The UK's Autumn Budget confirmed that the concept of domicile will be dropped from the UK tax system. Instead, like many other countries, we will look solely at residence (with no changes to the existing Statutory Residence Test).
This means we will also be abolishing the concept of UK resident but non-domiciled (known as being non-dom) and removing domicile as the basis for UK inheritance tax (IHT).
Currently, IHT applies as follows:
- To the worldwide assets of a UK domiciled person
- To the UK situated assets of a non-UK domiciled person
This means currently a non-dom can put their non-UK assets into an offshore trust, and provided they were non-dom at the time, the trust will protect those assets from IHT even if they become UK domiciled (or deemed domiciled) later.
The trust will be classed as an excluded property settlement, as its non-UK situated assets are excluded from IHT.
This has been a very common planning technique for non-doms who realised they were going to be remaining in the UK long enough to become 'deemed' domiciled (originally after 17 years but now after 15 years of residence in the UK).
These rules are all being changed and the new system will come into effect from 6 April 2025.
New long-term residence test
Instead of domicile, we will look at whether the settlor is long-term UK resident, with this being defined as someone who has been UK resident for at least 10 of the last 20 years.
Once an individual is long-term UK resident, their worldwide assets will be subject to IHT.
Offshore trusts
The new test says that a trust will only be an excluded property settlement (so outside the scope of IHT) at any time the settlor is not classed as a long-term resident. Or put another way, if the settlor is long-term UK resident, any offshore trust s/he set up (no matter how long ago) will now be within the scope of IHT.
In most cases, the offshore trust will be a discretionary settlement, which means the offshore trustees will need to file special IHT trust returns, and pay IHT, on every tenth anniversary of the trust's creation and whenever assets are appointed out (as an exit charge).
Currently, the rate of IHT paid by trusts is a maximum of 6%. As the charges will only apply from 6 April 2025, they will be reduced pro rata. For example, if the trust's next 10-year anniversary is in April 2027, that will mean 2 years since the change of rules, so 2/10 (or 1/5th) of the IHT will be payable.
The rules are different if there is a qualifying life interest in the trust – here the assets are taxed as if the life tenant owned them.
These trusts can only be excluded property settlements if both the settlor and the life tenant are not long-term UK residents.
What if the settlor has died?
If the settlor died before 6 April 2025, the old rules still apply, so you only need to look at the settlor's domicile on the date the trust was set up/assets were settled.
If the settlor dies after 6 April 2025, you need to know if the settlor was a UK long-term resident at the date of death.
If the settlor was not long-term UK resident, then the trust's non-UK assets are outside the scope of IHT.
But if the settlor was long-term UK resident on the date of death, then all the trust assets (including any situated outside the UK) will be subject to IHT for the duration of the trust.
Gift with reservation of benefit rules
The UK also has a system for taxing gifts where the donor retained a benefit, known as the gift with reservation of benefit or GWR rules.
A classic example is where someone sets up a trust but is still one of the beneficiaries. The settlor therefore has retained a potential benefit, even if nothing is actually paid out of the trust to the settlor.
Under the current rules, if a non-dom sets up a trust with 'excluded property', then it doesn't matter if the settlor has retained a benefit. The trust asset will still be outside the scope of IHT even if the settlor has become UK domiciled by the time they die.
Under the new rules, if the settlor retains a benefit in the trust, and is long-term UK resident on the date of death, then the GWR rules mean the whole value of the trust is subject to IHT as part of the settlor's estate.
Alternatively, if the settlor were to give up the reserved benefit during their lifetime (e.g. by being excluded from benefit) the GWR rules class this as a lifetime gift. This means the settlor has to survive by at least 7 years to ensure no IHT is due.
Limited 'grandfathering'
There is a limited grandfathering from these GWR rules, for trusts that had already been set up before 30 October 2024. These trusts won't be subject to the GWR rules but only for the non-UK assets that were already in the trust.
The GWR rules would still apply to any UK situated assets, and that remains the case even if those are sold and reinvested offshore. Similarly, any new additions to the trust will be caught by the GWR rules.
The grandfathering doesn't stop the trust having to pay the special IHT charges mentioned above, on every tenth anniversary or on capital 'exits' from the trust.
Watch out for settlors who leave the UK
There is also an exit charge when a trust ceases to be in the scope of IHT. This could happen where the settlor is currently long-term resident (which brings the offshore trust into the scope of IHT) but then leaves.
Once the settlor ceases to be long-term resident, the offshore trust would become an excluded property settlement again. This would result in an exit charge arising.
This means trustees need to keep careful records of:
- Any trust they administer where the settlor is UK resident
- How long the settlor has been UK resident, to see if they are long-term resident
- The value of all the UK trust assets on the tenth anniversary, if the settlor is not long-term UK resident
- The value of all the trust assets, including offshore, on the tenth anniversary if the settlor is long-term UK resident
- The value of any capital distributions (exits) made since the settlor became long-term resident
- When the settlor ceased to be long-term resident, triggering the IHT exit charge.
Offshore trustees may well feel this is a lot to take into account where the settlor is UK resident!
The exit charge would also apply in the much less likely scenario of a UK domiciled person setting up an offshore trust. Under current rules, that trust would be fully within the scope of IHT because of the settlor's domicile status.
But from 6 April 2025, when the concept of domicile is abandoned as the basis for IHT, the question instead will be whether the settlor is long-term UK resident.
If they are not, there would be an immediate exit charge to IHT on 6 April 2025, but there would be no further IHT charges for the trust provided the settlor remains not long-term resident.
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.