In the run-up to 5 April 2017, much planning was undertaken by non-UK domiciled individuals in the expectation that the Finance Act 2017 would include new rules that would substantially affect their UK tax position. It was anticipated that the Act would be passed a couple of months into the new tax year, and would apply with effect from 6 April 2017. However, Theresa May’s unexpected announcement of a general election has thrown a large spanner into the works.
The Government has indicated that many proposed changes will be dropped from the Finance Act 2017, as there will be insufficient time for parliamentary scrutiny of them prior to the election. It has now become clear that the changes which are to be dropped include all of the reforms to the taxation of foreign domiciliaries, including the new deemed domicile rules and the inheritance tax provisions regarding indirect interests in UK residential property. This comes after the fairly last-minute abandonment of certain anti-avoidance provisions, which the Government had originally intended to include in the Act, but which were poorly thought out and would have required too much work in the limited time available.
Where does this leave individuals affected by these reforms? Was all the activity in the run-up to 5 April 2017 for nothing?
It is impossible to be conclusive, but it seems very unlikely that the reforms will fall by the wayside. The most likely scenario is that once a Government has been (re-)formed after the election, the provisions which are to be omitted from the severely truncated Finance Act 2017 will be enacted as part of a Finance (No 2) Act 2017. This might not happen until autumn 2017, but it is likely that the commencement of these provisions will be back-dated to 6 April 2017, as would have been the case if the Finance Act 2017 had been enacted as planned.
Our view is that, generally, taxpayers should proceed on this assumption. This means that, for example, a taxpayer who is not yet deemed domiciled under the current law but who would be deemed domiciled in 2017/18 under the “15 out of 20 years” rule, if it is brought in, would be ill-advised to settle a trust now using foreign assets. The most likely outcome is that the “15 out of 20 years” rule will be enacted later this year, with effect from 6 April 2017, such that the individual will be treated as having been deemed domiciled at the time the trust was made – resulting in an inheritance tax liability on the funding of the trust, and a trust which will not qualify as a protected settlement.
However, as we have all learned in recent years, there are no certainties in politics. It is not completely impossible that a change of regime or of key personnel will result in the non-dom tax reforms not being enacted, or being enacted in a form which is different from what affected individuals have been preparing for.
A further possibility is that the changes will be enacted with effect from a later date, e.g. 6 April 2018. That is arguably what the Government should have been aiming for anyway, once it became clear that the legislative process would be knocked off course by the Brexit vote. Postponement would allow further time for the rules to be considered and finessed.
However, there would be justified anger on the part of those who have taken action on the assumption that the reforms would have effect from 6 April 2017. There would undoubtedly need to be special measures to prevent detriment to those who have acted in reliance on the Government’s statements, for example individuals who have disposed of foreign assets in the belief that rebasing relief would apply (as discussed below). This would be a complicated solution to the problem, and the current Government has invested political capital in the reforms having effect from 6 April 2017. It follows that in our view, backdating of the changes to 6 April 2017 is much more likely.
For the many individuals who have taken steps in reliance on the Government’s stated intention to enact the non-dom tax reforms with effect from 6 April 2017, there is nothing to be done. The real quandary now is for those who are in the process of taking action, or who had been preparing to take action, in reliance on the promised legislation. For these individuals, there are no easy answers, but we have some thoughts.
- De-enveloping of properties
Many non-UK domiciled individuals are in the process of “de-enveloping” UK residential property, i.e. taking it out of the ownership of an offshore company and into personal ownership. This process has been prompted by the Government’s repeated statements that, with effect from 6 April 2017, it would change the law to eliminate the inheritance tax benefit of corporate ownership. Individuals in this position now have a choice – whether to allow the “de-enveloping” to proceed, or to put the brakes on, in the hope that the inheritance tax changes regarding UK residential property will be abandoned.
