The Government confirmed on 13 July its intention to proceed with the policies previously announced, but which were unexpectedly not included in the Finance Bill earlier this year. It has published revised legislation to appear in the Finance Bill after the summer recess which includes all the proposed reforms to the taxation of non-UK domiciled individuals that were left out of the previous Finance Bill. Set out below is a summary of the changes which will apply retroactively from 5 April 2017:
Deemed domicile for all tax purposes
Individuals will become deemed domiciled for all tax purposes once they have been UK resident in 15 of the previous 20 tax years. The effect is that such individuals will therefore be subject to the same tax regime as UK domiciliaries. In addition 'formerly domiciled individuals’ (those now non-UK domiciled individuals who were born in the UK with a UK domicile of origin), but who return to become resident in the UK will no longer be able to claim non-UK domiciled status.
Individuals who become deemed domiciled on 6 April 2017, and who have previously paid the remittance basis charge, will receive the benefit of rebasing for their directly held foreign assets to their market value on 5 April 2017. The rebasing applies automatically but it is possible to elect for it not to apply to a particular disposal. As previously confirmed the rebasing applies to offshore funds where the gain is taxed as income (that is, to non-reporting funds). Rebasing is not available to individuals who become deemed domiciled after 6 April 2017.
Segregation of mixed funds
All non-UK domiciled individuals who have been taxed on the remittance basis prior to 2017/2018 (other than formerly domiciled individuals) have the opportunity in the 2017/2018 and 2018/2019 tax years to separate out the constituent parts of a mixed fund account (that is, a bank account containing a mix of income, capital gains and capital). The individual will need to identify the amount of income, gains and capital in the mixed account and make a transfer of the income and/or gains to a new account leaving the clean capital in the old mixed account. The clean capital can then be brought to the UK without a tax charge arising.
Inheritance tax on residential property interests in offshore structures
Individuals and trustees with interests in closely held companies and partnerships which directly or indirectly derive their value from UK residential property and loans and collateral associated with such property will be liable to inheritance tax. Such property will no longer be classified as excluded property in the hands of non-UK domiciled individuals or trusts settled by such individuals.
This draft of the legislation is broadly the same as the previous draft save for some technical changes and the addition of provisions to close potential avoidance using the de-minimus interest rule. Under the legislation if the value of the interest is less than 5% of the total value of all the interests in the close company, that interest is disregarded. Provisions have now been added so that an interest of a connected person will also be taken into account in valuing a relevant interest.
New rules for offshore trusts
Trusts created before an individual becomes deemed domiciled under the new rules will be protected in relation to income tax, capital gains tax and inheritance tax unless tainted by additions. The effect will in a number of cases be beneficial when compared to the current regime.
The rules are complex but broadly speaking:
- for income tax purposes, income is no longer treated as arising to the settlor but is instead taxed if the settlor receives a distribution which can be matched to accumulated income in the trust. Distributions to non-UK resident close family members (or remittance basis user's close family members who do not remit the distribution) will also be taxable on the settlor. The changes for income tax purposes are applicable for all offshore trusts and not just those of deemed domiciliaries.
- for capital gains tax purposes, a UK resident and deemed domiciled individual will only be taxed as he is now on distributions received from a protected trust. That is, distributions are taxed to the extent they are matched to stockpiled gains (albeit the remittance basis would no longer be available).
There are a number of anti-avoidance rules which are not included in this Finance Bill, but which are expected to be introduced from 6 April 2018. These include provisions to:
- prevent the “washing-out” of stockpiled gains to non-UK resident beneficiaries;
- tax a UK resident settlor on gains matched to distributions to close family members who are non-UK resident or remittance basis users and who do not remit the distribution; and
- tax distributions which are made to a non-UK resident beneficiary where that beneficiary has made a subsequent gift to a UK resident individual.
Tainting an offshore trust has severe implications for a deemed domiciled settlor who is able to benefit from the trust. The trust would lose its protected status and broadly the effect is that the settlor would be taxed on all income and gains of the trust on an arising basis thereafter.
Valuation of trust benefits
The Government has also confirmed that it will proceed to introduce new rules for valuing benefits from trusts where beneficiaries receive an intangible benefit. It is understood that these provisions will also take effect from 6 April 2017 and will cover loans to beneficiaries, the use of art and residential property.
What should affected individuals be doing?
Individuals who are now deemed domiciled should review their position in light of these changes, for example considering their non-UK assets and whether to take advantage of rebasing now or perhaps electing for it not to apply if they wish to make use of a loss. It is also advisable to consider whether an individual will be able to benefit from the transitional rules allowing segregation of mixed funds.
Given the complicated rules on offshore trusts and the severe implications of tainting, settlors of trusts established before becoming deemed domiciled should take advice on how such a trust can retain its protected status.
Individuals and trustees holding residential property in offshore structures should review those structures, particularly where there are loans or collateral in place and advice taken on the costs and benefits of restructuring.
Trustees of offshore trusts should also consider whether any planning is required in relation to distributions or segregation of pre-6 April 2017 income.