Revolution or Evolution? – Reform of UK Non-Domiciled Individual Taxation
This month’s Spring Budget surprisingly made no mention of the changes to the UK taxation of non-domiciles, which take effect from 6 April 2017. The changes have been announced for some time,
and draft legislation was released at the end of 2016, but details on the new rules are sparse.
It can be argued that the new rules refine the old rules and eradicate some of the inconsistencies. As with all things in tax, the ‘devil is in the detail’, much of which the government and HMRC is yet to
Current Non-Domiciled Rules
The current tax rules allow individuals, who are resident but not UK domiciled, to elect to be taxed under the Remittance Basis. This enables them to only be taxed on their UK income and gains, as well as any overseas income and gains remitted to the UK. This is in contrast to UK resident and domicile taxpayers, who have to pay UK tax on their worldwide income and gains.
Successive governments have considered the current non-domicile tax regime to be overly generous. Therefore, in an effort to make the system fairer, governments have been making Remittance Basis expensive for long-term UK residents to access. Non-domiciled individuals, who have been resident for seven out of the previous nine years, must pay a £30,000 Remittance Basis Charge to claim the Remittance Basis. This charge increases over time and is in addition to any other UK tax due:
- £30,000 for individuals resident in the UK for at least seven out of the previous nine tax years
- £60,000 for individuals resident in the UK for at least 12 out of the previous 14 tax years
- £90,000 for individuals resident in the UK for at least 17 out of the previous 20 tax years
These timescales and Remittance Basis Charges are only applicable for income tax. For Inheritance Tax (IHT), it has been the case for some time that non-domiciled individuals are deemed UK domiciled for IHT in their 17th year of UK tax residency. This often resulted in a mismatch in status, where an individual was deemed UK domiciled for IHT, but was claiming the Remittance Basis for income tax Consequently, the new rules are seeking to align the two regimes.
Key non-domiciled changes coming into effect from 6th April 2017
- Deemed Domicile – Individuals who have been resident in the UK, for at least 15 out of the previous 20 tax years, will be deemed domiciled for income tax and IHT.
- UK Domicile of Origin – More aggressive changes will apply to non-UK domiciled individuals, who were born in the UK with a UK domicile of origin. From 6 April, these individuals will be deemed domicile for UK tax irrespective of how many years they have been resident in the UK.
For example, a person may have been born in the UK to UK domiciled parents but lived outside the UK for the majority of their life. Under the current rules, this individual would have a legitimate claim to be domiciled outside the UK. However, from 6 April, this individual will be deemed UK domicile for income tax and IHT.
- Rebasing of Assets – For UK capital gains tax purposes, non-domiciled individuals who will be deemed domicile on 6th April 2017 will receive an uplift on the cost basis of their overseas assets. The uplift will be the value at 5th April 2017. This tax relief is not expected to benefit individuals who are deemed domicile after 6th April 2017 and is only available to individuals who have paid the Remittance Basis Charge.
The rebasing provisions will not be extended to trusts. The rebasing is automatic, on an asset by asset basis, but can become inapplicable by an irrevocable election should the un-rebased position be more beneficial.
- Offshore Trusts – When the non-domicile reforms were first announced, it was expected that there would be significant changes to the taxation of income and gains arising within offshore trusts. However, after consultation, HMRC has confirmed that the changes will be less transformative than expected.
Non-UK source income and capital gains, arising within an ‘excluded property’ trusts, will not be taxed on the settlor if they are deemed domiciled; it is different if the settlor is domiciled under general UK law or who was born in the UK with a UK domicile of origin.
Instead, non-UK income and gains will only be taxable when matched to a benefit received, which is similar to the current rules.
The UK taxation of offshore trusts warrants a separate blog and we will post further updates once the detail of the new rules are more clear.
- Capital Loss Election – The government has confirmed that deemed domiciled individuals will be able to utilise their overseas capital losses irrespective of whether a Capital Loss Election is made. However, a further irrevocable election will be required.
- Cleansing of Mixed Funds – From 6 April 2017 to 5 April 2019, individuals have an opportunity re-organise and segregate any offshore mixed funds into income, capital gains and capital. This is an unprecedented opportunity to access capital in mixed funds which can be brought to the UK tax-free.
A mixed fund is an overseas fund of money or other property, typically a non-UK bank account, which comprises:
o More than one type of income or capital gains, and/or
o Income or capital gains from more than one tax year.
HMRC have not released any guidance on the practicalities of the cleansing mixed funds. Once this is available, we post a further blog, focusing specifically on this. We encourage our non-domiciled clients to be aware of this rule change as we consider it an opportunity not be missed.
- UK Inheritance Tax (IHT) on Main Homes – From 6 April 2017 an additional allowance called the Enhanced Nil Rate Band is available for UK IHT. The Enhanced Nil Rate Band is an additional £100,000 per person in 2016/17, rising by £25,000 each year to £175,000 per person in 2020/21. The Enhanced Nil Rate Band applies only to a deceased person’s main home.
Nil Rate Bands are transferable, therefore, civil partners and married couples are potentially eligible for a total UK IHT exempt amount of £1 million, including the main home, by 2020/21. There are clawback rules, limitations and provisions to regarding the sale proceeds of downsizing. Professional advice should, therefore, be sought to ensure the maximum benefit of the Enhanced Nil Rate Band is obtained.
Our clients, who are US persons, may benefit if they are deemed domiciled for UK IHT after 6 April 2017. This is because US persons can be subject to both the UK IHT regime and the US Estate Tax regime. However, the US Estate tax regime is typically more generous therefore the global ‘death tax’ liability, for UK a deemed domicile US person, is usually determined by the UK IHT tax rates.
- UK Inheritance Tax (IHT) on UK Residential Property Held Through Offshore Entities – Currently, UK residential property held through offshore entities, can be outside the scope of UK IHT if the entities qualify as ‘excluded property’.
From 6 April 2017, the definition of excluded property will change so that UK residential property, held indirectly by offshore companies or partnerships, will fall within the scope of UK IHT. Depending on an individual’s interest in the offshore entity, all or part of the UK residential property will come into the UK IHT net. The new rules will not apply to interests in offshore entities of less than 5%.
This is a very complex area, and other tax provisions apply to UK residential property held indirectly through offshore entities, so we urge clients to seek advice on this matter if they have not already done so.
Despite the rule changes from 6 April 2017, there are still significant UK tax savings to be obtained by non-domiciled and deemed-domiciled individuals. If you have any questions about the above, please do not hesitate to get in touch with your usual contact at US Tax & Financial Services Ltd.