On 18 August 2016, the Government published the latest Consultation Paper on the taxation of non-UK domiciliaries, which was originally due to be published on 9 December 2015. The Consultation Paper sets out the Government's thinking as to the introduction of a new regime for deemed domiciliaries to apply from 6 April 2017. Technically, the document takes the form of another consultation (which will run until 20 October) but there are areas of the new regime that now appear close to being settled. If implemented in the form set out in the document, the proposed new regime will have a significant impact on deemed domiciliaries and it is likely that individuals affected will need to review their positions (and in particular the positions of non-UK resident structures which they have created) on an urgent basis.

This note deals with the points which are likely to be of most interest to clients. There are points which are of more limited interest (such as the treatment of loss elections) that are not covered.

On 8 July 2015, the then Chancellor of the Exchequer George Osborne MP announced the introduction of a regime to apply from 6 April 2017 to long-term non-UK domiciled residents of the UK. Such individuals will be treated as deemed domiciliaries for all tax purposes (and not merely inheritance tax purposes) where they have been resident in the UK for at least 15 out of the previous 20 tax years. In other words, the announcement made it clear that the regime would apply from the 16th consecutive year of residence.

Throughout the autumn of 2015, after the publication of the initial consultation document on 20 September 2015, a consultation process was held and the Government indicated that it would publish its reply to the responses received in the consultation process at the time of the Autumn Statement on 9 December 2015. The original intention was for draft legislation to be available at the time of the March 2016 Budget, so that non-UK domiciliaries would have an entire tax year in which to plan for the introduction of the new regime, to the extent they were affected.

In fact, for a variety of reasons, not least the complexity of what the Government was attempting to achieve, considerable delays have occurred. The Brexit referendum result on 23 June 2016 also called into question whether it was sensible to proceed with a major change to the taxation of non-UK domiciliaries in circumstances where many aspects of the tax system (and particularly those affecting persons from outside of the UK) would inevitably be affected by the Brexit process. However, it appears that the Government has decided to press on with the changes, and it further appears that the changes will have effect from 6 April 2017. There is no indication that any postponement or deferral is in contemplation.

This means that those affected have only a limited period in which to plan and the draft legislation is in many respects incomplete (and in other respects non-existent). The legislation states in terms that it should not be used for planning. This is obviously an unsatisfactory situation and will contribute to a sense of discomfort amongst the non-domiciled community.

At the start of the consultation process it was feared that the new regime would operate harshly for non-UK domiciliaries who became deemed domiciled (for example, by making all structures created by non-UK domiciled deemed domiciliaries transparent to such individuals for capital gains tax and income tax purposes, although not for inheritance tax purposes). During the consultation process it emerged that this was apparently not the Government's aim and that a new system would be created for deemed domiciliaries particularly as regards the application of the attribution rules for income and gains from foreign trusts. In fact, the regime set out in the latest consultation document is, for the reasons explored in more detail below, in many ways difficult (and in some respects unattractive) for individuals who become deemed domiciled on 6 April 2017.

Some taxpayers will consider that the new regime will operate in a manner inconsistent with prior government statements (i.e. more harshly). Nonetheless there will be individuals who, with advance planning and with the application of considerable care (if not to say sophistication) to the oversight and day-to-day running of structures held for their benefit, will be able to enjoy a reasonably attractive regime for the future even if they become deemed domiciled.

DEEMED DOMICILE

The Government has confirmed certain aspects of the deemed domicile test, which can now be regarded as finalised. Two categories of individuals will be treated as deemed domiciled for capital gains tax and income tax purposes, these being:

individuals born in the UK with a UK domicile of origin this will mean that the somewhat limited class of individuals who are UK resident and who claim to have acquired a domicile of choice outside of the UK, having had a domicile of origin in the UK (and having been born here), will now no longer be able to claim the benefits of their non-domiciled status since they will be deemed domiciled for all tax purposes (including inheritance tax); and

individuals who have been resident in the UK for at least 15 out of the prior 20 tax years (i.e. from the 16th consecutive tax year of residence) will also be deemed domiciled.

The Government has listened to the concerns of the professional

advisory community as regards the second limb of the test and in particular its impact for inheritance tax purposes. At present, an individual will be deemed domiciled for UK inheritance tax purposes where he / she has been resident in the UK for a period exceeding 16 years in any period of 20 tax years (i.e. from the 17th consecutive tax year of residence). In order to break his / her deemed domicile, such an individual must become non-UK resident for four complete tax years (or three complete tax years and must die in the fourth tax year of non-residence). The new legislation will confirm that individuals who are non-UK resident for four complete tax years will no longer be considered deemed domiciled for inheritance tax purposes.

