The proposals announced as part of Summer Budget 2015 are the latest in a proliferation of rule changes affecting the taxation of non-domiciled individuals in the UK. The key changes will be subject to consultation from the end of the summer and the final details will therefore only be known as we approach implementation on 6 April 2017. In the meantime though, it is worth reflecting on the recent evolution of the non-dom regime and what it says about the new direction of travel, including the types of planning that are likely to work in the future. What is clear is that non-dom taxation is only likely to become increasingly complex and less favourable.

Domicile
As a reminder, three categories of domicile are recognised under general law: domicile of origin, which one inherits in most cases from one’s father at birth; domicile of choice, by which one acquires a new domicile on the basis of presence in a country and an intention to remain there permanently or indefinitely; and domicile of dependence, which is now of primary relevance for children under 16 and women who married before January 1974. Domicile of origin revives if a domicile of choice or dependence is lost.

There is a fourth category of domicile – deemed domicile – which under current rules attaches to those resident in the UK for 17 of the last 20 tax years despite that they are not domiciled under general law. Deemed domicile is currently relevant for inheritance tax purposes only.

Timeline

Pre-tax year 2007/8

Prior to Finance Act 2008, UK resident non-domiciled individuals (RNDs) were not subject to tax on income or gains arising overseas to the extent they were not remitted to the UK. This remittance basis of taxation was automatic.

2008/9

From 6 April 2008, in order to continue to benefit from the remittance basis of taxation, RNDs who have been resident in the UK in at least 7 of the previous 9 tax years are required to pay a remittance basis charge (RBC) of £30,000 in respect of each tax year for which the remittance basis is elected.

2012/13

The RBC is increased for longer-term UK residents. A new £50,000 charge is introduced for claimants who have been resident in the UK in at least 12 out of the previous 14 tax years.

2015/16

The remittance basis charge for longer-term RNDs is increased to £60,000 p.a. if resident in the UK for 12 of the last 14 years and a new £90,000 RBC applies if resident for more than 17 years out of the last 20.

2017/18

Further restrictions on the availability of the remittance basis of taxation are set to apply and as part of the reforms the £90,000 remittance basis charge will become redundant.

The New 15/20 Deemed-Domicile Rule (15/20 Rule)

The intention is that from 6 April 2017, RNDs who have been resident in the UK for more than 15 of the last 20 tax years will be deemed domiciled for all UK taxes and will no longer be eligible for the remittance basis of taxation. As a result, income and gains will be taxable as and when they arise and regardless of whether they are brought to the UK or not, and the resident’s worldwide estate will be within the scope of inheritance tax. The reforms stop short of abolishing inherited non-dom status with the effect that children’s domicile status under general law will be determined in light of the existing rules.

A significant amount of tax may now be due. For example, while an RND who has been in the UK for 18 years can expect to pay £90,000 in respect of this tax year to shelter, say, £1,500,000 worth of foreign income and gains, from 2017/18 he will pay up to £505,000 in tax (but no RBC) in respect of the same sum.

*Assumes that allowances have been exhausted and that tax applies at the highest marginal rate.

What of individuals who, having legitimately sheltered foreign income and gains overseas under the remittance basis, are now taxable on an arising basis under the new 15/20 Rule? Will all foreign income and gains be taxable in year 16? This would seem unlikely as the arising basis by definition should only tax income and gains arising in the current tax year. However, it also appears unlikely that such foreign income and gains will automatically become clean capital and therefore capable of remittance without further tax. Even under the current regime, a taxpayer who moves from the remittance basis to the arising basis will still be taxable on as yet untaxed foreign income and gains if there is a remittance to the UK. Clients and advisers will need to think carefully about how to plan for the abolition of permanent non-domicile status.

The Returning Dom

Individuals with domicile of origin who acquire foreign domicile of choice and subsequently return to the UK with that foreign domicile (Returning Doms) are to be treated differently. They will be taxed as UK domiciled if they return to live in the UK, regardless of their actual intentions and regardless of when they returned.

Departures

At present, domicile under general law is lost after three calendar years following acquisition of a foreign domicile, while deemed-domicile is lost once a person has been non-UK tax resident for more than three tax years. The proposals set a new 5 tax year test for loss of domicile under the 15/20 Rule.

