Thought leadership from our experts

Better out than in?

Paul Davidoff, Bircham Dyson Bell, United Kingdom

At the time of writing, we are a few weeks away from a referendum about whether the UK should remain a part of the EU. From a 'private client' standpoint, maintaining that one is not fully 'a part of' the UK has often provided a privileged tax status, notably by being non-UK resident or non-UK domiciled. However, changes have already been introduced and important changes are coming which will reduce or eliminate those tax advantages.

In general, individuals domiciled outside the UK have had only their assets located in the UK subjected to UK inheritance tax (IHT). Those resident outside the UK have also been exempt from capital gains tax (CGT) and have only been subject to income tax (IT) on their UK-source income.

Even those resident in the UK, but domiciled elsewhere, have been able to avoid CGT and IT on their non-UK income and gains, by taking advantage of the 'remittance basis' (RB) of taxation. This suits those with substantial income and capital gains arising outside the UK, as these 'resident non-doms' (RNDs) will not have to pay IT or CGT on those income and gains, or even report such income and gains to H M Revenue & Customs, unless that money is brought into the UK. After 7 years of UK residence, RNDs have to start paying an annual charge to take advantage of the RB, but for some this is a price worth paying for the tax saved and to be able to avoid disclosing all to HMRC.

Already, for many years, a non-UK domiciliary who has been resident in the UK in 17 out of the last 20 tax years (including the year in question) will be 'deemed domiciled' in the UK for IHT purposes. This rule brought that individual's worldwide estate within the scope of IHT.

From 6 April 2017 this is to be reduced to 15 out of the previous 20 tax years and not only in relation to IHT: individuals will be deemed domiciled for IT and CGT too. Consequently, the RB will no longer be available at all for those long-term RNDs, who will, ahead of 6 April 2017, need to review their position: will they make disclosure to HMRC (claiming the benefit of a double-taxation treaty or relief) or will they reorganise their lives so that they cease to be resident in the UK?

Where IHT is an issue, a common solution has been to settle the RND's non-UK assets on trust (so that the settlor may continue to benefit). Whilst not an entirely straightforward arrangement, it has generally achieved its aim of enabling the settlor to benefit whilst keeping the trust's assets outside the scope of IHT, even when the settlor later becomes deemed domiciled. The UK's IT and CGT treatment of such trusts is fiendishly complicated and, again, the rules are expected to change for 'deemed domiciliaries' from 6 April 2017.

Critically, one group has been singled out for 'special treatment': those who were born in the UK and have their 'domicile of origin' in the UK. It may be that an individual was born in the UK with a UK domicile, but later (either through their parents' emigration or through their own relocation as an adult) acquired a 'domicile of choice' elsewhere: if they later return to the UK but intend to return in due course to the place of their new domicile, they will become deemed domiciled for IT and CGT as soon as they are UK resident again (so that the RB will not be available, even for a supplemental charge).

The rules for IHT are expected to be similar, but with the deemed domicile status arising only in the second year of UK residence out of three. This deemed domicile status is different from the ordinary deemed domicile rule for IHT: even if a trust is created of non-UK assets before becoming deemed domiciled, once the settlor becomes deemed domiciled, the trust will immediately fall into the UK's IHT regime for trusts and, if the settlor can benefit from the trust, the trust's assets will also be treated as belonging to the settlor for IHT purposes. This will make it very difficult for this special group of RNDs to keep their non-UK assets outside the scope of IHT, unless they can limit their UK residence to one year in every three.

Indeed, new rules in 2017 are expected to bring all UK residential property within the scope of IHT, regardless of whether they are held directly, through a trust, a company, some other vehicle or combination of any of these and whether or not the owner is UK resident or domiciled.

This is only a part of the British government's recent swathe of changes to prevent perceived tax avoidance by wealthy foreign investors, who are thought by some to have been driving up house prices in London and the South East of England over recent decades by adding UK residential properties to their portfolio, whether as an investment or as a bolt-hole from a less stable home country. We already have (very briefly):

  • the 'annual tax on enveloped dwellings' (ATED) – primarily an annual tax charge on UK residential properties owned by companies – originally for properties of >£2m, but now for >£500k;
  • restriction on the exemption from CGT on the sale of a person's main residence, where that person's or their spouse's/civil partner's tax residence has not been the place where the property is situated and they have spent fewer than 90 days there in a tax year;
  • removal of the exemption from CGT for non-UK residents in relation to disposals of UK residential property (and a requirement to submit a return and pay the CGT within 30 days);
  • retention of the 28% CGT rate for disposals of residential property (even though the general CGT rate has fallen to 20%);
  • application of the 28% CGT rate to companies (instead of the lower corporation tax rate) on disposals of properties to which ATED applies;
  • increase in the Stamp Duty Land Tax (SDLT) rate for companies to 15%;
  • a change in SDLT, so that properties over £937,500 now pay more SDLT (with the highest band being 12% for individuals);
  • a SDLT surcharge of 3% on purchases of additional residential properties (even where the property already owned is outside the UK).

One might begin to wonder whether there will be any tax advantage in being non-UK resident or non-UK domiciled where UK residential property is concerned, or in holding such property in any form of structure. Of course, that is presumably the intention, but there will still be benefits in some situations.

Exactly how 2017 will look, especially the detail of the taxation of offshore trusts and application of IHT to all UK residential property, remains to be seen, but what is certain is that long-term RNDs and those with foreign connections and foreign structures that own UK residential property (whether directly or otherwise) are going to need carefully considered advice and, potentially, a reorganisation of their financial and property affairs, or even a change of tax residence, before 6 April 2017 comes around.