Reforms to taxation of non-domiciled individuals: consultation published

Introduction

On September 30 2015 Her Majesty’s Treasury published its long-awaited consultation on two of three proposed changes to the taxation of individuals domiciled outside the United Kingdom.

The three measures – announced by Chancellor George Osborne in the 2015 Summer Budget published on July 8 – are intended to target perceived unfairness in the treatment of foreign-domiciled individuals compared with those domiciled in the United Kingdom. The measures are as follows:

• Non-UK domiciled individuals with a domicile of origin outside the United Kingdom will be deemed to be domiciled in the United Kingdom for all tax purposes – income tax, capital gains tax and inheritance tax – after they have been resident for 15 of the past 20 tax years;
•  Individuals with a UK domicile of origin will be unable to take advantage of a subsequently acquired foreign domicile at any time when they are UK resident, irrespective of the number of years they spend in the United Kingdom; and
•  Non-UK domiciled individuals will no longer be able to shelter UK residential property from inheritance tax by holding it through an offshore company or other offshore vehicle. This will apply to property held through companies owned by both individuals and trustees.

All three new measures are due to take effect from April 6 2017. However, while the first two are to be legislated in the Finance Bill 2016, the third will be included in the Finance Bill 2017.

A separate consultation will take place on the latter measure and should be published later this year (for further details on the initial proposals in relation to this measure, please see “Summer Budget 2015: new rules for non-domiciled individuals“).

This update looks at the details of the proposals in the recently published consultation considering the first two of the measures mentioned above, for long-term UK resident non-domiciled individuals and non-domiciled individuals who were born in the United Kingdom with a UK domicile of origin and who subsequently return to the United Kingdom for a period of residence.

This update also provides suggestions for possible planning in advance of the introduction of the measures where this may be relevant. However, the form and scope of the measures may change substantially during the consultation process.

Principal points

Non-domiciled individuals whose domicile of origin is outside United Kingdom
The following points apply to non-UK domiciled individuals whose domicile of origin is outside the United Kingdom:

•  Non-domiciled individuals who have a foreign domicile of origin, were born outside the United Kingdom or both will be deemed to be domiciled in the United Kingdom for tax purposes after they have been UK resident for 15 of the past 20 tax years.
•  Such individuals will lose their ‘deemed domiciled’ status once they have spent at least six consecutive tax years resident outside the United Kingdom.
•  While they are UK resident and deemed domiciled, individuals will pay income tax and capital gains tax on their worldwide income and capital gains in the same way as UK-domiciled and resident individuals.
•  While they are deemed domiciled in the United Kingdom, they will be liable to inheritance tax on their worldwide estates.
•  Property in non-UK resident trusts established by such individuals before becoming deemed domiciled in the United Kingdom will be outside the inheritance tax net as ‘excluded property’ to the extent that it is non-UK situate property or – if UK-situate property other than residential property – it is held by the trustees through a non-UK vehicle (eg, a company).
•  Settlors of such trusts will be taxed not on income or gains in the trust structure, but instead on the taxable value of benefits received. This regime may be extended to all non-domiciled individuals, regardless of their length of UK residence.

Non-domiciled individuals born in the United Kingdom with UK domicile of origin

The following points apply to non-domiciled individuals born in the United Kingdom with a UK domicile of origin:

•  Individuals born in the United Kingdom with a UK domicile of origin who subsequently acquire a foreign domicile of choice will be treated for tax purposes as if they are UK domiciled once they become UK resident.
•  While they are UK resident, they will be subject to tax on their worldwide income and capital gains on the ‘arising’ basis, as would a UK-domiciled individual.
  While they are treated as UK domiciled, they will also be subject to inheritance tax on their worldwide estate.
•  Any offshore trust that they established before April 6 2017 while non-UK domiciled, or that they may establish after that date while domiciled and resident outside the United Kingdom, will be taxed as a relevant property trust during any period in which they are UK resident and/or treated as UK domiciled, and subject to 10-year anniversary and exit charges.
•  Ten-year anniversary charges will be apportioned based on the settlor’s period of UK residence during the past 10 years. There will be no exit charge if the settlor leaves the United Kingdom and remains non-UK domiciled.
•  On departure from the United Kingdom, such individuals will cease to be treated as UK domiciled on becoming non-UK resident, unless they have been UK resident for 15 of the past 20 tax years or have ceased to be non-UK domiciled under the general law. In either or both of these situations, they will continue to be treated as UK domiciled until the later of their reacquisition of a foreign domicile of choice (if necessary) or their having been non-UK resident for at least six consecutive tax years.

