The treatment of non-UK domiciles that are resident in the UK has, in some circles, been a contentious issue for a number of years. The tax rules for non-domiciled individuals have been around for centuries and some argue that they are not relevant today. Whilst this may be correct, legislation does provide tax benefits for those people who come to the UK.
In recent years the government has announced changes to the treatment of non-UK domiciled individuals who are resident in the UK and these changes come into force on 6 April 2017. Before we look at these changes it is worth refreshing ourselves of the rules around domicile and residence.
When advising clients it is important to establish their domicile and understand how this works in England, Scotland, Ireland and Wales. Domicile is linked to the individual country but we do talk about UK domicile as a whole, covering all the nations of the UK.
There are three types of domicile that can apply in the UK:
- Origin. This is acquired at birth and an individual will adopt the domicile of their father, and if the father dies or the parents are unmarried or divorced before birth then the mother’s domicile is used. On this basis, just because someone is born in the UK does not necessarily mean that they will have a UK domicile.
- Dependency. A child under the age of 16 will follow the domicile of the parent from who they acquired their domicile of origin. If the parent acquires a new domicile of choice, the child will also adopt that domicile of choice.
A domicile of dependency will apply to women who married prior to 1 January 1974 as they adopted the domicile of their husband from the date of marriage. If the marriage was on or after 1 January 1974 the woman retained her domicile of origin or choice if she had acquired one.
- Choice. This is where an individual takes up residence in a new jurisdiction, losing their UK domicile and acquiring a new domicile of choice. This can be difficult to establish as a client will need to sever ties with the UK with the intention of remaining in the new country either indefinitely or permanently. HMRC will generally not challenge someone who has become a UK domicile, but are more likely to investigate a claim that someone has become non-UK domiciled.
Currently, with regard to inheritance tax (IHT) an individual who is domiciled in the UK will pay IHT on their worldwide assets, wherever they are located, whereas an individual who is non-UK domicile will only pay IHT on their assets situated in the UK. This can result in a massive difference when valuing an estate.
There is also a deemed domicile rule. An individual who has been resident in the UK for 17 out of 20 tax years will be deemed domicile at the start of the seventeenth tax year. From that point, for IHT purposes, they will be treated as being domiciled in the UK and be taxable on their worldwide assets.
There are a number of longstanding double tax treaties meaning that individuals from India, Pakistan, France and Italy cannot become deemed domicile.
Whether an individual is resident in the UK or not will depend on a statutory residence test that was introduced from the 2013/14 tax year.
We will not go into exact details in this article but there are three tests to establish if an individual is non-UK resident or UK-resident in a particular year.
A UK resident is liable to UK income tax and capital gains tax on their worldwide income and gains, and may receive a credit for any tax suffered in the country in which the income and gains arise if there is a suitable double tax treaty in place, or through unilateral relief.
However, resident non-UK domiciles can opt to be taxed on the remittance basis. This can be beneficial to those who have substantial foreign income and gains as these can remain outside of the UK tax net in return for an annual payment. Someone who has been resident in the UK for seven out of nine tax years will have to pay £30,000 each tax year, rising to £60,000 if they are resident for 12 out of 14 tax years and then £90,000 after 17 out of 20 tax years.
In return for this payment they will only pay UK tax on the foreign income and gains that they bring into the UK and are taxed in the year they are remitted. In addition to this the person claiming the remittance basis will lose the personal allowance and annual capital gains tax exemption.
…and from 6 April 2017
There are a number of changes coming into force.
Deemed domicile status
This rule is being broadened in two ways. Firstly, the deemed domicile status will apply once an individual has been resident in the UK for 15 out of 20 years, meaning that it will apply in their sixteenth year of residence. Secondly, it will not only bring the individual within the UK IHT tax net but will also mean that they will pay UK income tax and capital gains tax on worldwide income and gains, similar to the tax position on a UK domiciled resident.
If the individual leaves the UK and ceases to be resident they will lose their deemed domicile status for income tax and capital gains tax after six consecutive tax years. As a concession, inheritance tax will be lost after only three years, similar to the rules as they currently stand for IHT.
There are other concessions aimed purely at those that will become deemed domicile on 6 April 2017 and who have used the remittance basis at some point in the past.
They will be allowed to rebase their overseas assets with regard to capital gains. This is limited to assets held directly by individuals as at 8 July 2015, and not those held by trusts or companies or acquired after that date. The value of these assets can be rebased to their value as at 5 April 2017 removing any gains accrued. While this may appear attractive, it may not suit all, especially those who may have incurred a capital loss.
They will also be able to rearrange their mixed funds during the 2017/18 tax year, allowing them to allocate clean capital, foreign income and foreign gains into separate accounts. If they then remit any money to the UK, it is easier to identify what needs to be taxed in the UK. Any foreign income and gains remitted will be subject to UK tax in the year they are remitted with no allowance for any tax deducted in previous years in other jurisdictions. This could help avoid the situation where income and gains are taxed twice.
UK domicile of origin
Although only applying to a small number of individuals, HMRC are closing the loophole that allows those individuals who were born in the UK with a UK domicile of origin to claim non-UK domicile status. This is where someone acquires a new domicile of choice, after choosing to leave the UK for another jurisdiction, but then subsequently returns to the UK.
From 6 April 2017 in such circumstances the individual will become a UK domicile immediately for income tax and capital gains tax, and in their second tax year of residence for IHT, without waiting for them to remain in the UK for 15 out of 20 years.
Excluded property trusts
This change also impacts excluded property trusts established by those affected individuals whilst they were non-UK domiciled. When they return to the UK, the property in the trust will lose its excluded property status immediately, reverting again back to excluded property status if and when they leave the UK.
This can have implications as whilst back in the UK the trust may become subject to periodic and exit charges.
It is not unusual for non-UK domiciles to purchase UK residential property through an offshore trust or company. As the residential property is not owned by an individual, it therefore falls outside of the IHT calculation and the UK Government has looked at this loophole previously, introducing the Annual Tax on Enveloped Dwellings (ATED) in order to tax the companies and trusts.
From 6 April 2017 where a UK residential property is owned through an offshore company the owners of the shares in the company will become liable to UK inheritance tax when they die on the value of the shares attributable to the UK residential property.
With regard to trust structures that hold shares in offshore companies which own a UK residential property, the property or the value of the shares derived from UK residential property will not be excluded property. The trustees could therefore be liable to ten year anniversary charges and exit charges on any distributions relating to the UK residential property.
In addition to these changes, as the residential property is owned by a ‘non-natural’ person it will continue to be subject to the ATED regime and the annual charges that apply.
These changes could have a significant impact on clients, who are caught by one aspect, or suffer from the changes as a whole, and the cost in taxation could be significant given that foreign assets, income and gains could all become taxable in the UK. Some individuals may become deemed domicile immediately on the 6 April 2017.
There is still time to plan for these changes but the deadline is approaching and it is important for advisers to look at how these changes will affect those non-UK domiciles with overseas assets.