Fair Deal? Non Domiciled Tax Changes Go Ahead
With a slowing housing market, the rumour mill is in full swing with suggestions that the Autumn Budget will focus on Stamp Duty reform and also potential reform of pension tax relief. Pension tax relief reform is consistently rumoured, and it is expected that the government is aiming to further restrict pension tax relief for Higher and Additional rate UK taxpayers. With no substantive change having occurred for some years, we wait to see whether the Autumn Budget will seek to be less generous, under the existing regime, or will seek wholesale reform of pension tax relief.
These rumours are shifting focus away from a government announcement, over the Summer, that that the proposed changes to the tax treatment of non-UK domiciled individuals will go ahead. The changes were dropped from the Spring Finance Bill because there was not enough time for scrutiny before the June election; this left taxpayers in limbo.
The government has confirmed that the changes will be back-dated to 6th April 2017. It was speculated that the introduction of the new rules would be delayed, but some taxpayers had already restructured their affairs with the expectation of the changes taking effect from 6th April 2017. Those who did take action would have been left in a worse tax position if the new rules were not back-dated.
Despite the government’s confirmation, the new rules have not yet been passed into law. With the government’s slim majority and a history of uncertainty on the new rules, one can understand why some taxpayers may wait until the new rules actually become law to take any action.
Those who do wait will be at a disadvantage if they want to benefit from the Mixed Fund Cleansing transitional relief. Under current proposals, this transitional relief will only be available up to 5th April 2019; taxpayers that wait for the final law will be left with a reduced window to exercise this valuable relief. Given that the delay in introducing the non-domicile tax reforms was to suit the government’s election timetable, we suggest it is both fair and appropriate for the timeframe for this relief to be extended to 5th April 2020; US Tax FS will make representations to HM Treasury.
The expected changes to the nom domicile tax rules are summarised below:
Under the new rules, individuals who have been resident in the UK for 15 out of the previous 20 tax years will become “Deemed Domiciled” for Income Tax, Capital Gains Tax and Inheritance Tax purposes:
- Income Tax and Capital Gains Tax– Deemed Domiciled individuals will no longer be eligible to use the Remittance Basis tax option. This means they will be subject to UK tax on their worldwide income and gains.
- Inheritance Tax –The concept of Deemed Domiciled has been a feature of the UK Inheritance Tax rules for some time. Individuals who are Deemed Domiciled for UK inheritance Tax fall fully within the scope of UK Inheritance Tax, rather than their exposure generally being limited to their UK assets. However, under the current rules, Deemed Domicile status is acquired after 17 years of UK tax residency out of 20. The proposed new rules will, therefore, align the Deemed Domicile timeframe for Income Tax and Inheritance Tax to the same 15 year period.
- Returning non-domiciliaries – A separate regime will come into force for individuals born in the UK, with a UK “Domicile of Origin”, who subsequently acquired a “Domicile of Choice” outside the UK. If these individuals return to the UK, they will be treated as UK domiciled from the date of return.
Importantly, these individuals are not ”Deemed Domiciled” but actually domiciled, and they will not be eligible to benefit from the Rebasing of Foreign Assets relief, Mixed Fund Cleansing relief or Offshore Trusts protections outlined below. The government has suggested that returning non-domiciliaries will receive a limited grace period in respect of their exposure to UK Inheritance Tax.
Rebasing of Foreign Assets
As a relief measure, individuals who are Deemed Domiciled on 6th April 2017 and who have previously paid the Remittance Basis Charge, will be able to rebase their foreign assets to the fair market value at 5th April 2017. This means that Capital Gains Tax will be assessed on gains accruing from this date. The rebasing will apply automatically, however, an election can be made not to rebase an asset if this is more beneficial. HM Revenue & Customs have not published guidance on how to value foreign assets.
This relief is only available for individuals who become Deemed Domiciled on 6th April 2017 and will not apply to individuals who become Deemed Domiciled in later years.
Mixed Fund Cleansing
Non-UK domiciled individuals, who have previously filed on the remittance basis, have a two-year window from 6th April 2017 to rearrange mixed funds in their foreign accounts. This opportunity means they can separate an account’s constituent parts such as income, capital gains and capital. Any ‘clean capital’ that is identified and isolated, can be brought into the UK without a tax charge.
This tax relief is a rare opportunity for remittance basis taxpayers to access “capital” which can be brought to the UK tax-free. The proposed rules are convoluted and the relief requires that transfers from offshore accounts take place on the same day. This prohibits cleansing accounts in stages; clients may, therefore, wish to wait until the final rules became law before taking any action.
The proposed rules generally allow for offshore trusts, set up by an individual before becoming Deemed Domiciled, to be protected unless the trust becomes tainted. If a trust becomes tainted, a Deemed Domiciled settlor, who can benefit from the trust, would be taxed on all income and gains of the trust on the arising basis.
Income in a trust will not be treated as automatically arising to the settlor. Under the new rules, the taxing point will occur when distributions are received by the settlor, which are matched to accumulated income in the trust. Capital distributions received by settlors will be matched to stockpiled gains.
Anti-avoidance rules are expected to be introduced from 6th April 2018, relating to close family members, ‘washing out’ gains to non-resident beneficiaries and gifting to UK residents.
New provisions for determining the value of non-cash trust benefits will also be introduced. These rules will provide clearer treatment for the valuation of benefits such as the use of trust assets.
Inheritance Tax on UK Residential Property Interests Held in Offshore Structures
UK residential property held by offshore structures and owned by non-UK domiciled individuals or trusts will no longer be classified as excluded property for UK Inheritance Tax. It is expected that, from 6th April 2017, UK Inheritance Tax will be assessed on individuals and trustees who directly or indirectly own UK residential property through overseas closely held companies and partnerships.
The provision includes a de-minimis 5% rule, whereby if the individual or trust’s interest in the offshore structure is less than 5%, the property will be excluded for UK Inheritance Tax.
If you have any questions or concerns about the above changes, please do not hesitate to contact us.