Non-domiciled individuals whose domicile of origin is outside United Kingdom

With effect from April 6 2017, non-UK domiciled individuals who have a domicile of origin outside the United Kingdom or were born outside the United Kingdom (or both) will be deemed to be UK domiciled for all tax purposes after they have been resident in the United Kingdom for 15 of the past 20 tax years (the ’15-year rule’). This includes inheritance tax, for which the period of UK residence for an individual to be treated as UK domiciled under the existing rules is 17 of the 20 tax years ending with the relevant tax year.

Accordingly, from the start of an individual’s 16th tax year of residence, he or she will be unable to claim the remittance basis of taxation for income tax and capital gains tax purposes, and will be taxed on the ‘arising’ basis on his or her worldwide income and gains. The individual will also be subject to inheritance tax on his or her worldwide estate.

The new rules will not affect an individual’s domicile status under general law.

The new rules will also not affect the domicile status of any children of the individual. Their domicile status under the general law and for tax purposes will be determined according to their own individual circumstances and the child’s own length of UK residence will be the deciding factor. However, years spent in the United Kingdom while an individual is under the age of 18 will count for the purposes of deemed domicile, so it will be possible to become deemed domiciled in the United Kingdom before reaching adulthood.

The following points also apply:

•  From April 6 2017, the £90,000 annual charge to claim the remittance basis for individuals who have been resident in the United Kingdom for 17 of 20 tax years will be redundant, as such individuals will by then be taxed on the arising basis.
•  The £30,000 charge (for UK residence in seven of nine tax years) and £60,000 charge (for UK residence in 12 of 14 tax years) will remain unchanged.
•  The consultation indicates that the government intends to include in the year count any year in which an individual is UK resident, even if he or she enters or leaves the United Kingdom at some point during the year (ie, even if it is a split year for tax purposes). If this is the case, some individuals may become deemed domiciled after only 13 tax years and a few weeks, rather than a full 15 tax years.
•  The government has asked in the consultation for views on the need to retain a de minimis exception in cases where an individual has been UK resident for at least 15 tax years where total unremitted foreign income and gains are less than £2,000 a year.
•  It seems likely that the new rules will apply with effect from April 6 2017, irrespective of when an individual arrived in the United Kingdom. The budget technical paper indicated that there will be no grandfathering of the existing rules for those already in the United Kingdom, but that for those who leave the United Kingdom before April 6 2017 but would nevertheless be deemed domiciled under the 15-year rule on April 6 2017, the present rules will apply. The consultation itself is silent on the question of grandfathering.
•  After having spent at least six consecutive tax years abroad so as to lose deemed domiciled status, a non-domiciled individual (ie, one who retains a foreign domicile under the general law) will be able to spend another 15 tax years as a UK resident before again becoming deemed domiciled. During this period, such individuals will be able to claim the remittance basis of taxation for income tax and capital gains tax and will be subject only to inheritance tax on UK assets that they hold directly (subject to the proposed change in the inheritance tax rules relating to residential property).
•  The consultation indicates that it is intended that legislation will be introduced to allow individuals who become deemed domiciled to claim relief on their foreign losses against their capital gains in the same way that they can currently claim relief for UK capital losses.

Proposed changes to existing inheritance tax rules
The consultation indicates that the government is considering changing the rules in relation to the loss of deemed domiciled status for inheritance tax purposes as they apply to all individuals. This is because under the existing rules, an individual who loses UK domicile under the general law and acquires a foreign domicile of choice is nevertheless treated as domiciled in the United Kingdom for inheritance tax purposes if he or she was so domiciled within the preceding three years. Accordingly, if the rules were to be left unchanged, individuals with a UK domicile who subsequently acquire a foreign domicile would be able to lose their UK domicile status for inheritance tax purposes significantly faster than long-term UK resident individuals with a foreign domicile who were deemed to be UK domiciled under the 15-year rule.

The government is considering a number of options, but the consultation indicates that its preferred option is for a UK-domiciled individual to become non-domiciled for inheritance tax purposes on the later of either the date on which he or she acquired a domicile elsewhere or the point at which he or she has not been resident in the United Kingdom for six years.

