Ever since last summer, when the UK Government unexpectedly announced plans to abolish indefinite non-dom status, people who have been living in the UK for, say, 14 or 15 years, have been asking one another, their advisers, and – well, just about anyone else who might have a clue – what on earth they should do.
Here, London-based non-dom expert Mark Davies, founder and managing director of Mark Davies & Associates, provides some answers with respect to the new “deemed domicile regime” for long-term UK residents.
There is some ambiguity ahead for non-doms living in the UK.
Until 5th April 2017, non-doms could benefit from being able to shelter their foreign income and gains from UK tax indefinitely, under the so-called “remittance basis”, and their non-UK assets could be kept outside the scope of UK inheritance tax until they became domiciled in the UK, or deemed domiciled (under the old rules).
To claim the remittance basis, non-doms must pay a flat charge of £30,000, £60,000 or £90,000 a year, depending on their length of UK residence.
Under the old rules, now about to end, where a person has been UK tax resident in 17 of the previous 20 tax years, they became “deemed domiciled for inheritance tax only”, and their worldwide estate became subject to inheritance tax.
However, as a result of the UK Government’s plans, unveiled last year, to abolish indefinite non-dom status, this is to change.
The result will basically diminish the difference in tax treatment between UK domiciled persons and those long-term UK residents who claim non-dom status.
* The UK’s non-dom regime dates back to 1799, when William Pitt the Younger was prime minister and Britain was fighting France (plus ça change). Income tax was introduced as a ‘temporary measure’ and all taxpayers had the option to elect to be taxed on the “remittance basis”.
* The rule restricting the remittance basis to foreign domiciliaries, or non-doms, was only introduced in the 20th century.
* £6.6bn: How much income tax was paid by the UK’s 80,700 non-doms in 2013-2014.
* £4.91bn: How much income tax was paid on their UK earnings, under the remittance basis, by the UK’s 50,900 non-doms in 2013-2014.
From 6th April 2017, individuals who have been tax resident in the UK for more than 15 of the previous 20 tax years will no longer be able to benefit from their non-dom status, and will acquire the new “deemed domicile” status in the UK.
What’s important to understand about this new measure is that this new deemed domicile status will cover income tax, capital gains tax and inheritance tax.
In short, this eliminates the possibility of claiming the remittance basis of taxation once an individual has been UK resident for 15 tax years. Hence, the personal worldwide income, gains and assets of deemed domiciled individuals will automatically be subject to UK tax.
Crucially, those individuals who have been UK tax resident for 15 tax years and who may have been planning for the old deemed domicile rules will now have to reassess their plans. Quickly.
Below are some basic options they may wish to consider.
1. Offshore trusts
The Government has confirmed that there will be transitional provisions that will give protection for offshore trusts that were established prior to an individual becoming deemed domicile.
Although the draft legislation has not been provided to show the mechanics of these measures, we know that these individuals will not be taxed on foreign trust income and gains. Instead, they will be taxed on distributions or on the value of the benefits they received from such trusts, wherever enjoyed.
In other words, the taxable value of trust benefits is to be calculated with no reference to the trust’s underlying income or gains.
It is currently unclear at which tax rate trust benefits shall be taxed, though, and how certain trust benefits, such as use of a residential property, will be valued.
This may offer an opportunity for those who will become deemed domicile as a result of the changes to settle an offshore trust before 5 April 2017.
However, setting up an offshore trust may not be possible without a tax liability if you are already deemed domiciled after 5th April 2016 under the old IHT deemed domiciled rules.
2. ‘Freezer’ trusts
One way a non-dom who already deemed domiciled in the UK is to make use of a “freezer trust”. To do this, the taxpayer makes use of a trust set up by a neither UK domiciled nor deemed domiciled family member, from which the taxpayer cannot benefit.
He either lends funds or sells assets to the offshore trust in exchange for an IOU. The trust then uses the income generated from investments to repay the debt.
It should be noted here that until the draft legislation is circulated ahead of receiving Royal Assent in Summer 2017, tax advisers and their clients cannot be certain that existing structures or proposed planning will be successful.
3. Pensions – Qualifying Recognised Overseas Pension Scheme (QROPS) and Qualifying Non UK Pension Scheme (QNUPS)
While the primary reason for using QROPS and QNUPS is for pension planning, they can also offer Inheritance Tax protection.
As with the suggested measures for existing trusts, the investment would grow tax free until such time as the individual wishes to receive a pension.
4. Family Investment Companies (FICs)
A FIC operates in a similar way to a discretionary trust. Its governing documents include bespoke provisions covering the distribution of profits and the treatment of capital of certain shares in the FIC, which allows for a potentially exempt transfer (PET) of the shares in the FIC to other family members, which would not be subject to UK inheritance tax, should the donor survive seven years.
Another benefit for choosing a FIC is that the controlling shareholder has greater control than they would in a trust.
The family members would be the shareholders and could be directors of the company (if it is an onshore FIC) and therefore able to choose the company’s investments and also the extraction of funds, by salary or dividends.
The Government also intends to reduce corporation tax on onshore FICs to 17% by 2020. However, onshore FICs can result in tax being paid twice. Not only will the FIC be subject to corporation tax on its profits, but dividends paid from taxed income would be taxed again when paid to family members.
But if the FIC is used as a ‘piggy bank’, profits can be collected in the FIC and paid out to family members free from UK tax once they are no longer UK tax resident.
5. Business Investment Relief (BIR)
BIR allows individuals to remit capital, foreign income and gains to the UK to invest in a qualifying business without incurring a liability to income or capital gains tax. This means that future growth might be subject to UK corporation tax at a lower rate as opposed to UK income tax which would otherwise be due on foreign income if capital remains invested abroad.
It would be necessary to claim the remittance basis and, where necessary, pay the remittance basis charge in the current tax year,and those funds would have to be used only for qualifying investments, around which there are many restrictions.
This relief also extends to UK investment property businesses.
6. Business Property Relief (BPR)
Once an individual has already become deemed domiciled then an investment of capital, foreign income and gains can be made in a qualifying investment that could qualify for BIR and also BPR. BPR can provide an inheritance tax shelter on the company’s shares and a reduction of IHT against business assets, such as commercial property used in the business.
It should be noted that this will only be advantageous to businesses carrying out a genuine trade, for example letting businesses do not qualify for BPR.
7. Resetting the Clock
The most extreme means of planning for the new deemed domicile changes is to avoid becoming deemed domicile in the first place. An individual may leave the UK for six tax years in order to “reset the clock”.
Previously it was only necessary to leave the UK for four tax years in order to lose deemed domicile status; however, the new 15-year rule shall require individuals to leave the UK for at least six tax years instead.
In summary, these are the options, as they stand now, for those coming to the end of their UK non-dom ride.
For those who say “none of the above” at this point, it may be time to consider Option 7, which is, obviously, to leave the UK.
Mark Davies & Associates Ltd is a London-based boutique firm of chartered tax advisers, which advises individuals, businesses and non-domiciled persons who are resident in the UK.