Planning for deemed domicile after 15 years

Claire Weeks

Emma-Jane Weider

Speed read

Following changes to the rules in April 2017, non-domiciled individuals who have been tax resident in the UK for 15 out of the preceding 20 tax years are ‘deemed domiciled’ for UK income tax, capital gains tax and inheritance tax purposes. The tax implications of being deemed domiciled can be mitigated by appropriate planning in the preceding tax year(s). The use of offshore trusts is particularly beneficial, provided the trusts are settled and operated in accordance with the strict legislative conditions.

As we start the new calendar year, our thoughts turn to the end of the current tax year and the planning that our clients need to undertake by 6 April 2019.

For the purposes of this article, we focus on UK resident individuals who are non-UK domiciled as a matter of common law (‘res non-doms’ or RNDs), but who will become ‘deemed domiciled’ for UK income tax, capital gains tax (CGT) and inheritance tax (IHT) purposes from the start of the 2019/20 tax year as a result of having been UK tax resident for 15 out of the preceding 20 tax years.

A recap of the common law of domicile

Domicile is a vital element for determining an individual’s liability to UK income tax, CGT and IHT.

As a matter of common law, there are three types of domicile:

Domicile of origin: A domicile of origin is acquired at birth. A child born to married parents during his father’s lifetime will take the domicile of the father at the date of the child’s birth. A child will otherwise take the domicile of the mother at the date of the child’s birth. A domicile of origin can be displaced by a domicile of dependency or choice.
Domicile of choice: To acquire a domicile of choice, an individual must be physically present in a given jurisdiction and have a fixed and settled intention to live there permanently or indefinitely. It is important to note that intention does not depend on the individual’s wishes in respect of his domicile; it is not an intention to acquire a domicile but the intention to reside in a particular territory permanently or indefinitely.
Domicile of dependency: We explain above how a child acquires their domicile of origin from the relevant parent. However, if the domicile of that parent changes while the child is unmarried and under the age of 16 the child will acquire that new domicile as well.

It is only possible to have one domicile at a time and under English law, an individual must always be domiciled somewhere. Strictly speaking, an individual is domiciled in England, Wales, Scotland or Northern Ireland rather than ‘the UK’, although this article refers to ‘UK domicile’ for ease of reference.

We understand that HMRC has recently set up a department to pursue long term UK residents who claim not to have acquired a domicile of choice in the UK. This has resulted in a sharp increase in the number of enquiries received by HMRC on the question of domicile.

An introduction to deemed domicile for tax purposes

For tax purposes, there is a separate concept of deemed domicile. Deemed domicile is only relevant if the individual is actually non-domiciled as a matter of common law; it does not replace the concept or test for actual domicile.

From 6 April 2017, deemed domicile is relevant for income tax, CGT and IHT purposes. Under the new rules, an individual who has a non-UK domicile as a matter of common law is deemed to be UK domiciled once he has been UK tax resident for 15 out of the immediately preceding 20 tax years (ITA 2007 s 835BA(4); IHTA 1984 s 267(1)(b)) (the 15 year rule).

Although the focus of this article is on the 15-year rule, it is worth mentioning the other ways in which an individual can become deemed domiciled for different tax purposes:

For income tax and CGT purposes, this applies to individuals who were born in the UK with a UK domicile of origin, but who subsequently left the UK and acquired a domicile of choice (or dependency) outside the UK. Before returning to the UK when still foreign domiciled, such individuals are defined as a ‘formerly domiciled resident’; and are deemed domiciled in the UK during any period when they are subsequently UK tax resident (ITA 2007 s 835BA(3)).
A similar rule applies for IHT purposes (IHTA 1984 s 267(1)(aa)), but there is a grace period if the individual was not UK resident in either of the preceding two tax years.
For IHT purposes only, an individual who loses their UK domicile will remain deemed domiciled for three calendar years after the change of domicile (IHTA 1984 s 267(1)(a)).
Again, for IHT purposes only, a non-UK domiciled individual with a UK domiciled spouse can elect to be treated as domiciled in the UK (IHTA 1984 s 267ZA).

References to deemed domicile in the remainder of this article are references to the 15-year rule only.

Further detail on the 15-year rule

The start date for acquisition of deemed domicile under the 15-year rule is 6 April in the tax year after the 15 year rule is satisfied.

For example:

There is no requirement that the individual is UK tax resident in year 16.

For IHT purposes only, there is a further requirement that the individual was resident in the UK for at least one of the four preceding tax years (IHTA 1984 s 267(1)(b)(ii)). This is intended as a relieving provision so that an individual who ceases UK tax residence will be outside the scope of IHT in the fifth year of non-residence.

