Director Julian Hayden outlines the impact and opportunities of the UK's new tax rules for non-domiciled individuals.
Hear from Julian Hayden: a trustee's perspective
Julian has more than 25 years' experience of wealth structuring and planning in a corporate, private client and funds setting. His international client base includes wealthy individuals, entrepreneurs and families, who trust him with their personal and commercial wealth interests. More >
Draft legislation was published on 5 December 2016 giving further details of the UK government’s proposed changes to the taxation of non-domiciles.
The rules are still in draft and so subject to comment and adjustment but likely to receive Royal Assent in the Summer of 2017 but taking effect from 6 April 2017.
After an eighteen month period of consultation the new certainty for non-doms is welcome. It is clear that the government will now make key changes to the taxation of non-domiciles (“non-doms”).
The changes will affect all non-doms both in their personal capacity, and especially those who are settlors or beneficiaries of offshore structures. They will also affect overseas trustees and non-doms (resident and non resident) owning residential property in the UK.
The Finance Bill also reflects the government’s clear wish to stimulate investment in the UK. It is not all about increasing the tax take from non-doms. The draft legislation offers two main avenues for non-doms to mitigate their future tax liabilities and to encourage investment into and continued dealing with the UK:
- Proposed reform to Business Investment Relief (“BIR”) to encourage investment by non-doms into the UK.
- The other, the principal focus of this note – changes to the taxation of overseas trusts, creating the concept of “protected” trusts providing a major incentive for non-doms to establish and fund overseas trusts.
What are the big changes in the context of overseas trusts and planning around them?
First, non-doms who have been resident for 15 of the previous 20 years will become deemed domiciled for all tax purposes as from 6 April 2017. Broadly, thereafter they will be exposed to UK income tax and capital gains tax on an arising basis without benefit of the remittance system and their worldwide estates will be subject to inheritance tax.
Individuals with a domicile of origin in the UK who had acquired a domicile of choice in another country will effectively be treated as domiciled in the UK for any periods in which they are UK tax resident. This has very significant implications for any non-UK trust or other structure set up while non-UK domiciled.
Previously long-term UK resident non-doms were able to shelter overseas income and gains will face increased tax liabilities on becoming deemed dom after 15 years residence.
A second key feature of the draft legislation is that as from 6 April 2017 overseas structures that currently exclude UK residential property from inheritance tax will no longer be effective for that purpose. From that date, overseas companies holding UK residential property as a defence against IHT will become ineffective for that purpose and could be positively disadvantageous.
The changes were designed to encourage the “de-enveloping” of overseas structures holding UK residential property but unfortunately it seems the government has not been prepared to listen to lobbying for relief from the tax liabilities, particularly perhaps SDLT that can arise from de-enveloping.
Specialist advice is needed immediately for such structures but in considering whether to de-envelope or not, or the extent of any re-organisation regard should be had not just to the taxation implications. Certainly, the economic pros and cons will have to be analysed but so also will any other underlying rationale for the structure and its component parts. These situations need to be looked at on a case by case basis.
But there is good news – there are opportunities
The new rules for the taxation of overseas trusts are a positive incentive for non-doms to establish and fund trusts to hold their overseas assets before becoming deemed dom under the 15/20 rule. The need for review and action is most acute for those who will become deemed dom for all tax purposes on 6 April 2017.
The opportunity is also currently available for individuals who are already deemed domiciled for the limited purposes of UK inheritance tax but who are not yet domiciled in the UK under the general law. They will automatically become fully deemed dom as from 6 April 2017. They would have to find a means of settling assets into trust without incurring an immediate charge to IHT. If they are remittance basis users they may have the opportunity to transfer overseas assets into trust without an immediate liability to capital gains tax. That facility would be lost after becoming fully deemed dom. Any such possible planning would clearly need specialist advice.
