From April 2017 major changes will be made to the way individuals who are not domiciled in the UK (“nondoms”) will be treated.
These sweeping proposed changes were announced by the Government on 8 July 2015 and the majority will come into force from 6 April 2017. Although the draft legislation is yet to be published (and so the exact detail of the new rules is unknown), there is still a window of opportunity before the rules come into force for non-doms to review their position and consider whether they should take steps now.
OVERVIEW OF THE CURRENT POSITION
Non-doms are able to claim to pay tax on the remittance basis – which means broadly that foreign income and ains are not taxed in the UK unless they are brought to the UK. An annual charge is payable by longer term residents in order to access this favourable treatment. Non-doms are also only subject to UK inheritance tax(“IHT”) on UK assets unless they are treated as “deemed domiciled” for IHT purposes by virtue of having been resident in the UK for 17 out of the last 20 years. Non-doms who are deemed domiciled pay IHT on their worldwide assets.
The proposed changes will restrict the availability for individuals to claim non-dom status. With effect from 6 April 2017 individuals who are UK tax resident for more than 15 of the past 20 tax years will be deemed domiciled in the UK for all tax purposes. Deemed domiciled individuals will not be able to access the remittance basis – this means that all income and gains will be subject to UK tax regardless of where they arise – and such individuals will also be subject to UK IHT on their worldwide assets.
There will also be changes to the way residential property is taxed from an IHT perspective. Currently, a nondom who holds UK residential property via an offshore company is treated as holding non-UK assets (i.e. the shares in the offshore company) for IHT purposes. So, if the non-dom is not yet deemed domiciled for UK IHT purposes, there is no UK IHT in respect of the value of the UK residential property. From 6 April 2017, such structures will be “looked through” meaning that UK IHT will be due and will be calculated by reference to the value of the underlying property.
The proposed changes mean that non-doms should be reviewing their current structures and considering whether to take steps to collapse existing structures or put new ones in place. The solution is not the same for all individuals: it depends on many factors, including the key question of how long you have been resident in the UK (i.e. whether you have been resident in the UK for 17 of the past 20 years).
SHOULD I SET UP A TRUST?
If you have not yet been resident in the UK for 17 years of the past 20 then it may be worth exploring whether to put an offshore trust in place to hold certain offshore assets. The proposals suggest that non-doms who have set up offshore trusts before they become deemed domiciled will not be taxed on trust income and gains that are retained in the trust (i.e. would only be taxed when distributions are made).
Draft legislation has not been published on this particular point as yet, but if this is enacted as planned, certain non-doms who have an offshore trust which they do not need to access while they remain in the UK may find themselves in a better position after the change in law (as they will no longer need to pay the remittance basis charge to keep such sums out of the UK tax net). Many long-term residents who are not yet deemed domiciled who decide to put a trust in place before the new rules come in to force are also likely to be in a considerably better position than if no trust is put in place prior to April 2017.
However, if you have been resident in the UK for 17 of the past 20 years, you will already be treated as deemed domiciled for UK IHT purposes. As a result, it is usually not possible to set up a new trust and contribute assets to that trust without triggering a 20% upfront IHT charge.
WHAT IF I ALREADY HAVE A TRUST?
If you have already set up a trust then you may want to review whether this remains an appropriate structure. Certain trusts have a “protected” status for UK IHT purposes (usually if they were set up before you became deemed domicile for UK IHT purposes) whereas others do not. Trusts without this protected status, in particular, are likely to give rise to significant UK tax downsides when the proposed rules come into force.
Even for trusts with protected status, there are likely to be UK tax ramifications. If you (and your immediate family) do not intend to use any of the trust assets while you remain in the UK, then there may be benefits to keeping the trust in place – the proposals suggest that, provided gains and income are retained in the trust, the trust should largely be ignored for UK tax purposes. However, if you are likely to need to access the trust fund while in the UK, it is understood that a flat rate will apply to such distributions but the exact rate is not yet known. In addition, if the trust (or an underlying offshore company) holds UK residential property, you may want to consider whether to unwind the trust as the IHT benefits will no longer be available.
If on your facts there is little benefit to keeping the trust in place and you are a longer term resident, there may be tax advantages in winding up the trust before the new rules come into force so that distributions can be made while you have the benefit of the remittance basis (and so can collapse the trust in a tax efficient way).
WHAT HAPPENS TO HISTORIC GAINS (AND INCOME)?
The change in rules does not mean that all historic gains are “wiped out” – there is a distinction between gains that have already been realised and gains that are yet to be triggered but are latent within an asset.
If you have already disposed of an asset and triggered a gain prior to 6 April 2017, you may have claimed to be taxed on the remittance basis to shelter this gain. If you choose to bring the proceeds from the sale of this asset (cash or other assets representing those proceeds) into the UK, this will trigger a UK tax charge. Once you are paying tax on the arising basis (i.e. once you are treated as deemed domiciled) these historic gains will not disappear. Historic gains previously sheltered under the remittance basis are likely to suffer UK tax when the proceeds are brought to the UK (although with careful planning it may be possible to ensure that only future taxed gains are brought to the UK).
If you hold assets which have a latent gain (i.e. a gain which has not yet been realised) and you dispose of the asset once you are deemed domiciled for UK tax purposes, the gain will be subject to UK tax. Although it has been suggested that the draft legislation may include “automatic” rebasing, you may wish to think about taking steps to trigger the gain (i.e. “rebase” your assets) prior to the change in law while the gain can still have the benefit of the remittance basis. In other words, you may want to ensure that any unrealised gains in your offshore assets are crystallised before you are subject to tax on the arising basis.
WHAT ELSE SHOULD I THINK ABOUT?
If you have been resident in the UK for over 15 of the past 20 years, you will no longer be able to access the remittance basis from 6 April 2017. This means that you will pay tax on an “arising” basis. When on the remittance basis, it is possible to shelter certain gains and income offshore – tracking the underlying income and gains arising is relevant for UK tax purposes only to the extent amounts are remitted to the UK. Once on the rising basis, it will be necessary to identify exactly what gains and income are taxable which is not always easy when assets are held in complicated, multi-tiered structures. There is also a risk that once on the arising basis, tax will be triggered at multiple levels in the same structures and the mechanisms for set off of tax may not always eradicate such “double” tax.
Given that from April 2017 you may be paying UK tax on your worldwide assets for the first time, you may also wish to consider simplifying investments and structures or reviewing your assets to ensure these are structured in the most tax efficient way. Certain investment types lend themselves to non-dom investors whereas others do not – losing the benefit of the remittance basis of taxation may change which investment types would be most appropriate. There are also wider questions about the cost of running structures and the uncertainty posed by the risk of enquiry which may need to be addressed when deciding which structures to retain.
If you (or an offshore trust) hold UK residential property via an offshore company, you may also want to consider whether this structure should be collapsed. Holding UK residential property via a company has other UK tax implications (e.g. the application of the Annual Tax on Enveloped Dwellings) so the removal of the UK IHT benefit may make such structures less attractive. If changes are made to the structures you hold, it is also sensible to review your Will and wider estate planning.
If you would like to talk to us about the proposed changes outlined, please telephone contact one of the key contacts listed, or your usual contact at Stevens & Bolton LLP.