The consultation states that the reforms will be introduced so that if an individual who is not domiciled in the United Kingdom makes a gift or other transfer of an asset before he or she becomes deemed domiciled in the United Kingdom, but within seven years of death, and the transfer would be a potentially exempt transfer if it were not of excluded property, the transfer will not be included in the individual’s estate at death.

Under the existing inheritance tax rules, if a UK-domiciled individual leaves property to a non-UK domiciled spouse or civil partner, the spouse exemption is limited to the value of the nil rate band (currently £325,000). A non-domiciled spouse can elect to be treated as UK domiciled for inheritance tax purposes in order to gain full spouse exemption but the quid pro quo is that the whole of his or her estate is brought within the inheritance tax net. Under the existing rules, such an election falls away once the non-domiciled spouse has been non-resident for a period of four successive tax years. The government is considering increasing this period to six years to bring it into line with the other new rules.

Application of new rules to non-resident trusts
New regime for the taxation of benefits
The consultation indicates that a non-UK domiciled individual who set up an offshore trust before becoming deemed domiciled under the 15-year rule will not be taxed on income and gains in the trust structure simply because he or she was the settlor of the trust or considered to be so under anti-avoidance legislation. It states that “the Government will ensure that [such an individual] will continue to be protected from UK tax on offshore trusts that they have settled while neither their spouse or children receive any benefit from the trust”.

Instead, it states that “the Government intends to base the new rules on the taxable value of benefits received by the deemed domiciled individual without reference to the income and gains arising in the offshore structure”. While it is recognised that this will be a significant change to the way that the income and gains arising in offshore trusts and their underlying entities are taxed, there is no detail as to what such a new regime will look like. How and in what circumstances will tax be imposed, and what rate will apply? How will the value of an intangible ‘benefit’, such as a right to reside in a trust property, be determined? How will double taxation be avoided, given that UK source income will continue to be taxed on the arising basis and certain trust gains may also be taxed within the structure (eg, gains made on UK residential property held within the structure)?

The consultation indicates that the government is considering extending the new regime for the taxation of benefits received from offshore trusts to all non-domiciled individuals resident in the United Kingdom. For those who are not yet subject to the 15-year rule, such benefits would be taxable when remitted to the United Kingdom only if they were claiming the remittance basis. The reason for this is said to be for greater consistency and to avoid the complexity of transitioning to new rules when an individual has been resident for 15 years.

Inheritance tax on trusts
Offshore trusts that are set up by a non-UK domiciled individual before he or she becomes deemed domiciled under the 15-year rule will remain outside the scope of inheritance tax to the extent that the trust property is excluded property (ie, property that is situated outside the United Kingdom), as is currently the case under the 17-year rule. This is subject to the proposed new rule for the taxation of UK residential property.

Additional consequences
Broadly, the government intends that individuals who become deemed UK domiciled will pay tax in the same way as UK-domiciled individuals. With this in mind, the consultation sets out the following additional consequences of the proposed changes:

•  It is intended that earnings (including earnings and other income from employment-related securities) that relate to a period while an individual was not domiciled and not deemed domiciled in the United Kingdom and which are paid after the individual becomes deemed domiciled will still be eligible to be taxed under the remittance basis where all of the applicable conditions are met.
•  Individuals will be unable to use the special rules for non-domiciled employees claiming travel costs and expenses for themselves or their families once they become deemed UK domiciled. Instead, they will be able to claim tax relief for business travel in the same way as UK-domiciled employees.
•  Pensions arising outside the United Kingdom are currently taxable on a UK resident individual with a 10% reduction. The consultation indicates that this treatment will not be changed. However, a non-domiciled individual who is in receipt of a foreign pension can use the remittance basis of tax instead. The effect of becoming deemed domiciled will be that the individual will no longer be able to claim the remittance basis of taxation on a foreign pension.

Planning points
While the new 15-year rule for non-domiciled individuals without a UK domicile of origin gives rise to a significant curtailment of the tax advantages of that status, under the current proposals it is not as detrimental as it first appears. There has been a deemed domiciled rule for long-term UK residents for many years in relation to inheritance tax (albeit based on 17 tax years of residence until now, rather than 15 tax years), and it is unsurprising that one has now been introduced for income tax and capital gains tax.

