For more information, please contact: Matthew Edwards, Senior Tax Manager, Satis Asset Management Ltd; Tel: +44 (0)20 7004 7126; Email: firstname.lastname@example.org
Over the past ten years, certain elements of the media and political establishment seem to have become increasingly obsessed about the tax affairs of “non-doms” (people who reside in the UK, but are not considered to be domiciled here).
THE CONCEPT OF DOMICILE
Domicile is a concept of UK common law. A person’s domicile is generally the territory which that person considers to be their permanent home. There are three main categories of domicile: domicile of origin; domicile of dependence; and domicile of choice.
1. Domicile of Origin
For most people, the most important type of domicile is their domicile of origin. A person’s domicile of origin is determined by reference to the domicile of his or her parents. If the parents were married when the person was born, that person’s domicile of origin will follow the domicile of his or her father at that time. If the parent were not married or if the mother was widowed at the time of the person’s birth, then his or her domicile follows that of the mother.
2. Domicile of Dependence
Domicile of dependence is most often relevant in the case of a child where the domicile of the child’s parents changes before the child becomes an adult. Where the parents were married at the time of the child’s birth, the child’s domicile of dependence will follow any changes to the father’s domicile. Where the parents were unmarried, the child’s domicile of dependence will follow changes to the mother’s domicile. If the parents were unmarried at the point of the child’s birth, but marry before the child becomes an adult, the child will acquire the father’s domicile as a domicile of dependency from the date of the marriage.
3. Domicile of choice
A person’s domicile of choice is generally the jurisdiction which that person adopts as their permanent home. Most expats living in the UK will remain domiciled in their ‘home’ country unless or until they sever their ties to that country with the intention of remaining here indefinitely.
DOMICILE AND TAXATION
The concept of domicile has formed one of the defining factors in the territorial scope of UK taxation for a great many years, and expats who have been in the UK for some time will have become used to the fact that their tax affairs may be viewed differently from those for whom the UK is their place of domicile.
1. Income and Capital Gains Tax
Any individual who is resident but not domiciled in the UK can elect to be taxed using the “remittance basis” of taxation.
Broadly speaking, the remittance basis of taxation allows individuals who are not domiciled in the UK to shelter their offshore income and gains provided that they do not remit those income and gains to the UK, or otherwise have ‘enjoyment’ of the income and gains in the UK.
Prior to April 2008, claiming the remittance basis was something of a no-brainer for most expats in the UK, as there was no significant downside to doing so.
However, changes introduced in April 2008 and subsequently expanded, resulted in there being a series of tax costs tied to making such a claim, if the individual has more than £2,000 of foreign income or gains.
Firstly, anyone claiming the remittance basis would lose their personal allowance (this is the amount of income that a person can earn before tax becomes payable in the UK - £10,600 for 2015/16) and annual allowance for capital gains tax (£11,100 for 2015/16).
Secondly, and the cause of some concern among expats at the time, was the imposition of a £30,000 “remittance basis charge” for anyone who had been resident in the UK in seven of the previous nine tax years and who wished to claim the remittance basis. This remittance basis charge was subsequently extended to £50,000 (now £60,000) for individuals who have been resident in the UK for twelve of the previous fifteen years, and recently to £90,000 for those individuals resident in the UK in seventeen of the previous twenty years.
2. Inheritance Tax
Another tax advantage afforded to non domiciled individuals in the UK is the impact that domicile has for UK inheritance tax purposes.
For a UK domiciled individual, the inheritance tax payable on their death is typically calculated by reference to the value of their assets less liabilities over their available “nil rate band” (which is currently £325,000 per individual, although it is transferable between spouses).
However, for a person who is not domiciled in the UK and not “deemed domiciled” in the UK, inheritance tax is only chargeable on the value of their UK situs assets less liabilities over their available nil rate band.
Currently, a person is considered deemed domiciled for inheritance tax purposes, and therefore subject to inheritance tax as if they were UK domiciled, if they have been resident in the UK in seventeen of the previous twenty tax years.
However, a person who is not domiciled is able to shelter their non-UK assets from UK inheritance tax by settling those assets on trust prior to becoming deemed domiciled. Assets held within such trusts (commonly known as “excluded property trusts”) remain outside the scope of UK inheritance tax even after the individual becomes deemed domiciled in the UK.
THE CHANGES AHEAD
George Osborne’s 2015 Summer Budget included some far-reaching changes to the interaction between domicile and tax, which may lead to some expats in the UK needing to re-think their financial arrangements. These changes have been the subject of consultation, and are due to come into effect on 6 April 2017.
1. New Concepts of Deemed Domicile
As noted above, the UK has had a system of deeming long-term residents to be domiciled in the UK for inheritance tax purposes even if they have retained their non domiciled status under general law. The new rules introduce two concepts of deemed domiciled to replace the existing one. At this point, it is important to note that the new deemed domicile rules apply to income tax, capital gains tax, and inheritance tax (not just to inheritance tax, as has been the case historically).
Firstly, the new rules state that a person will be deemed domiciled in the UK if that person has been resident in the UK in fifteen of the previous twenty years.