Tax residence is assessed both under the statutory residence test and the old common law rules (for tax years prior to 2013/2014). A tax year for which an individual is UK resident will count in full for the 15-year rule even if the year is a ‘split year’ under the statutory residence test and even if the individual is treated as non-UK resident under the terms of a double tax treaty.

See example 1.

The tax implications of being deemed domiciled

An individual who is non-UK domiciled can choose to be taxed on the ‘remittance basis’ of taxation, such that he is liable to UK tax on UK source income and gains in the normal way, but is only liable to UK tax on foreign income and gains that are ‘remitted’ to the UK (ITA 2007 s 809A). Furthermore, the non-UK estate of a non-UK domiciled individual is (generally speaking) outside the scope of UK IHT (IHTA 1984 s 6).

Once an individual is deemed domiciled under the 15-year rule:

they will be subject to income tax and CGT on the normal arising basis (assuming he is UK tax resident); and
their worldwide estate will be subject to IHT.

Special rules apply to settlements settled by a non-UK domiciled individual who later becomes deemed domiciled, as discussed further below.

The regime for protected settlements

It has always been possible for an individual to settle an ‘excluded property’ settlement. Non-UK situs assets held by the trustees remain outside the scope of IHT, regardless of the settlor’s actual or deemed domicile status (IHTA 1984 s 48).

With the extension of the deemed domicile rules to income tax and CGT, it was also necessary to consider the income tax and CGT regimes applicable to such trusts. In the absence of further reforms, settlors who have become deemed domiciled in the UK under the 15-year rule would have been subject to tax on trust income and gains in the same way as UK domiciliaries. Instead, the government confirmed its intention to allow foreign income and gains realised in non-UK resident trusts settled by a non-domiciliary prior to becoming deemed domiciled under the 15-year rule to roll-up tax free. As a result, so-called ‘protected settlements’ are subject to a tax regime that is considerably more favourable than the regime that applies to non-resident trusts created by UK resident and domiciled individuals (or formerly domiciled residents).

For income tax, UK source income of a settlor interested trust (or a trust subject to the transferor provisions of transfer of assets abroad rules) is attributed to the settlor and taxed on the arising basis. However, these provisions are disapplied for ‘protected foreign-source income’ (ITTOIA 2005 s 628A; ITA 2007 ss 721A and 729A).

For CGT, TCGA 1992 s 86 is disapplied so trust and corporate gains are not attributed to a deemed domiciled settlor.

The above protections will be lost, and the settlor will be taxed in the same way as a UK domiciled settlor, if the trust is ‘tainted’. Tainting occurs if property or income is provided directly or indirectly for the purposes of the settlement by the settlor, or by the trustees of any other settlement of which the settlor is a beneficiary or settlor, at a time when the settlor is domiciled or deemed domiciled in the UK. The provisions on tainting are outside the scope of this article and merit careful consideration in each case. The rules applicable to loans are particularly difficult.

The above protections are also lost if the settlor acquires a common law domicile of choice in the UK.

Avoiding UK domicile

As noted above, the 15-year rule applies regardless of whether the individual is UK tax resident in year 16. As a result, tax residence in tax year 15 (i.e. as little as 15 days in some cases) will trigger deemed domicile from 6 April in the following year (year 16).

This means that an individual who wishes to avoid acquiring deemed domicile status must cease UK tax residence in year 14. In the current tax year, this is relevant to individuals who have been continuously resident since 2005/06.

This is primarily important for UK IHT purposes. From an income and CGT perspective, the domicile status of a non-UK resident individual is irrelevant. However, that non-resident individual will remain within the scope of IHT on his worldwide assets until he has been non-UK tax resident for three consecutive tax years and assuming he remains non-UK tax resident in the fourth year.

Planning for individuals who plan to remain in the UK beyond the 15th year

Segregated accounts

Many non-domiciled individuals who have chosen to be taxed on the remittance basis will have maintained separate accounts. This could include:

a non-UK ‘clean capital’ account for UK expenditure, as well as a UK account for remittances of clean capital;
a non-UK income account for non-UK income arising (including income arising on other accounts); and
a non-UK capital gains account for the sale proceeds of non-UK assets.

Once the individual is deemed domiciled and therefore taxed on the arising basis, there is no benefit to segregating income or capital gains going forward. These can therefore be paid into the clean capital account (together with any income or gains already in the UK). However, it is very important that existing remittance basis income and gains are not remitted to the UK in order to avoid a tax charge on such a remittance. The existing accounts must therefore be managed in the same way as before deemed domicile; e.g. by avoiding UK situs investments. See the box below.