Offshore trusts are likely to have an increasingly important place in the planning of non-domiciled individuals intending to come to the United Kingdom for a period, as it appears that there will be a number of tax advantages to holding property (other than UK residential property) within such a structure. These include the continuing ability to shelter non-UK assets from inheritance tax, as well as the ability to defer – and potentially avoid – tax on foreign income and gains (other than from disposals of UK residential property) arising in a trust, provided that the non-domiciliary and (almost certainly) members of his or her family do not benefit from the trust during a period of deemed domicile.

Nevertheless, the new regime may result in an increased tax burden in some situations, particularly if a decision is made to extend the new regime of taxing benefits rather than income or gains to all trusts with non-UK domiciled settlors, regardless of their length of residence. Accordingly, it will be vital for trustees and settlors to take advice before making or (in the case of the settlor) receiving distributions, in case there may be tax implications for the settlor as a consequence and, more generally, to understand all potential consequences of the new regime.

Non-domiciled individuals who are approaching 15 tax years of residence in the United Kingdom may wish to consider leaving the United Kingdom for a period in order to restart the clock on deemed domicile, particularly bearing in mind that the government seems unwilling to consider any grandfathering provisions in any circumstances. The consultation clarifies that a period of non-residence of at least six consecutive tax years will be required for an individual to lose deemed domicile. As highlighted above, given how the government proposes to treat split years of residence, it will be necessary to review carefully how and when this may affect an individual’s tax status for the purposes of the new rules, taking such years into account.

Non-domiciled individuals born in United Kingdom with UK domicile of origin

The government indicated in the 2015 Summer Budget that it wishes to make it harder for individuals whose domicile of origin was in the United Kingdom, but who subsequently acquire a different domicile of choice to claim non-UK domiciled status for tax purposes if they subsequently return to the United Kingdom.

Accordingly, individuals with a UK domicile of origin will be taxed as if they are UK domiciled on any occasion on which they are resident in the United Kingdom (and, in certain circumstances, for six years thereafter in respect of inheritance tax), even if under the general law they have acquired a different domicile. Thus, they will not be entitled to claim the remittance basis of taxation during any period of UK residence. The consultation clarifies that this rule will apply only to individuals who were also born in the United Kingdom.

If, under the statutory residence test, a tax year is split into a UK part and an overseas part, foreign income and gains arising in the overseas part will not be taxable in the United Kingdom. An individual with a foreign domicile of choice will continue to be treated as not domiciled in the United Kingdom while he or she is not UK resident.

On departure from the United Kingdom again, such an individual will be treated as being not domiciled again once he or she becomes non-resident, provided that both of the following conditions are satisfied:

•  The individual has not been UK resident for 15 of the past 20 tax years; and
•  The individual retains foreign domicile status under the general law.

If these conditions are not satisfied, the individual will need to satisfy the new rules discussed above by spending at least six consecutive tax years outside the United Kingdom (if he or she has retained or previously acquired foreign domicile status under general law) or acquiring a foreign domicile of choice, if later.

Application of new rules to non-resident trusts
Inheritance tax
Individuals born in the United Kingdom with a UK domicile of origin who have subsequently acquired a non-UK domicile under general law will be able to set up excluded property trusts on the same basis and with the same tax benefits as any other non-domiciliary while they are non-UK resident.

However, if they subsequently return to the United Kingdom, the assets in such trusts will cease to qualify as excluded property and will be liable to inheritance tax charges which arise while they are UK resident (ie, a charge of up to 6% of the value of the taxable trust property on each 10-year anniversary of the creation of the trust and proportionate or ‘exit charges’ if and when property leaves the trust between 10-year anniversaries).

The intention is that when a 10-year anniversary charge arises, it will be apportioned if the settlor is not UK domiciled under the general law, but is being treated as such by virtue of being resident in the United Kingdom and having been born in the United Kingdom with a UK domicile of origin. The apportionment will be based on the period of residence during the previous 10 years.

There will be no exit charge when such an individual leaves the United Kingdom and becomes non-resident once more.

The consultation indicates that the government is aware that there will be situations where trust property may be excluded property in one tax year and relevant property in the next as a result of people entering and leaving the United Kingdom on a regular basis. The government accepts this position, but it will be necessary for trustees to consider whether a 10-year anniversary charge or exit charge arises in respect of a tax year in which the settlor is UK resident.

