In the Summer Budget 2015 the UK government announced significant changes to the taxation of non UK domiciliaries (‘non doms’) to take effect from 6 April 2017. Whilst the government has since published a consultation paper on certain aspects, we are still waiting for the detail on key parts, including how the UK will tax non UK resident trusts and UK residential property held through non UK companies.
There has been some recent speculation that the government might postpone these changes, as it needs to focus on the tax implications of Brexit. Whilst this cannot be ruled out, we think it is unlikely as the government is usually reluctant to let the timing of announced changes slip. Absent any such postponement, the next announcement is likely to be in the Autumn Budget Statement, which will not leave much time to implement any changes. We are advising our clients to take steps now to get their ‘ducks in a row’, so they can move quickly once the detail is known.
We review the changes below and highlight some points for US tax advisers to consider for any of their clients that might be caught.
The UK concept of domicile
The UK has its own test of domicile. Whilst there are many wrinkles, broadly speaking, at birth a person takes on the domicile of his or her father if his or her mother and father are married, or his or her mother, if they are not married. A person will keep this ‘domicile of origin’ unless the relevant parent’s domicile changes whilst he or she is a child, or until he or she moves to another country and decides to make that new country his or her permanent home (i.e. acquires a ‘domicile of choice’). Because of this second limb, it has been possible for an individual to maintain non dom status, even after living in the UK for many years.
In the case of the US, domicile is linked to a particular state, as opposed to the US as a whole.
For UK inheritance tax purposes only (as things stand), a person is ‘deemed’ to be UK domiciled if they have been resident in the UK in 17 of the previous 20 tax years.
Tax benefits of non-dom status
The remittance basis
A UK resident non dom is able to claim the remittance basis of taxation, making him liable to UK income tax (IT) and capital gains tax (CGT) on UK source income and capital gains, but not on foreign source income and capital gains provided such items are not brought (remitted) directly or indirectly to the UK. If the remittance basis is not claimed, he would be liable to IT and CGT on a worldwide basis.
Once a non-dom has been resident in the UK for seven tax years, he will need to pay an annual charge of £30,000 to claim the remittance basis. This increases to £60,000 after 12 years and to £90,000 after 17 years.
Inheritance tax limited to UK situs assets
Under current rules, a non-dom is only liable to UK inheritance tax (IHT) on UK assets, where as a UK dom (or deemed dom) is liable to IHT on his worldwide assets (subject to applicable double tax treaties). Helpfully, shares in non UK companies owning UK property usually constitute a non-UK asset for these purposes, which can be a useful tool to limit the impact of IHT for non doms.
One of the key differences between UK IHT and US federal gift/estate tax is the available tax free sum: in the UK we have a ‘nil rate band’ which is £325,000, whilst in the US there is the more generous lifetime exclusion amount of $5.4m.
The key changes announced for April 2017
Proposed 15/20 deemed domicile rule
The government has announced that from 6 April 2017 non doms who have been UK tax resident for at least 15 out of the previous 20 tax years will become deemed domiciled (termed here: ‘deemed doms’) for all tax purposes, making them liable to IT, CGT and IHT on a worldwide basis.
This will be a significant extension to UK tax for many long terms UK residents and will have an immediate impact on those who have been resident in the UK for 15 tax years or more as at 6 April 2017. Such clients will need to review their tax affairs before that date.
Trusts set up by non doms
The government has also indicated that it will introduce a new regime for the UK taxation of non UK resident trusts set up by non doms. We have little detail to go on, but it is anticipated that:
- Non UK source income and capital gains arising to the trustees would only be taxed when a benefit is received from the trust, in theory allowing gross roll up of such foreign income and gains until that point. This could be attractive, but there is a concern that the full value of the benefit could be taxed (even if it represents a return of original capital) and it is not clear whether the benefit will be subject to income tax (rates up to 45%) or capital gains tax (rates up to 28%) or a hybrid.
- Non UK assets settled on trust by a non-dom should remain outside the scope of IHT, even if the settlor becomes a UK dom or deemed dom. These are typically referred to as ‘excluded property trusts’. This could be a useful planning tool for long term UK resident US citizens, who are at risk of becoming deemed dom, in respect of non UK assets. Such individuals may otherwise lose the economic benefit of the $5.4m US exclusion amount, as UK IHT would apply, absent other reliefs or exemptions, to the value of their worldwide estate in excess of £325,000.
For US trusts with UK based beneficiaries, there could be a risk of double taxation on distributions if the US based trustees are liable to US income tax on the trust income and gains on an arising basis, but the UK beneficiary is liable to UK tax at the point of distribution. Given the mismatch between (a) who is liable for the tax and (b) the timing of the charge, the credit system under the double tax treaty might not be effective at preventing a double charge.
UK doms and Inheritance Tax on death
The government also wishes to make it more difficult for individuals who have a UK domicile of origin to claim non dom status if they leave the UK and acquire a domicile of choice in another country (or state in the case of the US).
Under the new proposal, it will not be possible for a UK dom to acquire a domicile of choice elsewhere until they have been resident there for at least six years. In practice, it may take even longer to demonstrate that they have formed the necessary intention to make that new country or state their permanent home.
UK residential property owned through non UK companies
The government also plans to bring the value of UK residential property held through non UK companies or other ‘opaque structures’ within the scope of IHT. The present position is that the shares in such a company are a non UK asset, so outside the scope of IHT if held by a non-dom. This will also have implications for trusts owning shares in such companies, which might have been otherwise protected from IHT under the excluded property rules.
Any individuals or trustees holding UK residential property through such a structure should review their position; they could also be affected by the myriad of other changes that the government has introduced to discourage residential property ownership through corporate vehicles.
For individuals who are likely to become deemed dom, they should assess the impact of becoming liable to UK tax on their worldwide assets and earnings. Those that are also US tax payers should in particular consider how UK tax will apply to their investments and business interests. There are potential mismatches, including:
- Many US mutual funds are likely to be treated as ‘non reporting’ funds for UK tax purposes, which means that any gain realised on the disposal of units in the fund could be subject to income tax in the UK, as opposed to CGT. There could also be an element of double taxation on death;
- Municipal bonds may have favoured tax status in the US, but this will not necessarily protect them from UK tax; and
- The UK tax treatment of certain US structures is not always clear, in particular LLCs.
Turning to inheritance tax, they should also consider whether it would be sensible to set up an ‘excluded property trust’ before becoming deemed domiciled.
For the investment managers among you, you might find that increasing numbers of your customers require UK tax information for their accounts – for example, details of capital gains calculated in accordance with UK tax rules.
Lastly, existing trust structures and any structure owning UK residential property should be reviewed.
Start now – there could be a lot to do!