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Non-domiciliaries’ income & gains

Those individuals resident in the UK, but not domiciled for legal purposes, have faced increasing changes and complexity to their tax position.

Updated 26 January 2021

For the unfamiliar, there are significant differences to being resident in a country and being domiciled there. Being a resident covers temporary stays. Being domiciled reflects the country of the individual's permanent home and is important for legal purposes such as paying taxes, voting, and claiming benefits. Residence and domicile have different legal definitions and are determined largely by the length of time you plan to live in a specific location.

 

Background

Before 6 April 2008 UK residents not domiciled in the UK were only subject to tax on overseas income and gains when this was remitted to the UK [this is known as the 'remittance basis']. They were also not liable to capital gains tax on the gains of a non-resident trust or company, wherever those gains arose. The Finance Act 2008, however, changed all that.

There was change again in The Finance (No. 2) 2017, which introduced a fresh 'deemed domicile' criteria for income tax and capital gains tax and modified the existing deemed domicile for inheritance tax.

 

Definitions

Income Tax and Capital Gains Tax

Since 6 April 2017 a non-domiciliary is deemed domiciled in the UK for income tax and capital gains tax if he or she:

 

Inheritance Tax

A non-domiciliary is deemed domiciled in the UK for inheritance tax purposes if he or she has

 

Those affected by the 15/20 rule

Those non-domiciled who were…

… were deemed to have acquired at market value on 5 April 2017 all of their offshore assets held on that date that were not situated in the UK at any time during the period 16 March 2016 to 5 April 2017. These values were used in computing the resulting gain or loss on disposal after 5 April 2017.  It included, not only assets on which a gain subject to capital gains tax arose, but also gains realised on interests in non-reporting offshore funds that are subject to income tax.

Note – this only applies 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.

 

The remittance basis

Claiming the remittance basis

Unless their unremitted income and gains total less than £2,000 in the tax year, non-domiciliaries may claim the remittance basis on their overseas income and gains but are not then entitled to the income tax personal allowances or the annual exemption for capital gains tax. Overseas income for this purpose includes income arising in the Republic of Ireland. Before 6 April 2008 the remittance basis did not extend to such income.

 

The remittance basis charge (RBC)

If the claimant has been resident in the UK for at least seven out of the preceding tax years, and is aged 18 or more, he or she will only be entitled to claim the remittance basis for a tax year on payment of a 'remittance basis charge'.

The criteria is as follows:

The RBC is treated as tax (income tax or capital gains tax as the individual chooses) on unremitted overseas income or gains. It is collected at the usual tax due date, with interest and surcharges for late payment.

If characterised as payment of income tax in respect of unremitted overseas income, it will form part of the liability which determines the level of the individual's interim income tax payments for the following year. The unremitted income or gains on which the RBC has been paid will not be taxed again if it is eventually remitted to the UK. However, all untaxed unremitted overseas income and gains will be treated as remitted before income or gains on which the RBC has been paid.

As the RBC will be either income tax or capital gains tax, it should be treated as such under double taxation agreements.

If each member of a family is non-domiciled, each parent and each adult child therefore has a choice to make.

Where unremitted income and gains are expected to be under £2,000 (so no claim is required in order that the remittance basis may apply, but it is later found that the unremitted income gains are too much), the arising basis will apply automatically unless the individual is still in time to claim the remittance basis.

 

Remittances explained

The definition of remittances which represent overseas income or gains (including any from a ‘ceased source’, even one which ceased years earlier) includes:

The ‘immediate family’ includes spouses, civil partners (and those living together as husband and wife or as civil partners) and their children and grandchildren under 18.

There are exemptions for:

… but only when ‘purchased from ‘relevant foreign income’. Note that this does not apply to such items that represent otherwise unremitted overseas employment earnings and capital gains.

Although ostensibly only applying from 6 April 2008, this definition of remittances would have meant that events many years earlier could result in a tax liability in 2008/09 or later. However, any asset bought out of untaxed overseas income that an individual owned on 11 March 2008 is exempt from charge under the remittance basis, whether the asset is in the UK or overseas.

Furthermore, any asset in the UK on 5 April 2008 escaped the remittance charge for so long as the current owner owned it, even if it was later exported and re-imported. But, as was the case before 6 April 2008, a charge does arise if an asset bought from untaxed overseas income is turned into cash after import into the UK.