As a result, the legislation will effectively contain two tests: a 15 out of 20 test for residents of the UK for capital gains tax and income tax purposes (as well as inheritance tax purposes); and a 17 out of 20 test for non-UK residents for inheritance tax purposes only. It remains to be seen whether the requirement will be legislated that an individual must be non-UK resident for four complete tax years (which appears to be the Government's intention based on the announcement in the Consultation Paper) to break inheritance tax deemed domicile, as opposed to the existing situation. The four year period of non-residence required for the spouse of a deemed domiciled individual (or a straightforward UK domiciliary) to lose deemed domicile after making a deemed domicile election will remain unchanged.

What does this change mean in practice? In many cases, the change will only be of limited relevance. An individual who dies in the fifth year of non-UK residence having been a deemed domiciliary under the test as set out in the 30 September 2015 consultation document will no longer be considered to be a deemed domiciliary. Such an individual will be straightforwardly non-UK domiciled. However, an individual who resumes residence in the UK in the fifth year of non-UK residence will continue to be treated as deemed domiciled for inheritance tax purposes. Consequently, for returning deemed domiciliaries it will be necessary to be non-resident for six complete tax years in order to break inheritance tax deemed domicile.

CONSEQUENCES OF DEEMED DOMICILE NON-TRUST ASSETS

A deemed domiciliary who is resident in the UK will be subject to tax on their worldwide income and gains. Individuals becoming deemed domiciled for the first time on 6 April 2017 (but not thereafter) will benefit from a statutory upbasing of the value of their non-UK assets for capital gains tax purposes to the value at that date but only in respect of assets held on 8 July 2015. This is mostly consistent with the announcement made by the Government in the Autumn Statement on 9 December 2015. However, the restriction to assets held on 8 July 2015 is new and

it is hard to see the policy rationale for it. Note that the upbasing is not a capitalisation for tax purposes. Where an asset was purchased using foreign income, the asset may be upbased, but if the asset is sold, the income may still be remitted if the proceeds are brought to the UK.

In addition, the Government has announced that there is to be a one year window from 6 April 2017 during which non-UK domiciliaries will be able to undertake a reorganisation of account structures such that capital can be segregated from other funding (for example unremitted foreign income and gains), in order to enable tax efficient remittances to be made in the future. This process must be completed by 5 April 2018.

This announcement now appears to create an attractive opportunity for all non-UK domiciliaries (and not just deemed domiciliaries) to structure their affairs for the future. However, it is clear that to take advantage of the window, the individual must be able to identify the contents of the accounts. In practice, many non-UK domiciliaries will be unable to undertake such identification, because the accounts are mixed to such an extent that it is impossible to know what the accounts contain. The Consultation Paper indicates that non-UK domiciliaries have always been under an obligation to identify funds within an account but this is not the case where funds have not been required to be used in the UK. For this reason, it may prove to be the case that the ability to structure accounts through segregation using the statutory window may be of limited utility, although there will be circumstances in which planning will be possible (and attractive).

It is in our view unfortunate that the Government has not adopted a more flexible approach to this issue. The ability to bring funds to the UK using the equivalent of a single composite rate of tax, or an election procedure, could have alleviated some of the more unattractive aspects of the regime and could have resulted in significant funds coming to the UK (which, after all, was one of the Government's aims). The Government's attitude to this issue is consistent with its attitude towards the treatment of trusts (and indeed de-enveloping relief for residential property owned in corporate structures which is discussed in a separate note), namely that the legislation is less generous than some non-UK domiciliaries may have been led to believe on the basis of the Government's prior announcements.

DEEMED DOMICILIARIES THE TREATMENT OF NON-UK TRUSTS

During the consultation process, it became clear that the Government was considering a special regime for deemed domiciliaries, such that they would not be subject to tax under the attribution rules which apply for the purposes of

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the settlements legislation (s.624 and following Income Tax (Trading and Other Income) Act 2005), the transfer of assets abroad regime (s.714 and following Income Tax Act 2007) and the capital gains tax settlor charging provisions (at s.86 Taxation of Chargeable Gains Act 1992) in the same manner in which those pieces of legislation apply to "straightforward" UK domiciliaries. The indication was that deemed domiciliaries would enjoy a tax favoured status in respect of trust income and gains (including income and gains attributed to trustees) of which the deemed domiciliary was a settlor. There were indications that the Government was considering a regime whereby deemed domiciled settlors would only be subject to tax to the extent they received benefits from the structure in question and not otherwise (save to the extent that the structure received UK source income on which the deemed domiciliary would be subject to tax on the arising basis, as now).

The regime which is put forward in the Consultation Paper to some extent departs from the principles that the Government was previously understood to have been considering.