Secondly, the new rules state that a person will be deemed domiciled in the UK if:
a. the person was born in the UK
b. the person has a domicile of origin in the UK; and
c. the person is resident in the UK.
The first of these tests is perhaps the most understandable. Clearly, the Government wants to ensure that people who come to the UK are not able to access the benefits of non domiciled status for an extended period of time, whilst still providing an incentive for people to come to the UK.
It is the second of these tests that is rather more concerning. For example, under this test a person born in the UK to British parents, who emigrated as a child and acquired a foreign domicile of dependence, and who returns to the UK on a work assignment for, say, three years, will be considered deemed domiciled in the UK from the point that they become resident in the UK.
2. Impact on Income Tax and Capital Gains Tax
The most obvious impact of these new rules is that anyone who has been in the UK for more than fifteen years will lose the ability to claim the remittance basis after April 2017. Clearly this will only have an impact on people who would otherwise have been paying the £60,000 or £90,000 remittance basis charges.
What these new rules do mean is that the £90,000 remittance basis charge for individuals resident in the UK for more than seventeen years will cease to be relevant after April 2017.
There is one piece of relatively positive news in all this. In the recent budget documentation there is a statement that individuals who will become deemed domiciled in the UK on 6 April 2017 because of the operation of the new rules will be able to treat the cost base of their offshore assets as being the market value of the asset on 6 April 2017. This will result in any subsequent capital gain realised on a sale of the asset being calculated by reference only to the appreciation of the asset between 6 April 2017 and the date of sale.
There is also an impact on individuals who are beneficiaries of trusts established outside the UK. It has been a long established tax planning strategy for non domiciled individuals who have assets held by offshore trusts to accumulate income and/or gains in the trust and take one large distribution retained outside the UK, and claim the remittance basis for that year. After April 2017, this will no longer be effective for individuals who meet the new deemed domicile criteria.
Another important point to note regarding offshore trusts is that UK tax law contains provisions which require the settlor of an offshore trust, if UK domiciled, to pay tax personally on the income and gains of that trust. Historically, these rules have never been in point where the settlor was not domiciled in the UK when the trust was settled. The Government has stated that it wishes to avoid subjecting non domiciled individuals to the punitive and administratively burdensome tax consequences that the settlor would encounter under these rules when they become deemed domiciled, and has therefore indicated that the taxation of offshore trusts to deemed domiciled individuals will be limited to those receiving benefits or distributions from such trusts.
a. Additional Issues for those Born in the UK with a UK Domicile of Origin
There are some differences in the way that the new rules will apply to those who were born in the UK with a UK domicile of origin compared with those who are of foreign origin but have come to the UK.
The key differences deal with the issue of foreign trusts, and the way in which they are taxed. While individuals who have become deemed domiciled in the UK but have a foreign domicile of origin will retain certain protections with regard to the way in which foreign trusts are taxed as mentioned above, these protections will not apply to individuals born in the UK with a domicile of origin.
As a result of this distinction, individuals who expect to fall foul of the new rules in April 2017 should review any existing trust structures as soon as possible.
3. Impact on Inheritance Tax
At first glance, the impact of these rules on inheritance tax might seem somewhat limited, as the old deemed domiciled rule has been in place for many years.
However, the first (and most obvious) point to stress is that the threshold for becoming deemed domiciled will reduce from seventeen to fifteen years, although it is important to note that the excluded property trust regime is expected to continue to be available to shelter offshore assets settled on trust prior to becoming deemed domiciled.
The second point to note is that under the old rules, one could re-set the clock on the deemed domiciled provisions by ceasing to be resident in the UK for a period of at least four tax years. That requirement will increase to six years of non residence once the new rules come in to force.
A final point worth noting is the impact of these rules on departing expats. Under the old rules, a person who had become deemed domiciled in the UK would cease to be deemed domiciled here four tax years after their return home (or after they settle in a new jurisdiction). That timeframe is now extended to six tax years, and so the interaction with transfer taxes imposed by their home jurisdiction may be affected.
a. Additional Issues for those Born in the UK with a UK Domicile of Origin
As is the case with income tax and capital gains tax, there are some key differences between the way that the new rules will impact individuals born in the UK with a UK domicile of origin and those born overseas but who have come to the UK.
Again, the most striking difference concerns the taxation of offshore trusts. Excluded property trusts established by non domiciled individuals who were born in the UK with a UK domicile of origin will not be considered to be excluded property trusts once the settlor has become deemed domiciled in the UK. This means that the assets of the trust will most likely become subject to ongoing inheritance tax charges.
Individuals who believe that these provisions will impact them should review their trust structures as soon as possible.
April 2017 promises the most fundamental change to the taxation of non domiciled individuals since the introduction of the remittance basis charge in 2008.
While many expats in the UK may have already come to the conclusion that paying the remittance basis charge would be unlikely to ever have been financially viable and therefore that they should not be too concerned by these rules, some of the nuances may still warrant consideration.
Those who are approaching the seventeen out of twenty year test under the old deemed domicile rules should give some thought to accelerating any planning that they might have been considering to try to restrict the impact of the 2017 changes.
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