This choice is not a clear one, because for as long as a UK residential property is held by a company, that company is typically subject to the annual tax on enveloped dwellings (ATED), a levy which is payable annually but racks up day by day. Given the on-going exposure to the ATED if a property is left in corporate ownership, and the likelihood that the inheritance tax changes will be enacted in due course, we suspect that most individuals in this position will wish to press ahead with the “de-enveloping”. An exception may be non-UK domiciliaries who are elderly or in poor health – where the additional cost of paying ATED until the position becomes clearer may be small compared to the inheritance tax saving on their death if, contrary to our expectations, the reforms are not enacted later in the year.
Some long-term UK resident non-UK domiciliaries will have been preparing to sell or give away foreign assets in the expectation that, under the provisions of the Finance Act 2017, they would have been re-based for UK tax purposes, eliminating any latent gain on such assets as at 6 April 2017. Consideration should now be given to whether such disposals should be made, regardless of the dropping of the non-dom provisions from the Act, or whether they should be postponed until there is greater certainty.
If the disposal is delayed until later in the year, this may create a risk that due to appreciation of the foreign asset, or currency movements, there will be a taxable gain on the disposal, even if the rebasing relief is belatedly brought in with effect from 6 April 2017. On the other hand, the consequences of making a disposal of an asset which is pregnant with gain could in principle be very severe if, contrary to what is hoped, the rebasing relief is not introduced. However, in that situation, we hope it would be possible for the individual to use the remittance basis – as it would be very harsh for the new deemed domicile rules to be introduced retrospectively without the rebasing relief being introduced at the same time.
Where an asset has already been sold in reliance on the rebasing relief, there is an argument in favour of postponing the remittance of its sale proceeds – in case the relief is not introduced, and the proceeds would be characterised as containing foreign gain.
It had been announced that there would be a valuable two year opportunity, from 6 April 2017, for most individuals who had previously been taxed on the remittance basis to “cleanse” foreign bank accounts containing mixed funds, i.e. a mixture of sums with different tax treatments. The idea was that if during that period they could identify from their records the constituent parts of a mixed fund, and make nominated transfers from the account to other accounts, those transfers would allow the constituent elements to be separated out. This would enable capital contained within a former mixed fund to be remitted, tax-free, to the UK – whereas under normal principles, a mixed fund cannot be un-mixed, and a remittance from it is typically treated as comprising those sums which will give rise to the largest amount of tax, in priority to other sums. It is hoped that this measure will find its way into a Finance (No 2) Act 2017 later this year, but as noted above, this cannot be guaranteed.
Some individuals will already have begun conducting an audit of their mixed funds. In most cases, it would seem sensible to proceed with that exercise. There may also be no downside to carrying out transfers, on the basis that if the “cleansing” relief is indeed introduced in due course, it may well be possible to make the required nominations after the event; whereas if the relief is not introduced, nothing will have been lost (the individual will have started with a mixed fund, and will have ended up with a number of mixed funds). However, as above, there may be an argument in favour of deferring any remittances, in case funds which are thought to be clean capital, by virtue of nominated transfers, turn out to be mixed because the relief does not come to pass.
Even assuming that the non-dom provisions are enacted later this year, the delay in bringing them into law could produce some strange situations. For example, take the case of an individual dying now, owning the shares in a foreign company which holds a UK residential property. Under current law, if the individual is neither actually domiciled in any part of the UK nor deemed domiciled for inheritance tax purposes, there is no tax on the value of the shareholding, as it is excluded property; but the position may be changed retrospectively by a second Finance Act. What will the position of the administrators of the estate be, if the estate is wound up on the basis that no inheritance tax is due, but the law is changed retrospectively? If there are other UK assets, so that an inheritance tax return is required, and that return is submitted now on the basis that the deceased had an indirect interest in a UK residential property, which was excluded property, will HMRC be able to withhold clearance, on the basis of an expectation that the law will be changed? At first sight, the answer seems to be no, as HMRC must apply the law in force at the time. The position is messy, to say the least.
It is abundantly clear that something needs to be done about the process for tax reform in the UK, to avoid this kind of situation being repeated. UK taxpayers deserve better, wherever they are domiciled. The tortuous story leading to the present situation may be viewed as a comedy of errors, but it is not one which non-UK domiciled taxpayers will be particularly amused by. We hope, however, that this will be a case of all being well that ends well.