The previous article by Helen Ratcliffe and Sophie St John outlined the new rules which will help to decide whether an individual is UK tax-resident or not. As well as these changes, the considerable political and press interest in the allegedly over-favourable taxation status of non-UK domiciled individuals prompted the Government to announce, in October last year, a major overhaul of this area of the UK tax code. The new legislation mostly came into effect from 6 April 2008, but the legislation in its final form was not passed until July 2008. In a two-part article, Helen Ratcliffe and Victoria Pursall offer a few signposts through the maze, first for individuals, and then for trustees and beneficiaries of offshore trusts.

Individuals

The taxation of non-UK domiciliaries was always a complex area and has now become even more so. There are many traps for unrepresented taxpayers.

The changes affect the income tax and capital gains tax treatment of non-UK domiciliaries. Non-UK domiciliaries who are UK resident pay tax on their UK income and capital gains. Until 6 April 2008 they could, however, rely on the remittance basis of taxation to exempt them from UK tax on foreign income and capital gains unless they ‘remitted’ such income or gains to the UK (i.e. brought them into the UK).

From 6 April 2008, if a non-UK domiciliary has been resident in the UK for more than 7 of the preceding 9 tax years (and this includes years of residence in the UK prior to 6 April 2008), the remittance basis of taxation is only available if a levy of £30,000 per year is paid. The new charge will not apply, however, to minor children or to anyone who has less than £2,000 of unremitted foreign income and gains in any tax year.

If the £30,000 levy is not paid, the non-UK domiciliary will no longer have access to the remittance basis but will instead be taxed on foreign income and capital gains on an arising basis, which effectively means that they will be taxed in the UK on their worldwide income and gains, subject to any double tax treaty relief that is available to them.

Non-UK domiciliaries therefore need to review their affairs to see whether, on balance, they would be better off paying the £30,000 and being able to benefit from the remittance basis of taxation in that tax year.

There are several other areas where you should be aware that the rules have changed, some of which are noted below.

Funding expenditure in the UK – foreign bank accounts should be reviewed. Most individuals will need to maintain at least three accounts – one for income, one for capital gains (neither of which can be remitted to the UK without a tax charge) and one clean capital account. This should contain no income or gains, and can be used to fund tax-free UK spending. ‘Clean capital’ has a very specific meaning, however.

Purchase of personal property outside the UK from income or gains – if personal property that has been bought using foreign income or gains is brought into the UK, this will be treated as a remittance of that income or gain (and therefore taxable). The exception which there used to be for foreign investment income is no longer available. Fortunately, there are new exceptions for personal effects such as clothes, jewellery or watches for personal use and assets costing less than £1,000, but the non-UK domiciliary needs to be careful if, say, using foreign funds to purchase any expensive items such as paintings or furniture to furnish their UK property.

Offshore mortgages – from 6 April 2008 the payment of interest on new offshore loans (and also on loans in existence on 12 March 2008 where the terms have been varied) using foreign income will be a remittance and taxable, if the loan is secured on UK residential property. The tax-efficient purchase of UK property by a non-UK domiciliary is a complex area and we recommend that you contact us for a review of any existing or proposed property purchases to see if they can be made more effective.

Payment for services in the UK – if foreign income or gains are used to pay for services in the UK (e.g. school fees), this will also be a remittance to the UK and taxable.

Source ceasing – source ceasing arrangements (which allowed, for example, a foreign bank account to be closed and the income brought into the UK free of tax in the following tax year), no longer work with effect from 6 April 2008, even if the bank account was closed many years ago.

So far there have been no changes to the inheritance tax treatment of non-UK domiciliaries. If an individual is non-UK domiciled but resident in the UK, and owns assets outside the UK, these assets will not be subject to inheritance tax in the UK unless they have become deemed domiciled by being resident in the UK for 17 out of the last 20 tax years (though the rules for counting can mean that the 17 tax years can be nearer 15 real years). Planning well ahead of that 15 year deadline is vital to structure affairs to best advantage.

The inheritance tax position of spouses (or of a couple in a civil partnership) poses different challenges if one partner has a non-UK domicile but the other is domiciled in the UK.

Trustees and Beneficiaries of Offshore Trusts

As well as the changes for individuals, there are new traps and opportunities for offshore trusts.

Income of offshore trusts.

One important change is that a UK resident non-domiciled settlor will be taxed on all income arising after 5 April 2008 in an offshore trust which they established and where they or their spouse/civil partner can benefit, unless the settlor is a remittance basis user. Likely reasons for the settlor to be a remittance basis user are that they have not yet been resident in the UK for more than 7 out of the last 9 tax years, or that they pay the £30,000 to be able to use the remittance basis (see the earlier part of this article). A second important change is that non-UK domiciled beneficiaries will be charged on trust income distributed to them even if they receive it outside the UK and do not remit it – again unless they are remittance basis users.

Capital gains of offshore trusts.

The changes to the taxation of gains are even more wide-ranging than for income. Before 6 April 2008, it was possible to remit capital gains from an offshore trust to a UK resident (but non-UK domiciled) beneficiary or settlor without a capital gains tax charge. Since 6 April 2008, however, gains arising after 6 April 2008 will be taxable on a non-UK domiciled beneficiary if they receive the funds in the UK or (unless they are a remittance basis user) even if they receive the funds outside the UK. There is a glimmer of light in this in that since 6 April 2008 the capital gains tax rate has reduced from a maximum rate of 40% to a flat rate of 18%. With the ‘supplementary charge’, prior to 6 April 2008 if gains were not paid out for some time after they had arisen, the 40% could become 64%. Now, even with the full supplementary charge, the maximum rate is 28.8%. This, particularly in conjunction with new rules about which assets are regarded as being paid out first, may offer flexibility to trustees who previously felt that the 64% rate of capital gains tax had locked their trust into a strait-jacket.

The trustees of an offshore trust can elect to ‘rebase’ all assets owned by the trust and any underlying companies at their market value on 5 April 2008. If a distribution is then made to a non-UK domiciled beneficiary, any part of the gain which accrued before 6 April 2008 will not be taxable (even if the distribution is received in the UK and even if the beneficiary is not a remittance basis user).

The trustees of offshore trusts will need to keep the domicile status of settlors and beneficiaries under review and also bear in mind whether they are remittance basis users as this will affect the income and capital gains taxation of the trust and how the trust is administered. Trustee recordkeeping will have to change, as it will now be essential to keep track of any post-5 April 2008 gains in a trust. There are also various traps revolving around trustee borrowing and additions to trusts by settlors, so any offshore trustees running trusts where borrowing or additions are contemplated should take advice before taking any action.

In short, trustees, and their beneficiaries, face greater complexity, but there may in fact be cases where the new rules ease situations that have seemed intractable for a long while.