On the plus side, the regime is more attractive than that which applies for actual UK domiciliaries. Deemed domiciliaries will not be taxable on capital payments matched to pre-6 April 2008 capital gains and rebasing elections (if made) will apply. The inheritance tax treatment of trusts settled by non-UK domiciliaries holding foreign situs property has been re-confirmed (and there is no tainting concept for such trusts see below). On the minus side, the regime is very complex and will require considerable care in the administration of structures, with the consequences of making even the smallest mistake likely to be very unattractive.

Although the draft legislation does not use the term explicitly, trusts settled by a non-UK domiciliary will be "protected settlements" with respect to periods when the settlor is deemed domiciled if certain conditions are met. The legislation actually refers to "protected years" but the overall concept is that the trust will qualify for a special (protected) regime. We refer to this as a "protected settlement" below.

Readers may be familiar with the concept of "protected settlements" from the Finance Act 1998 where such a concept was introduced for UK domiciliaries. Many of the same features of that legislation are, in effect, carried over to the new legislation (or will be if the legislation is enacted in the form set out in the Consultation Paper).

In essence, if a settlement is a protected settlement, then:

source income on the arising basis;

the settlor is not subject to capital gains tax in respect of gains realised by the trustees or attributed to them from underlying companies, on the arising basis (including in respect of disposals of UK situs assets); and

the transfer of assets abroad regime which applies to income arising both at trust level and at underlying company level will be disapplied insofar as the attribution of the income to the settlor / transferor is concerned provided that the income is non-UK source and, if the income arises in a company or other entity held by the trustees of a trust, only it appears if the income is paid up to the trustees as a dividend.

This means that where the settlement in question meets the criteria for being a protected settlement, the situation is highly attractive for a non-UK domiciled settlor in that the non-UK source income and all gains of the trustees (or any underlying non-UK companies) will be outside of the scope of UK tax. In some respects, this is a better regime than the existing regime because it is not dependent on the payment of the remittance basis charge (which at its maximum level is currently 90,000 for any year in which the claim to be non-UK domiciled is made).

In order to benefit from the protected settlement regime, however, it is necessary to ensure that the settlement is not "tainted" after the settlor becomes deemed domiciled in the UK.

The manner in which a tainted settlement is taxed is different in respect of each separate regime (the settlements legislation which applies for income tax purposes; the transfer of assets abroad regime which applies for income tax purposes; and the settlor charging provisions of the capital gains tax regime).

In all cases however, the protected status of the trust will be lost where there is an addition to the settlement after the settlor becomes deemed domiciled in the UK, except where that addition is to cover a shortfall in administration costs. Property provided under a transaction entered into at arm's length is not treated as an addition for these purposes and nor is property provided pursuant to a pre-existing obligation (at a date not yet confirmed). It does not matter whether the addition is by a settlor or any other person. The mere fact of an addition will result in the settlement losing its protected status and, as a result, the income and gains of the trustees (and in many circumstances any underlying company) being attributed to the settlor and taxed on the arising basis.

the settlor is not subject to income tax in respect of non-UK

If implemented in the same manner as the proposals, we should expect that the concept of the addition of property will be widely

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settlements created by UK domiciliaries). For example, the sale of property to trustees on non-arm's length terms (which might include for an interest free debt) would constitute a tainting transaction. In addition, the transfer of property from Trust A to Trust B could constitute a tainting transaction for Trust B. Those involved with the administration of trust structures will therefore need to have a clear understanding of the new rules and will need to run structures on very disciplined lines. Each separate trust will need to be seen as a standalone entity and care will be needed in, for example, undertaking any transaction with a third party on what might be seen to be non-arm's length terms. We would expect HMRC to be somewhat aggressive in their investigations of structures such as this, and of course the availability of information under inter-governmental agreements (such as the UK / Swiss Agreement and under the Common Reporting Standard) means that they will have an ability to track certain aspects of the administration of structures in a manner which they have not had until now.

level, to the settlor), tainting will not occur if a benefit is received. Instead, for any year in which a benefit is received by the settlor, the settlor's spouse or the settlor's minor child, the settlor is taxed to the extent of that benefit (for example the income distribution) on a worldwide basis. This formulation is more consistent with the Government's prior announcements.

For the purposes of the transfer of assets abroad regime, it appears that the Government is struggling to come up with an appropriate manner of taxing the income in question. The basic indication is, however, that protections will be available in a similar way to the settlements legislation (so the transferor will only be taxed to the extent that a benefit is provided), but the manner in which this occurs is unclear. It appears that to be protected, income must be paid up to trust level where it will fall to be dealt with under the settlements legislation. There may be a variety of reasons for this including to defeat the application of the motive defence. But the formulation is odd. No legislation is yet available.

Tainting can also occur through other mechanisms, although the mechanisms apply differently for each separate tax and the consequences of tainting other than by addition are also different.