Returning Doms are subject to more complicated provisions, which are made worse by contradictory HMRC Technical Guidance. It is likely that they can use the same 5 tax year test but that if they have also revived their UK domicile under general law then they must also satisfy the 3 calendar year test. If they are neither domiciled under general law nor under the 15/20 Rule then domicile can be lost in the tax year following departure.

The New Trust Landscape

Changes are to apply to the taxation of trusts set up by RNDs. Such trusts have traditionally been used by non UK deemed-domiciled clients to mitigate potential UK inheritance tax as foreign situated assets which are settled while non-domiciled remain exempt from the tax even if the settlor is a beneficiary of the trust and becomes deemed domiciled at a later date.

The proposals distinguish between RNDs arriving in the UK (Arriving RNDs) and Returning Doms. In a positive change, to apply from 2017/18, Arriving RNDs will no longer be taxed on any income and gains within the trust even if they do not elect, or are no longer eligible to be taxed on, the remittance basis. However, any underlying structure that ultimately invests in UK residential property is no longer expected to be exempt from inheritance tax and any distributions received by the Arriving RND may be subject to UK tax unless they are still able to use the remittance basis of taxation. For Arriving RNDs who are deemed domiciled under the 15/20 Rule any trust income distributed will be taxed at rates of up to 45% and any capital gains which have been retained in the trust and distributed in later years will be subject to the s87 TCGA 1992 supplementary charge with a potential liability of up to 44.8%.

The Returning Dom will no longer benefit from any favorable tax treatment (IHT or otherwise) in respect of settlor-interested trusts settled at any time whilst non-domiciled. The following example compares the current situation, which allows eligible individuals to use the remittance basis, with the position under the new 15/20 Rule and the rule for Returning Doms. It assumes an excluded property trust has been set up, which includes bankable assets of £10m, income of £500,000 and annualised gains of £1,000,000.

*Assumes that allowances have been exhausted and that tax applies at the highest marginal rate.

 
How could a life policy help?

A UK-compliant life policy issued from Lombard International Assurance S.A. allows income and gains on linked investments to accumulate without the burden of tax (other than tax withheld at source which can often be reclaimed under Luxembourg’s network of tax treaties). Given that growth on the assets arises to the insurer rather than to the UK resident, there is often no need to use the remittance basis or pay the associated charges, on the basis that there are no other, or there are de minimis, foreign income and gains. Policyholders are also spared the significant administrative complexity of retaining multiple segregated accounts abroad. Clean capital policies can also be given as security for loans into the UK provided the facility is not serviced or repaid out of foreign untaxed funds.

A life policy, being a non-income producing asset, can ensure that there are no taxable sums arising in the trust and, as a result, no income or capital gains tax charge for the non-remittance basis user.  Withdrawals of up to 5% of the premium paid can be taken each policy year and if the policy is funded with clean capital it may be possible for the trustees to advance these sums as capital to beneficiaries.

For a Returning Dom, trust assets may be distributed before taking up UK residency with no UK tax liability. Clean capital proceeds can then be invested directly in a life policy to enable ongoing tax deferral and tax efficient withdrawals of up to 5% per annum. Alternatively, as inheritance planning will now be paramount, clients may wish to invest in a discounted gift trust, such as the Lombard International Assurance Wealth Preservation Trust, so as to achieve:

An immediate reduction in the potential IHT liability on death by virtue of the discounted gift into trust.
An initial Investment free of UK inheritance tax for the settlor after seven years
Investment growth that is outside the settlor’s inheritance tax estate from day one
Tax efficient regular withdrawals to be used as ‘income’
Withdrawals of up to 5% p.a. of the original investment amount, cumulatively, up to a maximum of 100% of the original investment, without any immediate income tax charge
Simplified reporting requirements given that only chargeable event gains need be included in the return
The non-dom tax regime is entering another period of substantial change and while not all of the alterations are yet known the overall trend is quite clear. We have seen that there is scope for increases in the remittance basis charge, and we can no longer rule out the possibility of future decreases in the number of years for which non-dom status can be retained. Clients and advisers will now be considering their options and for some a life policy could be attractive.

We can help you find the best solution even in the most complex financial situation, please contact Simon Gorbutt, Steve Sayer  or your usual Lombard International Assurance representative for more info.