In his Budget speech in July 2015 the then-Chancellor George Osborne announced far-reaching tax changes in relation to foreign domiciliaries, including what he called the abolition of permanent non-dom status. The period of nearly three years since that announcement has been unsettling for non-doms and their advisers alike.
Foreign domiciliaries can be forgiven for feeling dazed and confused by the longwinded and disorderly process of UK tax reform which was set in motion by the July 2015 Budget. The various changes announced by George Osborne have now, at last, all been enacted. This therefore feels like a good moment to recap on what has changed, and what it all means.
What has changed?
The following tax changes occurred as part of the Finance (No 2) Act 2017. The latter was passed in November 2017, but was backdated to 6 April 2017. Many of the changes are only relevant to UK resident foreign domiciliaries (RNDs); but some of the IHT changes are important also for non-residents:
- New deemed domicile rules have been made, which have effect for income tax and CGT as well as IHT. Foreign domiciliaries born outside the UK are now subject to a “15 out of 20 tax years” rule, which means that they are typically deemed domiciled in the UK from the beginning of their 16th tax year of residence in the UK, and unable to use the remittance basis from that time onward. There is a special rule for foreign domiciliaries born in the UK who had a domicile within the UK at birth; such individuals are essentially deemed domiciled in any tax year in which they are UK resident, so that the remittance basis is unavailable to them. Very few people are caught by this rule and it is not considered further here.
- In relation to individuals who are foreign domiciled and not deemed domiciled, the scope of IHT has been broadened, to encompass non-UK assets that have a connection with UK residential property. As is well known, these changes can affect the IHT status of non-UK shares in companies holding UK residential properties. However, they go much further than that. For example they can now result in non-UK bank accounts / non-UK investments being within the scope of IHT, where security has been given over the account / investments, for a loan which is connected with UK residential property.
- There is a generous “rebasing” relief for RNDs who became deemed domiciled for income tax / CGT purposes under the “15 out of 20 tax years” rule on 6 April 2017 (even if they were already deemed domiciled for IHT purposes) and who had previously paid the remittance basis charge for at least one tax year. This relief can be used in respect of most non-UK assets, and effectively wipes out the tax that would otherwise be due on the increase in the asset’s value between its acquisition and 5 April 2017. This is the case for non-UK assets within the CGT regime, but also interests in certain non-UK collective investment schemes where a gain would normally give rise to deemed income. However, deep discount bonds do not qualify for this relief, and nor do investment-linked life policies. Rather bizarrely, there is no equivalent relief for RNDs becoming deemed domiciled on 6 April 2018 or at the beginning of any later tax year.
- There is a useful “cleansing” relief, available to a wide class of RNDs, which allows cash in a non-UK bank account containing some combination of capital, income and/or gains to be separated into its constituent elements, to facilitate tax-free or low-tax remittances of cash to the UK. The relief applies to “nominated” transfers made between 6 April 2017 and 5 April 2019. It can be combined with the “rebasing” relief mentioned above – i.e. a non-UK asset can be sold, realising a tax-free gain which is effectively capital, and that capital can be separated (by means of a “nominated” transfer out of the account containing the sale proceeds) from any taxable sums which were used to acquire the asset. For the reliefs to be combined in this way, the sale and the subsequent transfer must occur before 6 April 2019.
- The tax legislation on non-resident trusts has been altered quite profoundly. The most important change is undoubtedly the creation of the concept of a “protected settlement”. A non-UK resident trust settled by a foreign domiciliary which qualifies as a “protected settlement” is non-transparent with respect to its foreign income and gains. This means that they are not treated as the settlor’s for UK tax purposes, even where the settlor is UK resident and a beneficiary of the trust. This is so even if the settlor has become deemed domiciled under the “15 out of 20 tax years” rule, provided that the trust has not been “tainted”. The basic concept here is that a trust whose settlor has become deemed domiciled will be “tainted” if property or value is added to it by the settlor, by another trust of which he is a settlor, or another trust of which he is a beneficiary. Going forward, it will be vital for the trustees of trusts created by RNDs who have since become deemed domiciled to take the utmost care to avoid “tainting” transactions. Any such transaction will cause the trust to become transparent vis-à-vis the deemed domiciled settlor, eliminating any income tax or CGT benefit of the trust being non-resident.
- Another change in relation to non-resident trusts concerns the valuation, for tax purposes, of benefits received from them. New valuation rules have affected the treatment of interest-free loans, loans where interest accrues but is “rolled up” instead of being paid, and chattel licences. The new rules on chattel licences are bizarre; the taxable benefit of a chattel being made available is now calculated by reference to the historic acquisition cost or market value of the item rather than its current value.
Some further recent changes affect the tax treatment of non-resident trusts and are highly technical. The two most important points are arguably the new rules on “washing out” of gains and “recycling” of distributions. These changes took effect on 6 April 2018:
- Under prior law, it was possible for gains of non-resident trusts to be “washed out” by means of distributions to non-resident beneficiaries, creating scope for later distributions to be made to UK resident beneficiaries, without those beneficiaries being taxed on the trust’s gains. However, the default position now is that gains cannot be “washed out” in this manner. There are some exceptions.
- Under prior law, it was also possible for a distribution from a non-resident trust to be made to a beneficiary who was not subject to UK tax on it (being non-resident or a remittance basis user), and for that beneficiary to make a gift, funded out of the distribution, to a UK resident individual – without the donee being taxed on the money. This is now generally impossible, unless there is a delay of at least three years between the distribution and the gift. Absent such a delay, the donee will typically be treated for UK tax purposes as if he or she had received the money in the form of a direct distribution from the trust.
What does it all mean?
Clearly, these changes represent a significant tightening up of the tax regime in relation to foreign domiciliaries and the structures they tend to create. However, arguably the new “15 out of 20 tax years” deemed domicile rule is fair. Many RNDs are content with 15 years’ use of the remittance basis, particularly once they understand that there is the potential to shelter assets from UK tax on a longer term basis through the use of an appropriate structure. It must be appreciated though that the regime is highly complex, and the need for expert advice is more pressing than ever.