On 5 December 2016, the Government published various fragments of the Finance Bill 2017, plus a response to the August 2016 consultation concerning the taxation of non-UK domiciliaries. These documents mean that we now have greater clarity about how the taxation of non-resident trusts and entities will change on 6 April 2017.
The scope of the reforms
By way of reminder, there are two main aspects to the proposals. The Government plans to introduce new deemed domicile rules, which will cause certain UK resident foreign domiciliaries to be treated as UK domiciled for all tax purposes, with the result that they will not be able to use the remittance basis of taxation.
In addition, the inheritance tax (IHT) legislation will be amended, so that indirect interests in UK residential property held by foreign domiciled individuals or trusts established by them will be within the IHT net. For example, shares in non-UK companies that hold UK residential property will be caught within the net.
The deemed domicile rules will only affect foreign domiciliaries who are UK resident, and chiefly those who have been resident for a long period; but the proposed IHT changes will affect foreign domiciled individuals all over the globe. Some foreign domiciliaries will be affected by both aspects of the reforms: a double whammy.
Good news, bad news
The information released on 5 December was positive for some, and negative for others. There was good news for foreign domiciliaries who will become deemed domiciled for all tax purposes on 6 April 2017 and who have established non-resident trusts, or plan to establish such trusts before the new tax year. The issue for individuals in this category is what sort of protection from arising basis taxation there will be for income and gains of such trusts.
The August 2016 consultation paper reiterated that there would be protection, but caused alarm by proposing that the conditions for such protection would be significantly tougher than had originally been indicated. However, the Government has U-turned on this, and on this topic we now seem to be more or less back where we started. This is obviously welcome, and the correct outcome.
The papers published on 5 December include some interesting new information on other changes that the Government proposes to make to the tax legislation on offshore trusts, some of which have only a tangential connection to the introduction of the new deemed domicile rules. For details, please see our briefing note on Non-resident trusts and entities.
Another topic of interest for foreign domiciliaries who expect to become deemed domiciled for all tax purposes on 6 April 2017 is the scope of the reliefs which have been proposed as a means of easing the transition to being taxed on the arising basis. There have been some important changes to the details of these, in particular the proposed relief for automatic rebasing of non-UK assets. For information on the state of play, please see our briefing note on Transitional reliefs.
However, as already noted, it is the proposed new IHT legislation on indirect interests in UK residential property which is likely to have the furthest reach. Such interests include, but are not limited to, shares in non-UK companies that hold UK residential property and receivables due from such companies. Perhaps the most striking change here is the proposal to treat foreign cash and investment accounts as, in effect, UK situated assets, where a security interest over the account has been granted to a lender in respect of a loan used to purchase UK residential property. As discussed in our briefing note on Inheritance tax on UK residential property, there is the potential for this new rule, and others, to produce irrational outcomes. Foreign domiciled individuals and trustees with assets that may be affected by the new rules should be seeking advice as a matter of urgency.
It is obviously to be expected, at this stage, that these tax reforms would be a work in progress. However, it is disconcerting how little progress has apparently been made and how much remains to be done before the Finance Bill can be enacted.
There are obvious gaps and technical defects in much of the draft legislation which has been published to date. It is debatable how much purpose there is in releasing draft legislation when it is so evidently in need of further time in the oven.
Moreover, it is unclear how much headway has been made with the legislative drafting work which will be needed to “switch off” various income tax charging provisions in relation to non-UK resident trusts, where the settlor has become deemed domiciled. These provisions are notoriously complex and the drafting is bound to be challenging. The recent publications suggest that the draft income tax rules may not see the light of day until mid-March 2017, by which time there will of course be no real time for defects to be pointed out and corrected. However, there are rumours that a first draft of these rules may emerge later this month or otherwise in January. Obviously we hope these rumours are correct …
The April 2008 reforms under the then Labour Government were implemented in a shambolic fashion, and were an object lesson in how not to make tax law. The process shook the confidence of foreign domiciliaries and their advisers, tarnished the global reputation of the UK tax system and undoubtedly deterred some foreign domiciliaries from moving to the UK. It remains to be seen whether the implementation of the April 2017 reforms will be any smoother. It is probably futile to point out that the Government still has the option of postponing these changes to April 2018 so that it has time to get the legislation right.