1 UK resident for more than 15 years
Under the current rules, a non-UK domiciled individual becomes deemed domiciled in the UK for inheritance tax ("IHT") purposes only from the start of their 17th year of UK tax residence in 20 tax years.
From April 2017 a non-UK domiciled individual will become deemed domiciled in the UK for all UK taxes from the start of their 16th year of UK tax residence.
This means that someone who has been UK resident for more than 15 of the past 20 tax years will no longer be able to claim the remittance basis of taxation and will be taxable on their worldwide income and gains as they arise. Their worldwide estate will also fall within the UK IHT net one year earlier than under the current rules.
There are, however, some helpful transitional reliefs, although these will not be extended to those individuals born in the UK with a UK domicile of origin (see further below):
- For non-domiciliaries who will become deemed domiciled in April 2017, non-UK assets held directly on 5 April 2017 can, unless the assets have been situated in the UK at any time since 16 March 2016, be up-based on disposal to their 6 April 2017 value for the purposes of income gains on non-reporting funds and all capital gains, meaning that they will not be taxed on latent historic gains. This rebasing will apply automatically, although individuals can opt out for specific assets, so that only assets standing at a gain are rebased, with latent losses preserved for future relief. This means that they will be able to sell these assets and bring the proceeds to the UK possibly with little or no tax, depending on the extent to which the proceeds represent mixed funds.
- Non-domiciliaries who have claimed the remittance basis since 2008, will have two years from April 2017 to separate their offshore “mixed funds” (i.e. those containing a mixture of capital, income and gains) into their constituent parts. This is a significant concession, which means that any “clean capital” once segregated, can be brought into the UK without a tax charge. However, the challenge will be to have the necessary records to be able to calculate the income and gains within the mixed fund.
People in this position should consider taking advantage of the rebasing and fund segregation options above to maximise clean capital and thus optimise their tax position in the future.
2 Non-UK trusts
Currently, a UK resident and domiciled settlor of a non-UK trust is taxed on the trust’s income if they or their spouse is a beneficiary of the trust, and on the trust’s gains if (broadly speaking) any family member is a beneficiary. Where the settlor is UK resident but not UK domiciled, the remittance basis is available for income within the trust and gains are not taxed on the settlor at all (if no distributions are made). Where the settlor is not taxed, income and gains which have accumulated within the trust may be taxed on UK resident beneficiaries when they receive benefits from the trust.
Trusts settled with foreign assets before the settlor becomes deemed domiciled in the UK will continue to benefit from “excluded property” status, meaning that they are outside the scope of IHT. Such trusts will also be “protected” for income tax and capital gains tax (“CGT”) purposes. However, extreme care must be taken, as these protections may be lost if further additions are made to the trust after the settlor has become deemed domiciled. Where protection is lost then the settlor may be taxable on the income and gains on the trust assets as they arise.
The proposed changes last spring included the proposal that capital payments made to non-UK resident beneficiaries would no longer reduce the capital gains within a non-UK trust available to be matched with distributions to a UK resident beneficiary (except in the tax year the trust is terminated). The Government announced in the spring Budget that it intended to legislate for this change in a subsequent Finance Act, possibly the Finance Bill published after the autumn Budget. This proposal may have a significant impact on the taxation of UK resident beneficiaries, even where those beneficiaries are not deemed domiciled under the existing or new rules.
Another proposed change for inclusion in a subsequent Finance Bill is that, where a non-UK resident beneficiary or remittance basis user receives a capital payment and, within three years, the beneficiary makes an onward gift to a UK resident, the recipient of the onward gift will be taxed as if the gift had come directly from the trust.
People who will become deemed domiciled on 6 April 2018 should consider settling assets on trust before then to take advantage of significant IHT mitigation. Trustees should consider making distributions to non-UK resident beneficiaries to potentially mitigate tax on future distributions to UK resident beneficiaries.
3 Returning expats
Currently, if an individual is:
- born with a UK domicile of origin;
- subsequently acquires a domicile of choice elsewhere; and
- then moves back to the UK
they can seek to claim that they remain non-domiciled.
Under the new rules, from April 2017 an individual in these circumstances will be treated as deemed UK domiciled for income tax and CGT as soon as they become UK resident and for IHT in the following tax year.
One major consequence of this is that any trust that they created while non-domiciled, which at the time would have been outside the UK IHT net, will become subject to IHT shortly after the settlor returns to the UK, meaning that there may be an IHT charge every 10 years and on distributions. Furthermore, they may be automatically taxed on all income and gains arising within the trust.
It is important that people in this position review the likely impact of the new rules on them sooner rather than later. Whilst they are still non-domiciled it may be that they should consider winding up any such trusts.
4 Losing UK domicile
Currently, an individual who has become deemed domiciled in the UK for IHT will lose this status once they have been non-UK resident for three tax years. An individual who is actually domiciled but not deemed domiciled in the UK who moves abroad and acquires a domicile of choice elsewhere, will remain deemed domiciled in the UK for three years after acquiring their new domicile.
Under the new rules, an individual who has been deemed domiciled for IHT will have to be out of the UK for four tax years before they lose this status.
5 UK residential property held in a structure
Currently, if a non-UK domiciled individual or a trust created by a non-UK domiciled individual holds UK residential property through an offshore company, the property will not be subject to IHT.
From April 2017, UK residential property held though an offshore company or a foreign partnership will be within the scope of IHT. This means there could be IHT on death, on transfers to trusts, or on property held in trust, where currently there would be none. In some cases, if a property is held through a trust from which the settlor can benefit, there may be a double IHT exposure, i.e. IHT charges within the trust and on the settlor’s death.
The benefit of loans, for instance between trustees and beneficiaries or between individuals, made to fund the acquisition, maintenance or enhancement of UK residential property are also to be brought within the scope of subject to IHT, as well as any collateral used to secure them. However in the hands of the borrower the debt may be deductible, but not necessarily the whole value, in all circumstances.
In addition, if after April 2017 shares in a non-UK company owning UK residential property are sold, or a loan made to acquire or enhance UK residential property is repaid, the proceeds of sale or the value of the loan will continue to be within the scope of IHT for two years following the sale.
The Government had previously suggested that they may introduce reliefs to apply when properties are “de-enveloped” from such structures. However, they have confirmed that they have no current intention to introduce such reliefs.
All structures holding UK residential property or such loans should be reviewed to establish whether action should be taken to minimise future tax.
There are various planning options available to mitigate the impact of each of the changes above.