The benefits of a protected trust
In one respect the proposed changes for overseas trusts have been improved in the Finance Bill. It now appears that for both overseas income and capital gains there will be no tax charge on a UK resident settlor on an arising basis. Instead, foreign income and gains will be taxed on the foreign domiciled (or deemed-domiciled) settlor only by reference to benefits received by the settlor or their “close family members” who will include spouse, cohabitee and minor children. The definition does not include minor grandchildren.
Further, an overseas trust established by a non-dom settlor will continue to be completely excluded from IHT in respect of its overseas assets and that protection can be extended to any UK situated asset with the sole exception of residential property simply by holding such asset through an overseas company or other entity, converting the asset from UK situs to foreign as the trustees would hold shares in an offshore company rather than the asset itself. The rules for protected trusts are therefore highly attractive. They can not only keep their IHT protection but could be used as gross “roll-up” vehicles for the accumulation of overseas income and gains, except to the extent that benefits are distributed to the settlor or close family members.
Needless to say, careful management will be needed as there will be provisions to end protected status through tainting by the addition of further assets to the trust. Consequently, great care and advice should be taken when considering the transfer of further assets to a protected trust.
Depending on the final detail of the tainting rules there may be planning opportunities, always deferred (or even tax free) subject to taking specialist advice. For example, it may be sensible for a settlor to establish several trusts rather than one. Each would be for different purposes. In a simple case one might be for the long-term roll-up of overseas income and gains, and another might be for assets where there was at least a medium term possibility of drawdown for the settlor or close family members.
Debts – deductible or not for IHT?
One area that will need continued review is the deductibility of debt for IHT. It seems that “connected party debt” will not necessarily be disregarded but that apparent benefit is then reduced through a proposal that “any loans taken out to acquire or maintain a UK dwelling [will be within the scope of] IHT in the hands of the lender”, i.e., the value of the loan will be within the taxable estate of the lender so that non-dom lenders who are connected parties may unexpectedly find themselves subject to IHT on the benefit of the loan. As with other aspects of the draft legislation much will turn on the fine detail and already questions are being raised about the status of loans from connected companies rather than from individuals.
Other areas where overseas structures may assist non-doms
Settlors and beneficiaries will want to review (with their advisers and trustees) any planning opportunities for their existing structures before 6 April 2017.
Additionally, the draft legislation contains at least two other provisions that may be relevant here:
- There are to be transitional rules relating to the separation of mixed capital and income in overseas bank accounts. There will now be a two years period of grace from April 2017 for unscrambling mixed funds. The facility does not apply to trusts but there may be opportunities for overseas distribution of trustee mixed funds to remittance basis user non-doms, so enabling them to take advantage of these rules. Great care would be needed and, of course, advice and it may be there will be further developments in the draft legislation in this area.
- Similarly, there are transitional rules relating to the re-basing of foreign held assets, but only for individual tax payers who will become deemed domiciled under the 15/20 rule in April 2017 and who have paid the remittance basis charge. It will not be available to offshore trusts or companies but query whether there may be similar opportunities for planning through distributions from trusts before April 2017.
Both these possibilities would need specialist advice.
Though the legislation is in draft the new rules now appear to be settled. It is clear the key changes will happen. Action can now be taken ahead of 6 April 2017 but that provides very limited available time for the taking of expert advice, designing and implementing a plan of action. The time required for procedural matters such as opening bank accounts, organising re-financing or appointing liquidators (such as in the de-enveloping of a UK residential property owned by a foreign company where perhaps the need for immediate tax advice is particularly acute) can be significant and urgent planning (and action) is required.
There needs to be immediate liaison between non-dom settlors, beneficiaries and their trustees – and with their respective advisers - not just to mitigate tax positions in the future but also to take positive advantage.
To ask Julian Hayden further questions, please email him at [email protected] or call him on +44 1534 740140.
This briefing is written from the perspective of a trustee and is only intended to provide a general overview of the matters to which it relates. It is not intended as advice and should not be relied on as such.