A separate exemption applies where a work of art is bought from unremitted overseas income or gains and brought into the UK for public display. Unremitted income or gains given offshore before 6 April 2008 to one’s spouse, for example, are taxed as a remittance if first brought into the UK after 5 April 2008.

As to identifying unremitted income and gains, remittances from a ‘mixed source’ (e.g. employment income, investment income, capital gains, original monies) are attributed on a ‘just and reasonable’ basis. A pre-existing division of bank accounts between ‘capital’ and ‘income’ holds good after 5 April 2008, so that remittances from the ‘capital’ account are made tax-free.

An individual can choose for each tax year whether or not to adopt the remittance basis. Of course income and gains arising in a year when that choice is made remain taxable in any year that they are remitted, even though the individual may by then be taxable on the arising basis. 

If the RBC is paid directly to HMRC by cheque or electronic transfer from overseas sources it will not be taxed as a remittance.

A remittance of overseas income or gains is exempt if, it is used to make a 'qualifying investment' within 45 days. That is, in shares issued to the investor in, or a loan made by the investor to, a private limited company carrying on a trade or investing in real estate, or a company which exists to make investments in such companies.

 

Rearranging mixed funds

For the two years up to 5 April 2019, non-domiciled individuals (including those who were or were not about to become deemed domiciled) were given as opportunity to rearrange their mixed funds overseas. This included those not currently UK resident but excluded those  born in the UK with a domicile of origin here. The ruling enabled these individuals to separate their funds into constituent parts: clean capital, foreign income and foreign gains. They would then be able to remit from these separate parts as they wish, in whichever order suits them. 

 

Loans and interest

Before 6 April 2008 interest on loans raised offshore to buy property in the UK might have been paid from unremitted overseas income without a tax charge. Now such interest payments are classified as remittances. There is an exception in the case of payments on debts existing at 12 March 2008 that were used to buy residential property in the UK for the life of the loan (or until 5 April 2028 if sooner), unless the terms of the loan are varied or any further advances were made after 12 March 2008.

HMRC consider as a remittance a loan raised to acquire property in the UK if the loan is secured on otherwise unremitted overseas income or gains. Before 4 August 2014, this was not applied to loans on a commercial basis that were regularly serviced from overseas income or gains. In such cases only the interest was treated as a remittance. Such arrangements were only protected if either the loan was repaid before 5 April 2016 or a written undertaking was given by 31 December 2015 (which is subsequently honoured) that the overseas 'security' would be replaced by 'onshore' security before 5 April 2016.

 

Temporary non-residence

If an individual…

…any overseas income remitted to the UK in those intervening years that arose while the individual was UK resident (but was not taxed as it arose) is taxed as if it had been remitted to the UK in the tax year of return.

A similar rule is to applies to overseas gains remitted to the UK in the intervening years, but only if the remittance basis applies to the individual for the year of return.

Under the existing law, gains realised during a period of temporary non-residence are already chargeable in the year of return where the ‘arising’ basis applies, save where the asset was acquired during that period.

 

Non-resident companies

Gains realised by a non-resident company that would be 'close' if it were resident (other than those chargeable on the company itself) are attributed to UK resident participators even if non-domiciled (if their 'participation' – including that of their 'associates' – exceeds 25%).

Those non-domiciled UK residents who are on the remittance basis will be chargeable only on remittances of gains on overseas assets.

Where the non-resident company's shares are held by a non-resident trust, the gains are attributed to the trustees. The re-basing election referred to below will then extend to the company’s assets held at 6 April 2008.

Since 6 April 2015 a non-resident company has been defined as 'close' if its residency became subject to UK tax on gains realised on disposal of UK residential property. 

The amount chargeable is the excess over market value as at 5 April 2015 (if held then) or cost.  From 6 April 2019 this was extended to non-close companies and to gains realised on non-residential UK land and buildings and to gains on 'substantial' interests in property-rich entities. 

An entity is 'UK property-rich' if at least 75% of the value of its assets is represented by interests in UK land (disregarding land that is used in the entity's trade) after deducting liabilities relating to assets other than UK land.

