Non-doms from 6 April 2017 and offshore trusts from 6 April 2018
Current Issues | Personal tax | 1st November 2017
Changes effective from 6 April 2017 materially increase the exposure of many non-domiciliaries to UK income tax, capital gains tax and inheritance tax.
The value of interests in offshore ‘close’ companies and partnerships so far as attributable to UK residential property will no longer be excluded for UK inheritance tax.
Furthermore, there are to be substantial changes to the tax treatment of the beneficiaries of non-resident trusts from 6 April 2018, which will affect UK domiciliaries as well..
From 6 April 2017 –
- Anyone actually domiciled outside the UK who has been a UK resident for at least 15 of the 20 preceding tax years will be deemed UK domiciled for income tax and capital gains tax.
- Anyone actually domiciled outside the UK who has been a UK resident for at least 15 of the 20 preceding tax years and for at least one of the 4 tax years ending with a particular tax year will be deemed UK domiciled for inheritance tax purposes in that year.
- Furthermore, anyone born in the UK with a UK domicile of origin who has acquired a new domicile elsewhere will be deemed domiciled in the UK in relation to a tax year for income tax and capital gains tax if they are resident for that year, and for inheritance tax if they are UK resident for that year and were UK resident for at least one of the two preceding years.
This is a change from the previous rule for inheritance tax, under which a non-dom was deemed UK domiciled if they had been UK resident for at least 17 of the 20 tax years then ending.
Double tax treaties may apply and could have an impact on this.
The new 'deemed domicile' doesn't apply in every circumstance. Thus, a resident but actually non-domiciled beneficiary receiving a capital payment from a non-resident trust will continue to enjoy the benefit of a re-basing election by the trustees as at 5 April 2008 after 5 April 2017, unless he or she was born in the UK with a domicile of origin within the UK.
There are special rules for those who prove to be ‘temporarily non-resident’ (which generally means non-resident for an interval of fewer than five years). For example, if the year of return is 2017/18, the new 'deemed domicile' doesn't apply for that year.
All non-doms should review their period of UK residence, to identify when they will become deemed domiciled – if they have remained UK resident after 5 April 2017.
Inheritance tax (IHT)
Trusts created by a non-domiciled individual (unless born in the UK with a UK domicile of origin) can remain protected from IHT to the extent the trust assets are non-UK situs, despite the settlor becoming deemed domiciled.
Trusts created by a non-domiciled settlor who was born in the UK with a UK domicile of origin will lose excluded property status when the settlor becomes deemed domiciled for IHT.
A change which affects all non-doms, not just those who become deemed domiciled, is that interests in ‘close’ offshore companies and partnerships (unless under 5%) are subject to UK IHT to the extent their value is attributable to UK residential property, from 6 April 2017.
Furthermore, loans made to individuals, trustees and partnerships to finance the acquisition of UK residential property directly or indirectly and ‘money or money’s worth made available as security, collateral or guarantee’ for such loans are also subject to UK IHT from 6 April 2017.
Finally, when such interests in companies or partnerships are disposed of or such loans repaid, the proceeds will continue to be subject to UK IHT for two years.
Those affected should review the potential inheritance tax liability, and consider the tax consequences of de-enveloping.
When interests in offshore companies and partnerships owning UK residential property and associated loans cease to be excluded property, there will often be a reservation of benefit therein by settlors of discretionary trusts from which the settlor may benefit.
There could also be a liability to a pre-owned asset charge on the settlor in the case of certain settlor-interested interest in possession trusts.
Re-basing at 5 April 2017 for capital gains tax and income tax
Those non-domiciled who become deemed domiciled on 6 April 2017 because of the 15/20 rule (and not because they were born in the UK with a domicile of origin here), and who have paid the remittance basis charge as long-term UK residents for any tax year up to 2016/17, will be deemed to have acquired at 5 April 2017 at market value all of their offshore assets held on that date that were not situated in the UK at any time in the period beginning on 16 March 2016 (or subsequent acquisition) and ending on 5 April 2017 in computing the gain or loss on disposal thereof after 5 April 2017. This will include not only assets on which a gain subject to capital gains tax arises but also gains realised on interests in non-reporting offshore funds that are subject to income tax.
This will only apply if the individual became deemed domiciled in the UK on 6 April 2017 as described and remains so for all tax years up to that in which the disposal occurs.
