Finance Act 2008 introduced new rules for the tax treatment of UK resident, non-UK domiciled taxpayers (referred to in this note as “non-doms”). The purpose of this bulletin is to outline the new tax regime that now applies and to highlight the tax planning possibilities that remain for non-doms.
Reminder of the background to the changes
Non-doms have historically benefited from a favourable tax regime in the UK. For example, under the tax regime that applied prior to 5 April 2008:
- The remittance basis of taxation applied so that the non-dom was not taxable on foreign income and capital gains unless they were brought to the UK.
- There were various methods of converting foreign income and capital gains into capital which could then be brought into the UK without a charge to tax arising.
- Non-doms holding foreign assets in an offshore trust were not taxable on the capital gains made by the trustees of the trust even if the sale proceeds were brought to the UK.
- Income tax anti-avoidance provisions that generally applied to UK residents who transferred assets into offshore structures only applied to non-doms on the remittance basis.
- Inheritance tax was only payable on UK assets and a charge on UK assets could be avoided by holding assets in an offshore structure.
The Government had talked of its intention to review the taxation of non-doms for several years. Seeing the above benefits as giving rise to loopholes and anomalies in the law, the Government announced in its Pre-Budget Report 2007 its intention to introduce measures to change the tax regime for non-doms and legislation was introduced in Finance Act 2008. The original Government proposals were watered down and although the changes are significant there are continuing tax benefits for the UK resident, non-dom going forward.
The remainder of this note outlines the tax regime that applies to both individuals and the trustees of offshore trusts with effect from 6 April 2008.
New regime for individual non-doms
A non-dom still benefits from favourable tax treatment in the UK. With effect from 6 April 2008 his tax liability can be summarised as follows:
- His residence status will be subject to the new “midnight rule” for the purposes of the 91 day average and 183 day tests thereby providing some clarity when counting days of presence in the UK (cf. recent case law and mixed views on whether days of arrival and departure are included). Furthermore, if in transit and he does not engage in activities substantially unrelated to his passage through the UK, then such days are also exempt.
- As a UK resident, a non-dom will be subject to UK income tax on UK source income and UK capital gains tax (CGT) on UK capital gains as the income and gains arise. This is known as the arising basis of taxation. The maximum rate of income tax is currently 40%. The maximum rate of CGT is 18% (although in limited circumstances this may be reduced to 10% by virtue of Entrepreneur’s Relief but only in relation to a capped amount (currently £1m) of gains arising on a disposal of shares or assets of a trading business).
- He will also be subject to UK income tax on foreign source income and UK CGT on foreign gains on an arising basis unless he is a remittance basis user in the tax year in question. If he claims the remittance basis, then his foreign income and capital gains will not be subject to UK tax unless the income and gains are brought to the UK. However, his income tax personal allowance and CGT annual exemption will be withdrawn.
- An adult non-dom with over £2,000 of unremitted foreign income and capital gains wishing to claim the remittance basis of taxation should:
- make an election in his annual tax return claiming the remittance basis; and
- if he has been resident in the UK for seven of the preceding nine tax years (note: years of UK residency prior to 6 April 2008 count), pay a charge of £30,000 (the “annual charge”).
- The remittance basis will apply without the need to make a claim or pay the annual charge in the following circumstances:
- if the non-dom is under age 18 throughout the year of assessment;
- if the non-dom has less than £2,000 of unremitted foreign income and capital gains in the year of assessment; or
- if the non-dom has been resident for less than six out of the nine preceding tax years, has no UK income and gains and has not actually remitted any foreign income or capital gains in the year of assessment.
- The definition of remittance has been widened. A remittance now includes:
- bringing foreign income and capital gains into the UK;
- bringing property or assets purchased abroad with foreign income or capital gains into the UK; and,
- using foreign income or capital gains offshore to pay for services provided in the UK or to satisfy a debt in the UK.
- Furthermore, the Government have invalidated means of recharacterising offshore income and gains as clean capital, such as “source-ceasing” and offshore gifts to family members, which were used to avoid a taxable remittance when bringing funds to the UK. There will now be a remittance not only when money, property or a service are provided for the benefit of a UK resident, non-dom; but also whenever money or other property is brought to, received or used or a service provided in the UK by or for the benefit of a “relevant person”. A relevant person includes the non-dom’s spouse or civil partner (or people living together as if they were spouses or civil partners), his minor children and minor grandchildren and also trusts and companies from which the non-dom or any of these people can benefit. Whilst these rules restrict the previous use of gifts to most family members, note that gifts to adult children or gifts from non-resident non-dom family members may still be useful.