Income and gains
As such individuals will be treated as having a UK domicile for tax purposes, they will have no protection in respect of tax on income or gains within the trust while they are resident in the United Kingdom. Accordingly, it appears that such individuals will be taxed on capital gains and income arising in an offshore settlement under anti-avoidance or other applicable rules, in some cases even if they receive no benefit from the trust. They will be unable to take advantage of the remittance basis while such income or gains remain outside the United Kingdom.

General application
Once again, the consultation is silent on the issue of grandfathering in relation to these rules. However, according to the technical paper, it seems likely that they will affect all former UK domiciliaries from April 6 2017 – even those who returned to the United Kingdom before that date. The six-year rule will affect any former UK domiciliary who leaves the United Kingdom after April 5 2017. It seems that the rules will also apply to trusts set up at any time while the individuals were non-UK domiciled if they are UK resident on or after April 6 2017.

The consultation does indicate that the government might be open to considering a grace period for the purposes of inheritance tax for individuals who return to the United Kingdom for a short period of perhaps a year or two. If this were to be introduced, such individuals would not be treated as UK domiciled for inheritance tax purposes. For the purposes of income tax and capital gains tax, however, they would still pay tax on an arising basis during their period of residence.

Planning points
Non-UK domiciled individuals born in the United Kingdom with a UK domicile of origin who return to the United Kingdom for a period will be in a less favourable tax position from April 2017 than those whose domicile of origin is elsewhere. Their treatment will be broadly comparable to those who are UK domiciled under the general law (at least during their period of residence and apparently in some cases for at least six tax years afterwards). Unlike for those with a foreign domicile of origin, the remittance basis of taxation will no longer be available to them, regardless of their period of residence in the United Kingdom.

However, it will remain possible for such individuals to establish excluded property trusts while they are non-resident in the United Kingdom (as long as they have been non-resident for a sufficient period to lose their deemed domicile). This will continue to be sensible inheritance tax planning in many cases, as it will allow assets in excess of the nil rate band (currently £325,000) to be put into trust for future generations without an immediate inheritance tax charge at the lifetime rate of 20%. In addition, it appears – based on the consultation – that, provided that the individual is not UK resident (and therefore treated as domiciled) on the date of any chargeable event for inheritance tax purposes (eg, on a 10-year anniversary), non-UK assets in the trust or UK assets (apart from UK residential property) held within an underlying offshore company or similar vehicle will be protected from inheritance tax charge as excluded property. This aspect requires clarification.

Individuals who are in this position and considering leaving the United Kingdom in the near future may wish to do so before April 6 2017 in order to avoid potentially being caught by the new rules – including, for longer-term residents, the rule requiring six consecutive tax years of non-residence for losing a deemed domicile if the individual has retained foreign domicile status under general law.

Following the introduction of these new rules, appropriate tax planning for a ‘returning’ non-domiciled individual may take a form closer to that for a UK-domiciled individual, including individual savings accounts, offshore life bonds and – for inheritance tax purposes – the use of reliefs for business property and agricultural property.

Consultation and legislation

It is clear from the consultation that there is still a great deal of consideration required by the government. Limited sections of draft legislation were included with the consultation, but there are significant issues on which final decisions have yet to be made in order to be able to start drafting workable rules.

In many areas, interaction will be required with other existing tax rules, such as the anti-avoidance rules relating to the taxation of income and gains in offshore trusts. Alternatively, these may need to be replaced with entirely new regimes. Interactions with relevant estate duty treaties will also require consideration.

Nevertheless, the government is planning to include the new measures in the Finance Bill 2016. As such, further draft legislation is expected to be published towards the end of 2015 – possibly shortly after the Autumn Statement scheduled for November 25 – or at the latest by early 2016.

Comment

The new measures are clearly far reaching and will represent a fundamental change in the taxation of non-domiciled individuals from 2017 – particularly those with a UK domicile of origin, for whom the benefits of that status will be severely curtailed if they return to live in the United Kingdom.

Although a consultation has been published on the proposed reforms of the taxation of non-domiciled individuals, there are insufficient details yet to draw conclusions to enable concrete planning decisions to be made. Further, the existing proposals may change before the legislation comes into force.

Nevertheless, it is useful to consider what options may be available to non-domiciled individuals who are likely to be affected by the new measures. Non-domiciled individuals who may be thinking of either leaving or coming to the United Kingdom in the next few years, or of investing in UK residential property, should ensure that they take advice on what planning steps – if any – may be appropriate on the basis of the developing proposals.