Deemed domiciled; long term residents
Indefinite non-domiciled status for UK tax purposes will become a thing of the past if the proposals in the Summer Budget are enacted. These are expected to take effect from 6 April 2017.
A non-UK domiciliary may elect to be taxed on the remittance basis (‘the RB’), and may be required to pay an annual charge for the privilege of doing so depending on how long they have been here. The effect of making this election is that the individual will not be liable to pay UK income and capital gains tax (‘CGT’) on non-UK income and gains that they do not remit to the UK. There is no limit on the number of years an individual can claim to be non-UK domiciled for income tax and CGT purposes, providing the individual does not acquire a domicile of choice in the UK, and, therefore, no limit on the duration for which the RB can apply. If the RB is not claimed then a UK resident non-domiciliary is taxed on the ‘arising basis’ and pays UK tax on their worldwide income and gains.
The proposed rules provide that long-term UK residents should pay tax on their worldwide income, gains and the value of their estate on death. It is proposed that from April 2017 non-UK domiciliaries who have been resident in the UK for 15 out of the last 20 tax years will be regarded as domiciled in the UK for all tax purposes notwithstanding that they may be non-domiciled as a matter of general law. This means that after 15 tax years a foreign domiciliary will become deemed UK domiciled and can no longer use the RB of tax and will be subject to:
- income tax on their worldwide income;
- CGT on their worldwide gains; and
- IHT on their worldwide assets on death.
The Government proposes that a year of UK residence will include years spent in the UK whilst a minor, and also split tax years. Therefore, it is possible that an individual could become deemed domiciled before reaching adulthood. However, six years’ non-residence will shake off deemed domiciled status and returning to the UK after such a period of absence will start the 15 year clock again.
Currently, non-domiciliaries with less than £2,000 of foreign income and gains in the relevant tax year can be taxed on the RB without paying the related charge for that tax year. RB users who are below the £2,000 threshold have the additional advantage of retaining their entitlement to the income tax personal allowance and the CGT annual exemption which are lost when the RB charge is paid. The Government is consulting on whether there should be any changes to these provisions for those who become deemed domiciled. As a result, this category of tax payer could pay UK tax for the first time.
Under the proposals, it will still be possible for non-domiciliaries to continue to protect their non-UK assets from IHT by transferring the assets into an offshore trust before they become deemed domiciled under the new 15 year rule. The assets comprised in the offshore trust will remain excluded property for IHT purposes and thus exempt from IHT.
However, distributions or benefits received from an offshore trust by a deemed domiciled individual will now be subject to UK taxes, regardless of whether the distribution or benefit is received in the UK or offshore. Crucially, this means that benefits, typically rent free occupation of a UK residential property, received from a so-called ‘dry trust’ that does not generate income or gains may now be subject to UK taxation based on the market value of the benefit received.
The Government is considering extending these rules to all non-domiciliaries who are resident in the UK rather than limiting the application to those who have become deemed domiciled under the new 15 year rule. If the non-domiciliary has not yet met the new 15 year rule, the Government states that it would be possible for them to avoid a UK tax charge by receiving distributions and enjoying benefits offshore. The Government will continue to consider these aspects before it publishes draft legislation.
Born in the UK, but moved abroad?
Part of the Government’s proposal includes a substantial change to the treatment of individuals born in the UK with a UK domicile of origin who have acquired a domicile of choice outside the UK and then subsequently return to the UK. The proposal is that the law will be changed to deem such individuals to be domiciled in the UK in any year in which they are UK resident.
This will affect a significant number of individuals who have previously moved abroad and developed strong enough ties to acquire a non-UK domicile of choice. Individuals who will be affected by this include particularly, for example, those who return to the UK for short-term work assignments. The Government is aware that this change of law will affect existing structures and that some of those which were previously established as excluded property settlements, will now be considered relevant property trusts in any year in which the settlor is UK resident. Trustees will need to be particularly cautious when approaching ten year anniversaries to consider the implications of a settlor’s residence and domicile status at that time.
The Government is aware that the implementation of this change of law may have dramatic implications, perhaps more so than those affecting income tax and CGT, for some structures. Accordingly, the consultation has requested suggestions for ways in which the effect of short-term residence will be mitigated, for example, by granting a two year grace period during which this rule would not apply.
It is proposed that when a ten-year anniversary charge is payable and assets, which were previously excluded property, have become relevant property by reason of these deeming provisions that the charge will be apportioned. The apportionment will be based on the period of time during the previous ten years during which the settlor was UK resident (and therefore deemed domiciled in the UK). The trust will be considered excluded property again if the settlor becomes non-UK resident (and not actually domiciled or deemed domiciled under any of the various provisions).
The proposals are a significant departure from current practice and will require detailed consideration of a settlor’s residence and domicile status on an ongoing basis. Individuals and trustees affected should consider the implications that these rules will have and take formal advice when more detailed legislation becomes available.