After a long wait, further details of how the non-dom rules will work have finally been released. The rules are of critical importance to those non-doms who:
- Hold their UK homes through overseas structures;
- Have been resident in the UK for a long time; or
- Were born in the UK with a UK domicile of origin.
From 6 April 2017 shares in many overseas companies holding a UK homes (and other UK residential property) will cease to be excluded from an inheritance tax charge. This means that where such shares are held by a non-domiciled individual there is likely to be an inheritance tax (IHT) charge of 40% on his or her death. Where the shares are held by trustees, the trustees are likely to become liable to IHT on the ten year anniversary of the trust and each ten year anniversary thereafter.
Now is the time for considering how to restructure such property holdings. Once the rules take effect from 6 April 2017 the associated costs of restructuring may outweigh the benefits.
The recent announcements indicate that the rules will be even more draconian than first thought:
- Previously, the government had led us to believe that they will introduce special reliefs to mitigate some of the associated tax costs of restructuring. However, it seems that they have now had a change of heart.
- Relevant debts will only generate a tax deduction where they relate exclusively to the property.
- Loans made between connected parties will be disregarded when determining the value of the property which will be chargeable to IHT.
- There will be a targeted anti-avoidance rule, the effect of which will be to disregard any arrangements where the whole or main purpose is to avoid or mitigate a charge to IHT on UK residential property.
- HMRC will have an expanded power so that the property cannot be sold until any outstanding IHT charge is paid.
The rules are complex and specialist advice is vital.
Long term residents
In September 2015 the government consulted on proposals to treat non-doms as deemed UK domiciled for tax purposes once they have been resident in the UK for 15 out of 20 years. Those that are deemed to be domiciled in the UK will not be able to claim the remittance basis of taxation. For many, this will mean that overseas income and gains will become chargeable to UK tax for the first time. It will also mean that on their death their estate will be chargeable to inheritance tax on their worldwide assets.
As with the rules described above, the rules are complex and may give rise to inequitable results, for example:
- Individuals (with the help of their tax advisors) will need to assess their tax residence status over the previous twenty years. There may be problems determining their residence status during the tax years arising before 6 April 2013, when the old common law rules of residence applied.
- Without advice, individuals who have been in the UK for just over 13 years may not realise that they have become deemed domiciled. This is because split years of residence are not disregarded.
- Children educated at UK boarding schools and universities may find themselves to be deemed to be domiciled in the UK sooner than expected because years of residence during one’s childhood are not disregarded.
The effects of these changes may be mitigated in certain cases. Many non-doms may wish tobreak UK residence before they become deemed domiciled here. Most would need to spend at least six full tax years as a non-resident. Care should be taken however. An individual may mitigate the income tax consequences of deemed domicile by breaking UK residence from 6 April 2017 but there may still be a potential IHT liability on foreign assets if they die or settle a trust during the following years.
Other non-doms may be relying on the government’s promise to ensure protection in certain cases. The government had pledged that it will allow some non-doms to rebase their foreign assets. The number of non-doms that may benefit from rebasing is more limited than initially expected. In order to qualify for rebasing the individual must have paid the remittance basis charge in any year before April 2017 and become deemed domiciled under the new rules on 6 April 2017. Those individuals who become deemed-domiciled in years after April 2017 and those who become deemed domicile because they were born in the UK with a UK domicile of origin will not be able to rebase their foreign assets.
There is a new opportunity for non-doms to ‘cleanse’ their mixed funds. Many non-doms who have lived in the UK for a long time hold a large pool of offshore funds containing capital as well as income and gains. Ordinarily the fund may contain ‘clean’ capital used to set it up in the first place but this cannot be remitted until after all the taxable income and gains have been remitted so effectively the capital is trapped in a mixed fund. There will be a time-limited opportunity to allow non-doms to rearrange their mixed funds to separate ‘clean’ capital from income and gains. This is a fantastic opportunity for many non-doms to bring their otherwise ‘trapped clean capital’ to the UK without incurring an additional tax charge on remittance. This window of opportunity will last one tax year from April 2017. Cleansing will not be available where an individual is unable to determine the component parts of their mixed fund. Professional advice will be essential in this respect.
There is also an opportunity for non-doms to mitigate their UK tax position by settling one or more overseas trust before they become UK deemed domiciled. Such a trust may qualify for protection from IHT, capital gains tax (with the exception of the non-resident CGT charge and the ATED CGT charge on UK residential property) and income tax on foreign source income. However, full protection is only available where no distributions are made to the settlor or other relevant person (such as the settlor’s family). Subject to full details of how these rules will work some non-doms may be interested in settling a number of trusts before 6 April 2017. Potentially they may receive distributions from one trust without losing tax protection in relation to the other trusts.
Born in the UK with a UK domicile of origin
From 6 April 2017 an individual will be treated as being deemed domiciled in the UK for tax purposes when they are living in the UK if they were born in the UK and had a UK domicile of origin. As mentioned above, this will mean that they are no longer able to claim the remittance basis of taxation. The consequences are particularly penal in relation to IHT. Once deemed to be domiciled in the UK the individual’s estate will be subject to IHT on their worldwide assets. A period of grace is available; individuals will not be treated as being deemed domiciled in the UK for IHT purposes unless they had been resident in the UK for at least one of the two previous tax years to the year in question.
The new rules will be particularly problematical for trustees of any trusts settled by that individual as they may lose their excluded property status and become chargeable to IHT. Such trustees are bound to face a number of challenges:
- Trustees may not know where the settlor is resident on a year by year basis.
- Where an individual moves in and out of the UK, the status of the trust will change year by year as it switches between being treated as a relevant property trust and an excluded property trust.
- Trustees who unexpectedly become chargeable to IHT as a result of these rules may not hold sufficient records to compute the tax liability.
Those affected should – with suitable tax advice – consider unwinding trust structures before the rules come into force.