Any gain that had already accrued by 5 April 2017 on the asset disposed of will therefore be tax-free. Individuals may elect for the re-basing not to apply to a particular disposal, for example if there is an overall loss but a gain over market value at 5 April 2017.
Thus, if the asset was originally acquired with clean capital, it will be possible to bring the entire proceeds from the disposal into the UK without triggering a remittance charge However, if it was acquired using previously unremitted foreign income or gains, an element of the disposal proceeds would still relate to such income or gains and will be taxed as a remittance.
Those affected should assemble details of assets affected. Any non-doms who would otherwise not have paid the remittance basis charge for any year up to 2016/17 should review the possible benefit of doing so.
Settlors of offshore trusts -
The treatment of the newly deemed UK domiciled settlors of non-resident trusts changes from 6 April 2017.
Capital gains tax (CGT)
Before 6 April 2017 the UK resident but non-domiciled settlor of a ‘settlor-interested’ non-resident trust (one which may benefit the settlor, the settlor’s spouse or civil partner, children or grandchildren) was not subject to CGT on the trust’s gains (unlike a settlor who is UK domiciled and resident). Instead, any UK resident beneficiary who receives a benefit from the trust that may be matched with trust gains may be charged CGT. This is to continue to apply if the trust was ‘created’ when the settlor was non-domiciled, despite the settlor becoming deemed domiciled after 5 April 2017, but only if deemed domicile is on the 15/20 basis and not because of being born in the UK with a domicile of origin here.
This protection continues so long as no property or income is added by the settlor or the trustees of any other settlement of which the settlor is a settlor or a beneficiary at a time when the settlor is domiciled in the UK or deemed domiciled. For this last, additions made to meet expenses relating to taxation and administration that exceed the trust’s income are disregarded. But loans on other than arm’s length terms can represent an addition to the trust. This means loans to the trust at less than the ‘official rate’ or loans by the trustees at more than the ‘official rate’. The ‘official rate’ is currently 2.5%.
Where the settlor is deemed domiciled with effect from 6 April 2017 and loans exist on terms that ‘taint’ the trust, this can be avoided by action taken by 5 April 2018. Tainting is avoided if the loan is repaid, together with all interest, by that date or the loan becomes on arm’s length terms by 5 April 2018 with effect from 6 April 2017.
Further changes affecting beneficiaries of non-resident trusts are to apply from 6 April 2018.
The first change is to disregard all capital payments to non-residents unless -
- the recipient is a ‘close member of the settlor’s family’ and the settlor is UK resident in the tax year the payment is received after 5 April 2018;
- the payment is made in the year the settlement ceases to exist after 5 April 2018, two or more beneficiaries receive capital payments and at least one is non-resident and one is resident in the UK; or
- the recipient is temporarily non-resident, in which case the payment is treated as received in the beneficiary’s period of return to the UK.
Also to be disregarded are capital payments to UK resident beneficiaries who migrate before the payment is matched to trust gains.
The disregarded capital payments therefore leave intact the pool of trust gains available to be matched with capital payments. Where chargeable gains are treated as accruing to a ‘close member of the UK resident settlor’s family’ who is either non-resident or the remittance basis applies to the beneficiary, and none of the gain is remitted to the UK in the year, the settlor is chargeable to CGT as if the gains accrue to him. The settlor may then recover from the beneficiary or any trustee of the settlement the tax he has paid.
A person is a ‘close member of the settlor’s family’ if the person is the settlor’s spouse or civil partner (treating two people living together as if they were married and treating two people of the same sex living together as if they were civil partners) or a child under 18 of the settlor or the settlor’s spouse or civil partner [or unmarried ‘partner’ of the settlor].
Furthermore, if a capital payment is received from a non-resident trust by someone who is a non-resident or a remittance basis user and is either not a ‘close member of the settlor’s family’ or the settlor is non-resident (including a payment received before 6 April 2018), and, after 5 April 2018 and while the original beneficiary has either remained non-resident or is a remittance basis user, the original beneficiary makes a gift within three years to a UK resident (or a gift is made before the original payment is received, in anticipation thereof), the recipient of that gift is treated as receiving a capital payment equal to the gift or, if less, the original capital payment (the latter amount as reduced in certain circumstances, such as a remittance to the UK by the original beneficiary), if the onward gift was intended at the time of the original payment.