- There are a number of exemptions from the new restrictive remittance rules;
- art with public access;
- payment for services provided by UK firms where payment is made offshore and the services relate wholly or mainly to property situated outside the UK;
- personal effects such as clothing, jewellery and watches;
- property with a value less than £1,000;
- temporary importation of assets (i.e. for 275 days only);
- assets brought in for repair and restoration;
- offshore income of the non-dom arising pre-5 April 2008 brought into the UK prior to 6 April 2008 by the non-dom that remained in the UK or is remitted again; and
- payment of interest on a foreign loan taken out before 12 March 2008 where the funds were remitted to the UK before 6 April 2008 to acquire a UK residential property and there has been no variation in the terms of the loan.
However, except for the first two the exemption will only apply where the asset derives from relevant foreign income.
Managing the annual charge
Going forward it will be important for non-doms to consider how best to manage their UK tax position in the light of the possible need to pay £30,000 to claim the remittance basis of taxation on their foreign income and capital gains.
The following points should be kept in mind:
- The charge only applies to an individual who has been over age 18 in part or all of the year of assessment concerned.
- It is possible to elect in and out of the remittance basis on an annual basis. This will allow a decision to be made about whether it is appropriate to pay the annual charge each year.
- Investments can be structured to realise income and gains in a particular tax year to avoid paying the annual charge each year.
- Assets can be transferred to one member of the family to avoid several members having to pay the charge.
- If the non-dom remits foreign income or capital gains to pay the charge, those sums will not be subject to UK tax provided that they are paid directly to HMRC.
- The charge is structured as a tax on nominated income and/or capital gains. It is possible to nominate the income and capital gains which will then be “franked” and treated as already taxed when the funds are actually brought into the UK. However, note that untaxed income and gains will be treated as being remitted first before the nominated income and gains even if it is the nominated income and gains that are brought into the UK so the benefit of the “franked” income is limited. Furthermore, if the nominated funds are remitted, complex ordering rules are triggered so they are best avoided. They may be avoided by setting up a new bank account with a relatively small balance yielding a small income balance which is nominated and never remitted.
- It should be possible to set off the annual charge against foreign taxes paid on the same income or gains although this will depend on the terms of any relevant double tax treaty.
New rules for offshore companies and trusts
With effect from 6 April 2008 new rules apply to the taxation of a non-dom shareholder of an offshore company or a non-dom beneficiary of an offshore trust.
A non-dom shareholder will now be subject to CGT on gains realised by an offshore close company (broadly one with five or fewer shareholders). However, the remittance basis will apply in respect of gains on non-UK assets if the non-dom is a remittance basis user.
A non-dom beneficiary of an offshore trust may also be subject to CGT on gains realised by the Trustees in certain circumstances.
With effect from 6 April 2008, a non-dom beneficiary of an offshore trust who receives a capital payment from the trustees after that date may be subject to a charge to CGT on receipt of the capital payment if the trustees have realised capital gains after 6 April 2008. This means that capital payments to a non-dom may no longer be free of UK tax if the trustees have realised capital gains which have not been matched against previous capital payments. Furthermore, there are transitional rules in place with regards to pre-6 April 2008 but post-12 March 2008 capital payments and gains.
Nevertheless, the remittance basis of taxation will apply to gains made by the offshore trustees on both UK and non-UK assets (cf. close companies where it is only available in relation to non-UK situs assets), provided that the non-dom beneficiary is eligible to be taxed on the remittance basis in the tax year in which the capital payment is received. This means that, unless the payment is received in the UK, CGT can still be avoided.
Offshore trustees now have a one off chance to elect irrevocably to rebase the entire trust fund to market value as at 6 April 2008. The time period for an election is by 31 January in the tax year after a capital payment is received by a UK resident beneficiary. There are concerns that such an election will alert HMRC as to the existence of the trust and place it on their “tax radar”, making it vulnerable to closer scrutiny and possibly an investigation. These concerns should be dealt with on a case by case basis.