We recently outlined the proposed changes to the non-UK domicile (non-dom) tax regime following the publication on 19 August 2016 of HMRC’s latest consultation document. A link to that blog can be found here. The consultation makes it clear that there will be a window of opportunity for individuals who will become deemed domiciled (deemed dom) in April 2017 to plan for these changes, albeit a short one. We have outlined our initial thoughts on what the planning opportunities may be. Of course, to make the perfect cake, ingredients and mixtures must be considered for each set of circumstances. It should also be noted that the recipe is not yet final – we are still in a consultation period and await further details and more draft legislation.
To rebase or not to rebase
Directly held assets
Individuals becoming deemed domiciled on 6 April 2017 with directly held non-UK assets should not rebase these assets now in most cases. Such individuals (if they have paid the remittance basis charge in any year before April 2017) will benefit from a rebasing of their assets sold after 6 April 2017 which means that any gain accruing before 6 April 2017 will be tax free. In contrast, a non-dom who decides to rebase before April 2017 will be taxable on the whole of the gain on the remittance basis.
It may also be beneficial to retain foreign assets standing at a loss until after 6 April 2017, in particular if the individual has not made a foreign loss election. The consultation confirms that once an individual has become deemed dom, his foreign losses will be available to set against worldwide gains going forwards. If no foreign loss election has been made, foreign losses made pre deemed dom are lost. Hence, by waiting until after 6 April 2017, a deemed dom can use the loss to reduce his worldwide gains in that and future tax years.
However, trusts are a different story. Trust assets do not benefit from the re-basing – even when settled by a non-dom becoming deemed dom on 6 April 2017 (a “deemed dom trust”). Also, under the proposed new rules, a deemed dom settlor who receives benefits from the trust (or his spouse or minor child does) will be taxable on gains as they arise. Further, the consultation suggests that the existing ‘matching rules’ for capital gains will not apply to deemed dom settlors.
Hence trustees of a deemed dom trust should consider rebasing trust assets, for example by selling and re-acquiring marketable assets or through ‘internal’ transactions. This should give the assets a higher base cost (and therefore lower gains) for if/when the settlor has to pay CGT on the arising basis on trust assets and also, with careful planning, give rise to the possibility of paying no tax on existing latent and realised gains.
Un-mixing the mix
Like a cake mixture, once different types of taxable (or tax clean) money (e.g. income, capital gains) have been mixed, they cannot be “un-mixed”. Generally, if an asset is sold at a gain this creates a mixed fund as the capital cannot be segregated from the gain. On remittance of a mixed fund a set of deeming rules is applied so that, broadly, the fund is remitted with the highest tax elements first.
As part of the changes, there will be a ‘one time only’ opportunity for non-doms to segregate mixed funds during the tax year 2017/18 as long as they can determine the component parts of their mixed fund. This means moving clean capital, foreign income and foreign gains (including separating the capital from the gain) into separate accounts. Thus the tax free and lower tax elements can be remitted separately from and without incurring tax on higher tax elements (e.g. untaxed foreign income). There are a number of steps non-doms with mixed funds can take to take full advantage of this opportunity, including:
- identifying the funds in a bank, for example by reviewing bank statements;
- selling foreign assets purchased with mixed funds before or in 2017/18, and segregating the sale proceeds; and
- arranging for bank accounts to be opened into which the segregated funds can be transferred.
Opening the envelope – the last straw!
To the apparent great surprise of HMRC (but no one else!) many non-UK holding structures for UK residential property have been retained, in spite of the somewhat relentless tax attacks in recent years, to preserve the inheritance tax protection. That is, if a non-dom, not yet deemed dom, or a trust settled by such an individual, holds non–UK assets, such as shares in a non-UK company, the non-UK assets will be exempt from IHT even where there is an underlying UK property. If the non-dom were to hold the UK property directly, it would not be exempt.
Since this inheritance tax advantage in holding UK residential property in a non-UK structure will be removed from 6 April 2017, many non-doms may now wish to de-envelope. This latest consultation makes it clear that the government is not minded to introduce reliefs for de-enveloping and so individuals thinking about extracting a property from a non-UK structure should be prepared to pay some tax, including ATED-CGT and non-resident CGT and in many cases SDLT. Advice should be taken on how to minimise the tax due on de-enveloping and going forward. The history of the structure, future plans, and timings are all likely to be relevant to this exercise.
As discussed above, it may well be more advantageous for a trust to de-envelope now to avoid a direct CGT charge on the settlor (if applicable) and to potentially wash out historical gains. This will be very dependent on the particular facts of the case and advice should be sought as soon as possible.
It may also be the case that where the structure is ultimately owned by a deemed dom personally, that advantage can be taken of the rebasing to 6 April 2017. If so it may be prudent to wait until after 6 April 2017. Again the position is likely to be complex and advice should be sought as soon as possible.
Individuals, trustees and directors connected with this type of structure should gather all the information they can on the structure and its history. Such information may include any advice taken out initially on why a structure should be used; details of any periods when the property was let out; likely gain in the property and structure, other assets in the structure and any historical income and gains. Advice should be taken as early as possible even if (and almost particularly) the information is not available or complete. Gaps in information could be very relevant to recommended planning steps.
Note that repaying, re-financing or taking out commercial bank debt may be required in many cases, particularly given the comment in the consultation about connected loans becoming non-deductible. This can be time consuming and will need to be taken into account regarding the timings of any planning.
Settle new trusts
If a non-dom wishes to provide for his adult children he may wish to settle non-UK assets on trust before becoming deemed dom (provided he is not already deemed dom for inheritance tax purposes under current rules). The trust will be protected from the new tax changes if the settlor, his spouse and any minor children do not benefit. Although there may be UK tax consequences for any UK resident beneficiaries if they receive benefits from the trust, from the settlor’s point of view there would be a number of advantages; he would have reduced his estate for inheritance tax purposes, will not be subject to income tax or CGT on the trust income and gains and would have made long term provision for his children.
Individuals who believe they are affected by this rule should take advice on their domicile status. This will involve a complete review of their family background, including looking at whether their parents were married at the time of their birth, their parents’ domicile at the time of birth and where they were born. This may unearth some surprising results particularly if a family has historically been internationally mobile.
Returning-doms with trusts settled while non-dom, should review those trusts and communicate with their trustees, making them aware that they are caught by the new rules. He should keep careful records of his periods of UK residence and know when the 10 yearly inheritance tax charge falls, perhaps also leaving the UK for that year. UK residence for that tax year could have draconian results under the new rules.
Non-doms who may be affected by the changes should take tax advice now in order to be in best possible position to put in place any planning once it becomes clear how the detail of the tax changes and proposed reliefs will work.