHT.
A new measure included within Budget 2016 confirms that individuals who become deemed domiciled in April 2017 as a result of these changes will be able to rebase their overseas assets to market value at 6 April 2017 for capital gains tax purposes. This means that on a future disposal, UK tax will only apply to gains accruing after this date. It is unclear at this stage how this measure will apply to all individuals who become deemed domiciled after April 2017.
Excluded Property Trusts
One welcome clarification included in the Consultation document is that offshore trusts settled before an individual becomes deemed domiciled will retain their favoured 'excluded property status' for inheritance tax purposes. This means that trust assets situated outside the UK continue to be outside the scope of IHT. It should be noted, however, that IHT exemption will no longer apply to UK residential property held by an offshore company/trust structure with effect from 6 April 2017.
The Consultation document confirms that overseas income and gains retained within the trust can roll up tax free, and it would appear that this is to be the case even where the settlor is able to benefit from the trust. At first sight, this appears to be a relaxation of the current anti-avoidance rules where the settlor (who is also a beneficiary) is taxed on income and gains arising in an offshore trust, subject to a remittance basis claim.
Whilst overseas income and gains would roll up tax free, it is proposed that any benefits received from the trust, including income or capital distributions, by a deemed domiciled individual, their spouse or children, will be chargeable to UK tax.
This is a major change in the basis of taxing offshore trusts. The Government appears to be moving away from a system of taxation based on the income and gains that have arisen in the trust, to a system of benefit taxation, where tax is based on benefits received from the trust, regardless of whether the benefit represents underlying income, gains or core capital of the trust, and regardless of whether the benefit is received in the UK or overseas.
It is not clear at this stage what the rate of tax on such benefits will be.
Currently, non-domiciled individuals who currently pay the annual remittance basis charge of either £30,000, £60,000 or £90,000 to access the remittance basis regime may be potentially better off under the new regime, particularly if benefits from the trust are not required.
However, where the trust is a 'dry trust' (for example, a trust holding UK property occupied by a beneficiary, but that has no income or gains), the occupation by the beneficiary is regarded as a benefit, and it is therefore possible that a tax charge could arise. It is not yet clear how this situation will be addressed.
Benefits received whilst an individual remains non-deemed domiciled will not be taxable if the individual claims the remittance basis and does not remit the funds to the UK.
UK source income arising within the trust will continue to be taxable on an arising basis in the hands of the settlor if the settlor can benefit from the trust and there was a UK tax avoidance motive when the trust was settled.
Losing Deemed Domicile Status
An individual can lose deemed domicile if they leave the UK and remain non-UK resident for at least six consecutive tax years. So, if an individual leaves the UK during 2016/17, they will need to remain non-UK resident until at least 6 April 2023 to be eligible for the remittance basis upon their return to the UK.
Treaty non-UK residence does not count as a year of non-UK residence, so individuals will need to ensure that they are clearly non-UK resident under the Statutory Residence Test during their six years abroad.
When the individual returns to the UK having spent six tax years overseas, the 15 year clock will reset and the individual will be able to spend another 15 years in the UK before becoming deemed domiciled again.
It should be noted that during the first six years of non-UK residence, an individual will remain liable to UK IHT on their worldwide assets.
Whilst full details of the above changes are not expected to be published until Finance Bill 2017, non-domiciled individuals should review their tax planning arrangements immediately to take advantage of the short window for planning opportunities up to 6 April 2017.
- Settle an offshore trust
For those individuals who are not deemed domiciled under the current 17 out of 20 year rule but who will become deemed domiciled under the new rules from April 2017, estate planning needs to be urgently reviewed and we may recommend setting up an excluded property trust now.
This includes individuals approaching 15 years of residence in the UK. For example, if an individual arrived in the UK in say March 2003, although they have only been here for just over 13 years, they will currently be in their 15th year of UK tax residence and will be affected by the new rules from 6 April 2017.
Settling an offshore trust now may have the following tax benefits:
- Tax free roll up of foreign source income and gains within the trust
- No liability to the remittance basis charge
- IHT protection for overseas assets held within the trust (provided no UK residential property is held within the structure).
- Review existing trusts
Individuals who will be regarded as deemed domiciled from April 2017 should review their trusts and consider extracting income and capital gains from the trust now whilst they are able to claim the remittance basis. From April 2017, based on current proposals, it is likely that all distributions from such structures will be immediately taxable (with no ability to claim the remittance basis).
- Leave the UK to re-start the clock
Individuals who will become deemed domiciled on April 2017 by virtue of the new rules may choose to leave the UK before April 2017. They may need to spend at least six tax years outside the UK to restart the 15 year clock.
Due to the complex and uncertain nature of the proposed legislative changes, it is essential for those affected to tax comprehensive professional advice as soon as possible.