It is therefore possible that a settlement may enjoy partially protected status where tainting for one purpose has occurred but not for others.

For the purposes of the capital gains tax settlor charging provisions, tainting will occur if capital or income is applied for the benefit of a settlor; a spouse of a settlor, including a civil partner; any minor child of the settlor; or such an individual receives a benefit from the trust. This is not consistent with the Government's prior indications.

Therefore, for capital gains tax purposes it is likely that trusts benefiting from protected status will need to be seen to be "locked boxes". Nothing must be added to the trust and no benefits must be provided from the trust to a settlor whilst the settlor is alive and UK resident for the protections to continue to be available. In some cases, this sets the bar impossibly high and for this reason settlors may have to accept that for capital gains tax purposes if they are deemed domiciled, settlements will not be protected settlements. The consequences of this will depend on the individual settlor's situation.

For example, the investment policy of the trustees may be to invest in offshore funds for which attribution under the settlor charging provisions is not possible under the existing legislation. But each situation will be different and will need to be assessed differently on its own facts. Once tainted for the capital gains tax settlor charging provisions, protected status is lost forever for capital gains tax purposes.

For the purposes of the settlements legislation (which attributes income arising at trust level, although not underlying company

MITIGATION STRATEGIES

Many non-UK domiciliaries who will become deemed domiciled will be looking to implement mitigation planning prior to 6 April 2017. Obviously they will be doing so in an environment which is not ideal since the final legislation is not known. Examples of planning which we would expect would be considered in this instance include:

Advancing benefits such that they are received prior to 6 April 2017. This would include in particular the receipt of distributions of foreign income and gains from foreign trusts in order to be able to fund non-UK expenditure.

Extracting assets from which benefits are being received from existing trusts prior to 6 April 2017. For example, if a foreign trust structure owns a UK residential property, then for a variety of reasons it will almost certainly make sense for that property to be extracted from the structure, particularly if it is occupied by a beneficiary rent-free. The structure is unlikely to offer any inheritance tax protection in the future.

The segregation of assets into multiple trusts where a trust is settlor interested. Where such planning can be implemented (and respected), the use of multiple structures whilst perhaps an administrative inconvenience, reduces the risk that a taint in one structure results in the loss of protected status for other structures. This may also involve adding sums to trust before 6 April 2017 (where possible).

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Some non-UK domiciliaries (or the trustees of trusts for their benefit) may be looking to take advantage of the mixed fund planning window to 5 April 2018 in order to segregate accounts and then transfer funds which are clean for UK tax purposes into a UK resident company. UK resident corporate planning makes sense for many non-UK domiciliaries in circumstances where the UK rate of corporation tax is due to reduce to 17 per cent, and corporation tax does not in any event apply to all categories of assets, income or gains.

CONCLUSION

The regime set out in the consultation document relating to the taxation of non-UK domiciliaries represents a significant change (and probably a more radical change than the changes introduced by the Finance Act 2008). Combined with the changes to the taxation of residential property held by non-UK structures, the impact on non-UK domiciliaries who become deemed domiciled could in some circumstances be substantial.

There is no doubt that, if implemented in its current form (and there is no option at present but to assume that it will be implemented in its current form), the legislation which accompanied the Consultation Paper will impact some non-UK domiciliaries who become deemed domiciled negatively.

However, in our view, the following points also need to be borne in mind:

The regime which applies to deemed domiciliaries is still more attractive (and in our view far more attractive) than the regime which applies to actual UK domiciliaries.

There are positive features of the new regime, including the ability to rebase personally held assets; the ability to separate out mixed funds; and the fact that settlor interested non-UK resident trusts may not be immediately transparent for capital gains tax and income tax purposes.

In order to take full advantage of the new regime, prior planning will be required. This is to ensure that any benefits are received prior to 6 April 2017 and to ensure that after that date no tainting transactions occur. This may require a mind-set change on the part of some non-UK domiciliaries.

Fiduciaries responsible for the oversight and administration of non-resident structures of which deemed domiciliaries are settlors will need considerable skill in order to run those structures effectively in the post-6 April 2017 world. The consequences of making even quite small mistakes could be extremely negative. This may require deemed domiciliaries to accept that non-UK structures will not be as flexible in dealing with proposals, nor able to react as quickly, as has been the case in the past.

Even a tainted structure which is transparent for capital gains tax and income tax purposes still offers attractive inheritance tax protections (save in the case of the value attributed to UK residential property).

In some cases (and individuals with a UK domicile of origin born in the UK may be one example), the position may be so unattractive for a non-UK domiciled individual who becomes deemed domiciled with effect from 6 April 2017 that the only viable option is to cease to be UK resident. For certain individuals, this will be impossible, at least in the short term, in which case a longer term plan will need to be formulated and any structures they have created will need to adapt in the interim.