Until 5 April 2017 the ‘settlor’ of a non-resident trust which may benefit the ‘settlor’ was subject to income tax on the trust income as it arose, if UK resident, but a non-domiciliary might claim the remittance basis on foreign-source income.
If the property was settled when the settlor was non-domiciled, and the settlor is non-domiciled or becomes deemed domiciled under the 15/20 rule (and not because of being born in the UK with a domicile of origin here – a ‘formerly domiciled resident’), the foreign-source income will from 6 April 2017 no longer be chargeable on the settlor whether or not remitted to the UK (for example the trustees investing in UK shares), provided that no property or income is added by the settlor or the trustees of any other settlement of which the settlor is a settlor or a beneficiary at a time when the settlor is domiciled in the UK or deemed domiciled, For this last, additions made to meet expenses relating to taxation and administration that exceed the trust’s income are disregarded. But loans on other than arm’s length terms may represent an addition to the trust, as described above under capital gains tax.
Such income is termed ‘protected foreign-source income’. A UK resident settlor will remain taxable on any benefits actually provided to him or her of foreign-source income.
If benefits are provided to an individual who is a close member of the settlor’s family, and the beneficiary is either non-resident or taxable on the remittance basis, the beneficiary is subject to income tax thereon (up to the available protected income). But if the settlor is UK resident but not domiciled in the UK or deemed domiciled on the 15/20 basis and the beneficiary is either non-resident or taxable on the remittance basis, the settlor is taxable on the benefit.
Similarly, until 5 April 2017 a UK resident individual might have been subject to tax on income arising to a person abroad, under the ‘transfer of assets abroad’ regime. From 6 April 2017, this is not to apply to protected foreign-source income, defined as above.
It would seem that this treatment will not apply if the settlor is entitled to the income as it arises, because he has the interest in possession.
A similar provision to that described above for ‘onward gifts’ is to apply from 6 April 2018.
Very similar treatment is to apply to ‘onward gifts’ from 6 April 2018 under the ‘transfer of assets abroad’ regime,
Non-resident companies and capital gains tax
A participator in a non-resident ‘close company’ who becomes deemed UK domiciled for capital gains tax purposes will be taxable on his share of the gains of the offshore company regardless of where they arise – if the proportion attributable exceeds 25%.
Mixed funds offshore
Non-domiciled individuals whether or not about to become deemed domiciled (but not those born in the UK with a domicile of origin here), even those not currently UK resident, are given a window – the two years to 5 April 2019 - in which they may re-arrange their mixed funds overseas to separate them into their constituent parts: clean capital, foreign income and foreign gains. They will then be able to remit from these separate parts as they wish, in whichever order suits them. It can only apply to transfers of money. Where the mixed ‘fund’ is in the form of an asset such as a painting or securities, the asset should be sold in order to realise cash which may then be segregated.
All UK non-doms should consider whether to take such action.
Business investment relief (BIR)
BIR applies to remittances of foreign income or gains that are used to make loans to, or subscriptions for shares in, unquoted companies carrying on a qualifying trade, generating income from land, etc. Such remittances then escape tax. The legislation was softened with effect from 6 April 2017, most notably in extending the permitted investments to include shares acquired as well as those issued.
UK land and buildings owned by offshore companies
As part of the UK’s drive towards transparency, the Government wants a register of beneficial ownership for foreign companies which own land or property in the UK.
The Government will seek to establish the beneficial ownership information before a foreign company is able to buy that UK property. This would cover the company’s beneficial ownership and control, and be made publicly available, unless the company’s residence is in a jurisdiction which already has a publicly available register of beneficial ownership which provides information similar to that required by UK rules.
This, coupled with the extension of IHT to offshore companies holding UK residential property, provides the authorities with a tool to find beneficial ownership and target any avoidance of IHT (as well as ATED and non-resident CGT on UK residential property), but nothing is known yet of how they will gather this information for historically owned property.
Time for action
Those who may be affected should have reviewed their affairs, and considered action before 6 April 2017. Likewise, care should be taken to avoid ‘tainting’ settlor-interested trusts and structures by adding value after 5 April 2017. It is important to note that tainting includes loans at other than ‘market rate’, and action to remedy any such situations is only available up to 5 April 2018
The changes effective from 6 April 2018, now reflected in the Finance Bill published on 1 December 2017, may be amended before becoming law. Specific advice should be obtained before taking action, or refraining from taking action on the basis of this information.