Changes to the tax treatment of non-domiciled individuals and UK residential property
16 September 2016
Who will be affected?
- Investors in UK residential property
- Non-domiciled individuals who will have been resident in the UK for 15 of the last 20 UK tax years from 6 April 2017
- Individuals who have a UK domicile of origin and were born in the UK
- Trusts established by the class of individuals mentioned above
These changes will be effective from 6 April 2017. Save for a lead-in period that will apply in relation to mixed funds during the 2017/18 tax year, there will be no transitional provisions.
UK residential property
All UK residential property (no matter what the ownership structure or use of that property) will fall within the UK inheritance tax ('IHT') regime.Therefore properties held by non-UK resident companies will be caught by these new rules.
This will mean that:
Where an individual is the ultimate beneficial owner of a UK residential property:
- lifetime gifts of assets deriving their value from the underlying property or the property itself could be subject to an IHT charge; and
- on death, the individual's estate could be subject to an IHT charge by reference to the value of that property; and
Where a trust or similar structure is the ultimate legal owner of a UK residential property, the trustees could be subject to IHT charges:
- on a distribution of assets deriving their value from the underlying property or the property itself; and
- on each 10 year anniversary of the trust, by reference to the value of that property.
Certain anti-avoidance measures will be introduced, including those in relation to loans between connected parties which have historically reduced the value of a property for IHT purposes but will not continue to do so after 5 April 2017.Therefore, it will be important to review existing loan arrangements in this context to ensure that all parties are aware how they will be treated for IHT purposes going forward.
When a non-domiciled individual has been resident in the UK for 15 out of the previous 20 UK tax years (although this may be as little as 13 years, taking into account split years of residence), they will be deemed to be domiciled in the UK for all tax purposes, which shall mean that:
- the entirety of their worldwide estate will fall within the IHT regime (there will be no grandfathering for IHT purposes and therefore all assets held prior to 6 April 2017 and continuing to be held will be subject to IHT); and
- they will no longer be able to claim the benefit of the remittance basis.
The Government has proposed that certain individuals falling within this class may be able to benefit from a rebasing of their assets (as at their 6 April 2017 value) as well as the ability to separate mixed funds into their component parts (in relation to which there will be a grace period until 6 April 2018), so as to reduce the UK tax charges that may arise for the individual on these assets going forward. However, the individuals who and assets that will be able to benefit from these provisions will be restricted.
Individuals with a UK domicile of origin
Where an individual has a UK domicile of origin and was born in the UK, whenever they are tax resident in the UK, they shall also be deemed to be domiciled for all tax purposes, with the same results as set out above in relation to non-domiciled individuals.These individuals will not be able to benefit from the provisions relating to rebasing and mixed funds which will be available for non-domiciled individuals.
Where an individual has a UK domicile of origin and was not born in the UK, they will instead fall within the rules relating to non-doms outlined above.
Trusts established by UK resident non-doms
These trusts will fall into 2 different categories:
- the trust has been established prior to 6 April 2017 (and prior to the settlor becoming deemed domiciled for IHT purposes under the existing rules);
- no additions are made to the settlement after 5 April 2017; and
- neither the settlor, their spouse or minor children derive any benefit from the trust,
the trust fund will remain excluded property for IHT purposes and the settlor will not be taxed on foreign income and gains arising in the trust going forward.
The current tax treatment of such trusts shall, however, will continue to apply and:
- if the trust is settlor-interested, the settlor shall continue to be taxed on UK source income as it arises; and
- resident, non-domiciled beneficiaries shall continue to be taxed in the same way on distributions from the trust (albeit that individuals satisfying the 15 out of 20 year test will no longer be able to benefit from the remittance basis in relation to benefits received outside the UK).
If the trust fails any of the tests outlined above, it shall not benefit from a protected status and, as such, the settlor will be subject to UK income and capital gains tax in relation to all income and gains arising in the trust going forward.Trusts established after an individual has become deemed domiciled will fall within the IHT regime, as is currently the case.
It is, however, currently unclear as to whether this tax treatment will permanently apply to such trusts, notwithstanding the settlor's residence/ domicile status.
Trusts established by individuals with a UK domicile of origin
While the settlor of these trusts is deemed to be domiciled in the UK (ie while they are UK tax resident):
- the trusts that they established while they were not deemed to be domiciled and their underlying assets will fall within the IHT regime; and
- they shall be subject to UK income and capital gains tax on all income and gains arising in that trust,
regardless of who can potentially benefit or actually benefits from the trust.
As many more trusts (and the underlying trust assets) will fall within the IHT regime after the introduction of these changes, alongside the IHT charges that trustees may be subject to going forward, while the settlors of those trusts (and/ or their spouses) can potentially benefit from the trust's assets, those assets will also be includable in their estate for IHT purposes.This could result in a double tax charge in relation to the same assets.Where a settlor of the trust has no other connection to the UK (save for, say, some UK residential property that is owned by the trust in question) this issue may be overlooked.
While it is fairly commonplace to exclude the settlor and the spouse from benefitting under UK law governed trusts, it is not in relation to non-UK law trusts.It is therefore possible that some settlements may lose their protected status without the trustees and settlor being aware of this.All foreign-law trusts should therefore be reviewed with this in mind.
Much of the detail of the full extent of these proposals has yet to be provided in the form of draft legislation, the likely publication date of which will be 'later in 2016'. However, there is now sufficient detail to enable individuals and trustees to determine whether they will be caught within the scope of these new rules and, if so, which class of individual or trust they/ it will be. As the window for planning and restructuring is very small, advice should be sought now to enable individuals and trustees to be appraised of the implications of these new rules in relation to their affairs. This will mean that, once the detail of these proposals has been published, individuals and trustees should be able to act swiftly and decisively.
For more information please contact one of the team.