Reforms to the taxation of non-domiciles: The extension of deemed-domicile status

The past year has provided much uncertainty and upheaval for those who have moved to the UK from abroad and become resident here.  The vote in favour of leaving the European Union has led many EU and other migrants to question their future in the UK.  The personal tax arena has been no less turbulent.  Shock proposals were announced in the Summer Budget 2015 to remove and restrain many of the reliefs enjoyed by “non-doms” resident in the UK.  A first consultation in September 2015 was followed by a further consultation published in August 2016. The further consultation confirms many of the Government’s intentions with regard to “deemed-domicile” status and it is clear that many of the original proposals will go ahead despite clear opposition from those who responded to the first consultation.

This article will focus on the position of the resident “non-dom” and the extension of deemed-domicile status but we will first take a look at what these terms mean and the current position.

How would you describe residency?

Residence is a term that governs a person’s liability to income tax and capital gains tax.  If a person is resident in the UK for a given tax year, they will be liable to income tax and capital gains tax on their worldwide income and gains (unless they claim the remittance basis).  A person’s residence status for a given tax year will depend on the test in force for that tax year.  From April 2013 onwards, residence has been tested by the statutory residence test.  This broadly consists of three separate tests being:

1. The automatic overseas test;
2. The automatic UK test; and
3. The sufficient ties test.

If a person meets the automatic overseas test they will not be resident in the UK for income and capital gains tax and they do not need to consider the other two tests.  An individual must first consider whether or not they have spent more than 183 days in the UK in that tax year.  If they have, they will be resident for income tax and capital gains purposes.  If they have not spent as many as 183 days in the UK, the automatic overseas test consists of three questions.  An individual will meet the automatic overseas test if:

1. They were resident in the UK for one or more of the three tax years preceding the tax year and they have spent fewer than 16 days in the UK in that tax year;
2. They were resident in the UK for none of the three tax years preceding the tax year and they spend fewer than 46 days in the UK in that tax year; or
3. They work full time overseas in the tax year without any significant breaks and spend fewer than 91 days in the UK in the tax year and work in the UK for less than 31 days in the tax year (days of work being defined as more than three hours per day).

If an individual cannot meet the automatic overseas test, they will need to see if they meet any of the automatic UK tests.  If they do, they will be UK resident for that tax year. These are:

1. The individual spends 183 days or more in the UK in the tax year;
2. The individual has a home in the UK and spends at least 91 consecutive days at that home, at least 30 days of which fall in the tax year.  This will apply if the individual either has no overseas home or has an overseas home (or homes) but stays there on fewer than 30 days in the tax year; or
3. An individual works full time in the UK for any period of 365 days with no significant break and all or part of the 365 day period falls within the tax year.

If an individual does not meet either the automatic overseas test or the automatic UK test, their ‘ties’ to the UK will be tested to determine their residence status.  The number of ties that an individual has to the UK, defined within the test,  and whether or not they have been resident in one or more of the three preceding tax years, will determine how many days an individual can spend in the UK in a tax year without becoming resident.  A day means being present in the UK at midnight.

What is a domicile?

The term domicile relates, in the tax context, to inheritance tax.  An individual’s domicile of origin is inherited from their father or, if their parents were not married at the date of the individual’s birth, from their mother.  If a person’s parents move to another country accompanied by their child while the child is under the age of 16 and acquire a new domicile of choice, that child will take on the same new domicile as their parents known as a domicile of dependency.  An individual can acquire a new domicile of choice if they take up residency in a different jurisdiction with a settled intention to remain in that jurisdiction for their lifetime and sever their ties with the country of their domicile of origin.

An English, Welsh, Scottish or Northern Irish domiciled individual will be liable to UK inheritance tax on their worldwide estate.  Currently, an individual will be “deemed-domiciled” for inheritance tax purposes if they have been resident in the UK, as defined above, for 17 out of the last 20 tax years (although the position is different for those who are domiciled in countries with which the UK has Estate Duty Double Taxation Treaties such as India).  For these purposes, a tax year includes the year of arrival and departure, so it is possible to acquire a deemed-domicile after just 15 whole tax years if an individual arrived in the UK shortly before the beginning of a tax year and remains in the UK just over 15 years later.

Those individuals who are UK resident but not UK domiciled have, until recently, enjoyed a number of tax advantages.  An individual who is UK resident but non-domiciled will pay UK inheritance tax only on their immovable assets in the UK.  This includes land and property.  Their worldwide assets will not be caught by the UK inheritance tax net.  Moreover, such individuals can claim the remittance basis for their overseas income and gains.  This means that they are only taxed on their overseas income and gains to the extent that these are remitted to the UK.  However, for those who have been resident for seven out of nine tax years or more, a charge is payable for the enjoyment of this privilege at a level of £30,000 per year increasing to £60,000 for those who have been resident for 12 out of 14 tax years and £90,000 for those that have been resident for 17 out of 20 tax years.

