VIEWPOINT - Non-Domicile & Residence Tax Rules

04 August 2010

Jeffrey Cohen, Partner, Davenport Lyons

As we face another HMRC consultation on possible changes to the tax rules as it affects non-domiciled individuals, I take the opportunity of reviewing the various changes over the last three years. Following on from the pre-budget report of October 2007 the Government introduced new legislation bringing into effect the various proposed amendments to residence and domicile tax rules. These changes were both sweeping and radical.

The main changes can be divided into three areas Residence, Remittance & New Charge and Capital Gains Tax.

Residence – Changing Day into Night

Although there has been no change to the definition of residence, from 6th April 2008 in calculating the 91day and the 183day rule the day of arrival and the day of departure will now be included. The only exception will be if one is in transit, in other words, “airside”. A day is now defined as being in the UK at midnight. This clarifies the position left after the court decision on the Gaynes-Cooper case.

Remittance and Annual Charge

• The new rule applies to practically all forms of income including income from employment, investment and capital gains tax.
• It will be necessary to claim to be charged on the remittance basis. This election can be changed from year to year. However, where unremitted income/gains are less than £1,000 in a year the person will be taxed on the remittance basis automatically.
• If no claim is made to be taxed on the remittance basis then the person will be taxed on their worldwide income. As stated above, although a person can decide from one year to the next to elect for the remittance basis or elect for the charge, care has to be taken that one does not fall foul of the anti-avoidance rules. For example, if a person elects for the remittance basis in one year and the following year he elects not to claim on the remittance basis then, if he remits funds in that following year even though those funds have arisen in the previous year (when he was only paying tax on a remittance basis) then he will also be taxed on those now remitted funds.
• If a person elects to pay on a remittance basis then in addition to paying any tax on the money he remits into the UK there is an additional “penalty” of £30,000 per annum. There are no personal allowances or annual CGT exemption applicable. Because the £30,000, although collected by the tax man, is not treated as tax it is non refundable and cannot be claimed back (unless the particular country allows it) under a double tax treaty.
• An individual can elect for the remittance basis if he is non-domiciled in the UK or non UK ordinary resident, if they have been UK resident for at least 8 out of the last 10 years up to and including the year in which a remittance basis is claimed.

Special points to note:

• If investment income from outside of the UK is used to buy an asset outside of the UK then if that asset is subsequently bought into the UK it will be subject to tax, even possibly depending on the circumstances, on an arising basis.
• When a remittance consists of mixed funds ie mixture of capital and income it will be treated as income first if any. See also below about the changes to CGT.
• On the sale of a non UK asset, if part of the proceeds are remitted to the UK it will no longer be taxed on a pro rata basis but as a full remittance. If there is only gain then the whole lot will be treated as gains.
• Where a gift is made out of non UK income to a relative or a connected party outside of the UK and that party then remits the money to the UK, the donee in the UK will be liable to tax on the remittance basis. The definition of connected party is very wide and will include a trust, people living together whether married or not or whether civil partners or not. Gifts to unconnected parties are not affected by this rule change.

Capital Gains Tax Rule Changes

• If a close company (ie with less than 5 owners and a shareholder with at least 10%) which is situated offshore, makes a gain the gain will be attributed to the owners on an arising basis as far as UK assets are concerned and on a remittance basis with regard to non UK assets if a person has claimed remittance basis. In other words, if a property in the UK is held by an offshore company, then any gain is attributable to the owners of that offshore company. If there is a property abroad which is held by an offshore company which is subsequently disposed of, then any gain brought into the UK will then be taxed on a remittance basis if remittance is claimed ie a person makes the election and fulfils the eligibility mentioned above (basically being non domiciled but resident in the UK for at least 8 out of 10 years).
• The above rules are also extended to cover trusts. If the offshore company (which holds the UK asset) is held by an offshore trust then the gain will be attributable to the Settlor or matched with capital payments made to the beneficiaries and taxed on the remittance basis. The effect of this is also somewhat retrospective. The gain realised through a non UK trust since 5th April 1998 which has not yet been paid out to beneficiaries, will be available to match against capital payments. Not only will this cause difficulty in getting the information but in effect is retrospective taxation and in certain circumstances if there are old gains, it could mean that the rate will be as much as 39% otherwise the rate of capital gains is 28%.
• The capital gains tax rules are applicable to people who are non domiciled in the UK but resident in the UK and subject to the particular points raised above concerning remittance irrespective of whether they have been in the country for any length of time. With regard to the Settlor having attributable gains, that will apply if the Settlor is UK resident when the gains are realised and is able to benefit from the trust. This would include in the case of the discretionary trust if they are potential beneficiaries, if they not beneficiaries the gains will be taxed on other UK resident beneficiaries regardless of whether they are non domiciled or not when they, ie the beneficiaries, receive capital distributions from the trust.
• With regard to non domiciled Settlors they will be taxed on a remittance basis for foreign gains and once again if that is not possible then the gains will be taxed on a distribution from the trust to UK beneficiaries whether or not they are domiciled in the UK. Because of the retrospective nature of the legislation, as stated above, this will include gains made over the lifetime of the trust.
• There are also some incidental changes to the trust and tax rules, for example, that one must notify the Revenue within three months of the setting up of such an offshore trust or 12 months if a person became UK resident after 6th April 2008.

The Future for Tax Planning for Non-Domiciled Individuals

Over the last 2-3 years we have not seen the predicted flood of non-domiciled people going abroad and taking their investments with them. As long as one is careful and plans well one can mitigate the effect of these tax changes

So what should you do now if any of the above affects you?

Although there may be further changes to the new rules nevertheless there are a number of things one can consider:

• Uplift capital value of UK assets e.g. by re-basing
• Changing trust to a settlor interest trust
• Use of double-corporate structures, e.g. use of existing offshore company with say a Cyprus company
• Use of foundation (e.g. Stiftung or Anstalt or a new Jersey Foundation)
• Use of certain insurance bonds

Jeffrey Cohen is a Partner in the Private Client & Wealth Management department at Davenport Lyons. jcohen@davenportlyons.com