There is no exemption for a gain realised on disposal of a residence owned by a company, even if it is the main residence of a participator. So the common situation of a UK residence owned by an offshore company (to avoid UK inheritance tax), and in the case of 'expensive' dwellings now exposed to the annual tax on enveloped dwellings (ATED), has become far less tax-efficient.

It is worth noting that the benefit of living in a house in the UK may represent a 'capital payment' from a non-resident trust (in the common situation where the company is owned by such a trust), and it is clearly remitted to the UK.

 

Non-resident trusts

Settlors

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) is not subject to capital gains tax on the trust's gains (unlike a settlor who is UK domiciled and resident).  If the settlor became deemed domiciled after 5 April 2017, this continued to apply if the trust was 'created' when the settlor was non-domiciled, 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. These are known as protected trusts.

Before 6 April 2017, the UK resident non-domiciled settlor of a 'settlor-interested' trust was subject to income tax on all of the trust income as it arose.  From 6 April 2017, this only applied to UK income.

 

Tainting a protected trust

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 point, 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 2.25%.

 

Beneficiaries

A UK resident who receives a capital payment from a non-resident trust is deemed to have a capital gain to the extent of the capital gains of the trust ('trust gains') not previously attributed to earlier capital payments.

If the capital payment exceeds the unattributed trust gains to date, the excess capital payment is carried forward to be attributed to any later trust gains. A gain would then be deemed to arise in that later year.  The gains are treated as foreign gains for remittance purposes to non-domiciliaries.

Before 6 April 2008 the linkage between trust gains and capital payments was first in, first out (or FIFO). The trust gain was linked with the earliest previously unattributed capital payment. Since 6 April 2008 it is last in, first out (LIFO) for all beneficiaries in receipt of capital payments.

Trust gains arising after 5 April 2008 that are linked with capital payments prior to 6 April 2008 escape tax if the beneficiary is non-domiciled (even if he is not on the remittance basis) in the year the gain arises in the trust.

Furthermore, trust gains arising before 6 April 2008 that are matched with capital payments made after 5 April 2008 will escape tax if the beneficiary is not domiciled in the year the capital payment is received.

Capital payments to non-UK domiciled beneficiaries in the period 12 March to 5 April 2008 cannot be linked with trust gains arising after 5 April 2008. This increases the chance that a subsequent trust gain will be matched with a post-5.4.08 capital payment.

Trustees of non-resident trusts are able to make an irrevocable re-basing election, which will have the effect of excluding from tax for non-domiciled beneficiaries such part of the gain on a disposal made after 5 April 2008 as had accrued by that date.

The election has to cover gains on all assets held on 6 April 2008 by the trust and on the trustees’ participation in all assets held by non-resident companies that would be 'close' if they were resident, if the trustees' 'participation' – including that of their 'associates' – exceeds 25%.

The election had to have been by made by the 31 January next following the first year after 5 April 2008 that a capital payment is made to a UK resident.

A beneficiary who is only deemed domiciled, and who receives a capital payment from a non-resident trust, is able 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.

Finally, where a trust gain does arise to a UK resident non-domiciled beneficiary, and he is on the remittance basis, he is only taxable to the extent that the capital payment that gives rise to the attributed gain is remitted to the UK. This applies whether the trust gain arose on an offshore asset or a UK asset.

The supplemental charge (which increases the beneficiary’s capital gains tax liability by reference to the delay between the trust gain arising and receipt of the capital payment) is based on the year the capital payment is received, not when it is remitted to the UK by a non-UK domiciled beneficiary.

In essence UK resident non-domiciliaries are taxable on trust gains to the extent that both the trust gains and the capital payments relate to the period after 5 April 2008.

 

Losses on the disposal of overseas assets

It is important to realise that one’s domicile is not affected by the decision not to apply for or accept remittance basis of taxation.

Non-domiciled individuals taxed on the arising basis will have relief for losses on overseas assets. Those non-domiciled who do claim the remittance basis for any year may elect (but only with effect from the first such year) into a regime that enables them to get relief for such losses in the UK in the years they are taxed on the arising basis. The election will be irrevocable and will require disclosure of details of unremitted capital gains.

 

Specific advice should be obtained before taking action, or refraining from taking action, in relation to this summary. If you would like advice or further information, please speak to your usual Shipleys contact.

Copyright © Shipleys LLP 2021

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