The proposed changes

The Summer Budget of 2015 threatened to take away many of these advantages. In particular, the Government proposed that individuals will be deemed-domiciled for all taxes (inheritance tax, capital gains tax and income tax) if they have been resident in the UK for 15 of the last 20 tax years including years spent in the UK as a child.  This represents a significant change, particularly for income tax and capital gains tax for which the remittance basis had been available indefinitely while the non-domiciled individual was resident, subject to the large annual charges set out above. Individuals will not be able to use the remittance basis after they have been resident for 15 of the last 20 tax years and the £90,000 annual charge will be redundant. The recent consultation document has now confirmed the changes to deemed-domicile status that will be introduced from April 2017.  The Government also further consulted on the introduction of inheritance tax on UK residential property held by offshore structures such as companies and trusts and the impact of the deemed-domicile rules on non-resident trusts but these aspects will not be considered in this article.

The Government has confirmed the following major points:

1. Years spent in the UK as a minor will contribute towards deemed-domicile status.Many of the responses to the previous consultation had criticised the inclusion of years spent in the UK while under the age of 18 in the calculation of deemed-domicile.  The Government concluded that it was unfair for those who had been resident in the UK as a minor to enjoy non-domiciled status well into their 30s and has made no change to this proposal.
2. The number of years of non-residence required to lose deemed-domicile status for inheritance tax purposes will not increase as a result of the change.The amount of time that it takes to lose deemed-domicile status for inheritance tax purposes will not increase under the new rules to six consecutive years as had been assumed. Instead, deemed-domicile status will fall away for inheritance tax purposes for individuals who have been non-resident for more than four consecutive years.  This time frame will also apply to those who have elected to be treated as deemed-domiciled under the spousal election (which maintains the existing treatment).This creates a mismatch between the inheritance tax position and the income and capital gains tax position, as an individual will not be liable to income tax and capital gains tax on their worldwide income and gains while they are non-resident even when they are deemed-domiciled.
3. Those who become deemed-domiciled in April 2017 will be able to rebase their directly held foreign assets for capital gains tax to that date.This is a welcome relief for those who will become subject to capital gains tax on their overseas assets. However, this relief will only be available to those who have paid the remittance basis charge in any years prior to April 2017 and will not be offered to those who those who become deemed-domiciled in the tax years after April 2017 or those who were born with a UK domicile of origin.  The measure will also only be available to assets which were situated abroad when the Summer Budget 2015 was announced.
4. Residence will be tested using the rules in place for the year in question.
   This means that for tax years prior to 2013/14, the individual will need to use the test in force at the time to determine whether or not they were resident in that year.  They cannot rely on a statutory residence test for the whole period.
5. Split years will not be disregarded for the purpose of calculating whether or not an individual is deemed-domiciled.
   Responses to the first consultation had pointed out that including years where an individual has been able to claim split year status under the statutory residence test could mean that an individual becomes deemed-domiciled for all taxes after 13 full tax years if they arrived late in a tax year.  The Government has dismissed the suggestion that split years should be disregarded.  An individual will either be resident or non-resident for the whole year for the purpose of the calculation.The consultation paper gives an example of how this will work in practice. An individual who leaves the UK in their 15th year of residence can claim split year treatment under the statutory residence test for income and capital gains tax purposes for that year. However, in year 16, they will be deemed-domiciled for all taxes although while they are non-resident they will not be liable to UK income or capital gains tax (except on UK source income and UK residential property). However, as it will take four consecutive years to lose deemed-domiciled status for inheritance tax purposes (see 2 above), if the individual dies or makes a chargeable transfer in that year, inheritance tax may arise.
6. Retrospective rules
   The rules will not be retrospective for capital gains tax for individuals who realised gains during a period of non-residence before the Summer Budget 2015 who now find that they are deemed-domiciled for all taxes under the new rules.However, there will be no protection for inheritance tax purposes for those who left the UK before they became deemed-domiciled under the current rules and then return to the UK except for those who transferred non-UK property whilst non-domiciled and then die deemed-domiciled.  These transactions will be outside of the inheritance tax charge.
7. Those who are deemed-domiciled will lose the £2,000 de minimis for income and gains.Non-domiciled individuals who have less than £2,000 of unremitted foreign income and gains in a tax year do not have to claim the remittance basis. This will be retained for non-domiciles but will be lost by deemed-domiciles. However, deemed-domiciles will be able to use their personal savings allowance against their foreign source income (£500 for higher rate tax payers and £1000 for lower rate tax payers).
8. Those born in the UK with a UK domicile of origin will be deemed-domiciled for all taxes if they return to the UK after acquiring a different domicile of choice (even if they left during childhood), as originally proposed.
   The Government has not changed its position on this.  However, it will introduce a grace period of two years’ residence for inheritance tax only whereby the individual will not be deemed-domiciled for inheritance tax in this period.  For income tax and capital gains tax, such individuals will be automatically deemed-domiciled and will not be able to use the remittance basis but this treatment will not apply to non-resident trusts that were set up by such individuals while they were non-domiciled.If you would like to further dicuss any of the information detailed above, please contact Solicitor, Sarah Nettleship, from our Private Client Deepartment on 01892 701349 or at sarah.nettleship@ts-p.co.uk.