The process of opening new accounts can take several months and should be started as soon as possible.

Acceleration of income receipts and capital gains

As income arising in year 15 will be taxed on the remittance basis, but income in year 16 will be taxed on the arising basis, it may be worth accelerating income receipts that would otherwise fall due in year 16. For example, if the individual has interests in privately held companies, it may be possible for dividends to be paid early. Interests in non-reporting funds could be sold early to generate the offshore income gain.

The client may also wish to consider rebasing; i.e. the sale of personally held assets standing at a gain so that the gain is eligible for the remittance basis. If the client wishes to reacquire the assets, care must be taken with the ‘bed and breakfasting’ rules.

For completeness, we note that the transitional rebasing rules included in F(No. 2)A 2017 were only available to individuals who became deemed domiciled for CGT purposes on 6 April 2017.

Review investment strategy

Once the individual is deemed domiciled, UK and non-UK source income and gains will be taxed in the same way. The client may therefore wish to use this as an opportunity to invest in the UK, taking care to avoid remittances of existing income and gains taxed on the remittance basis.

The client’s investment strategy should be reviewed to maximise the use of allowances and reliefs (e.g. entrepreneur’s relief and investor’s relief for CGT and business property relief and agricultural property relief for IHT). Some clients may also want to consider tax deferral products like investment bonds and pensions.

Estate planning

A gift of a foreign situs asset whilst an individual is non-UK domiciled is a gift of excluded property and is therefore not a potentially exempt transfer. Where appropriate, clients may wish to consider making gifts before they become deemed domiciled. Careful consideration must be given to the gift with reservation of benefit (GROB) and pre-owned asset tax (POAT) rules in all cases. Such a gift would also rebase the value of the asset for CGT purposes (with the exception of gifts between spouses) and care must be taken where the donee is a relevant person for the donor to ensure that the resulting gain is not remitted. See example 2.

Non-resident companies

Consideration should be given to equity and debt interests in non-resident companies where the ‘look-through’ provisions in TCGA 1992 s 13 and the transfer of assets abroad rules may apply. Unlike the position for settlements, there are no special rules for such personally owned companies.

Planning with trusts

New trusts

Prior to 6 April 2017, it was common planning for an individual approaching deemed domicile for IHT purposes to settle an excluded property trust to shelter non-UK assets from IHT. These benefits remain, but now with the added advantages of the ‘protected settlements regime’ for income tax and CGT purposes.

Counterintuitively, the position under the new rules may actually be better for some non-domiciliaries who take advantage of this regime. Income and gains will roll-up free of tax, but without the necessity to pay the remittance basis charge of up to £90,000.

Careful planning will be required to ensure that settlements are not ‘tainted’. Loans to trustees (and underlying companies) will be particularly problematic. See example 3.

Existing trusts

The trustees may wish to consider accelerating income payments or capital payments to beneficiaries who are becoming deemed domiciled so that these payments are taxed on the remittance basis, rather than the arising basis. There is a potential trap for the unwary in circumstances where capital payments are not matched to income or gains at the time they are made. In this case, gains arising once the beneficiary is deemed domiciled may be matched to the historic benefits (so-called ‘back-matching’) without the benefit of the remittance basis, resulting in an immediate tax charge. Trustees should therefore consider whether historic capital payments were matched at the time they were made.

Once the settlor is deemed domiciled, the settlement may qualify as a protected settlement, provided the trust is not tainted. For these purposes, it will be particularly important to review existing loan arrangements.

Where tainting is unavoidable, the trustees may wish to consider excluding the settlor and his spouse from benefit in order to prevent the automatic attribution of income to the settlor. For CGT purposes, it would also be necessary to exclude the settlor’s children and grandchildren.

Alternatively, some settlors may prefer for the trust to be brought ‘onshore’ with the appointment of UK resident trustees. Such a UK resident trust will continue to benefit from excluded property status for IHT, but the trustees rather than the settlor will be subject to income tax and CGT on trust income and gains.

And finally… Do not forget the importance of common law domicile

As a final point, which really goes without saying, it is vital that an individual who is deemed domiciled for tax purposes does not lose sight of the continuing importance of his domicile as a matter of the common law. This is particularly important for protected settlements that only qualify for this special tax status if the settlor remains non-UK domiciled as a matter of the common law.

Issue: 1426
Categories: Analysis , CGT , IHT , Private client taxes , Trusts & estates , domicile , non-resident , tax planning

Collective insanity: the problem with offshore income gains

20 questions: The reforms to the taxation of non-UK domiciliaries