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UK Budget - potential changes for non-Domiciled Taxpayers

UK Budget - potential changes for non-Domiciled Taxpayers
Ines Zemelman, EA
05 May 2017

UK Budget - potential changes for non-Domiciled Taxpayers

Rumors are flying that the fall budget will place emphasis on reform of the Stamp Duty, and potentially tax relief for pensions as well. It seems that pension tax reform is always the subject of the rumor mill. This year, many expect the government to restrict tax relief for pensions for higher rate taxpayers along with additional rate taxpayers. There has not been significant change for many years, so it remains to be seen if the fall budget will be more or less generous, or will possibly be a complete reform of tax relief for pensions.

A Real Change

All of these rumors have taken the focus from another announcement this past summer. That announcement concerns proposed changes for taxpayers who are not domiciled in the UK. The government has announced that these changes will proceed. The plan to implement these changes was scrapped from the last Spring Finance Bill since there wasn’t sufficient time to analyze the proposal before the election. Unfortunately, this caused taxpayers to remain uncertain about whether the changes would move forward.

It has been confirmed that these changes will go into (back-dated) effect as of the 6th of April, 2017. Some believed the effective date of the changes would be postponed, but since some taxpayers already started to organize their finances in anticipation of these changes the change was back-dated. This avoided putting some taxpayers in a bad tax position relative to others.

Although the government has confirmed that these changes will go into effect, they have not actually been passed as law yet. Given the uncertainty that has surrounded the rules, and the slight majority enjoyed by the government, it is easy to see why taxpayers may choose to wait for the rules to actually be passed into law before taking action.

Taxpayers who choose to wait are disadvantaged if they would like to reap the benefits of the Mixed Fund Cleansing transition relief program. The currently proposed plan only allows this relief through the 5th of April, 2019. So, taxpayers who wait to plan their affairs until they see the final rule will not have as much time available to take advantage of this relief.

Because of this delay in finalizing these tax reforms, it would be appropriate to have the deadline extended one year to the 5th of April, 2020. Some have proposed this, although no action has yet been taken.

Deemed Domiciled --- 15/20 rule

  • Any non-UK domicile individual who has, as of 6 April 2017, lived within the UK a minimum of fifteen years during the last twenty will be considered “Domiciled” for the purposes of inheritance, capital gains, and income tax.
    • Split years under the statutory residence test will be treated as full years of residence.
  • Inheritance Tax - UK tax rules for the inheritance tax have used the “Deemed Domiciled” concept for many years. Taxpayers “Deemed Domiciled” are fully responsible for the inheritance tax in the UK, as opposed to only being liable for tax on their assets in the UK. The rules currently in effect use 17 out of the previous 20 years as the residency requirement.
  • Capital Gains and Income Tax - Taxpayers who are “Deemed Domiciled” can no longer use the option of “Remittance Basis”. What this means is that they will now be responsible for paying UK taxes on their income and gains worldwide. The new rules align the timeframe for “Deemed Domiciled” for the inheritance tax, capital gains tax, and income tax.
     

Non-Domiciliaries who Return - There is a separate plan for taxpayers who are born within the UK, and have a “Domicile of Origin” of the UK, but have a “Domicile of Choice” not in the UK. When these taxpayers return, they are treated as domiciled in the UK as of the date they return.

It is important to note that these taxpayers are not considered “Deemed Domiciled”; rather, they are actually domiciled. Therefore, they are not eligible for relief from the Rebasing of Foreign Assets, Offshore Trusts, or Mixed Fund Cleansing programs described below. It has been suggested by the government that non-domiciliaries who return will have a short grace period with respect to the inheritance tax.

Foreign Assets Rebasing

To provide some tax relief, taxpayers who are considered “Deemed Domiciled” as of the 6th of April, 2017, will be allowed to rebase foreign assets back to their fair market value as of the 5th of April, 2017 assuming they paid a Remittance Basis Charge in the past. So, the tax on capital gains will be imposed on gains starting on this date. This rebasing applies automatically, but, a taxpayer can choose to not rebase particular assets if that benefits them more.

Taxpayers who first have “Deemed Domiciled” status after the 6th of April, 2017 will not be eligible for this relief.

Mixed Funds

Taxpayers without UK domiciled status, who have used remittance basis when filing their taxes previously, will have two years from the 6th of April, 2017 for rearranging their mixed funds within any foreign accounts. Taxpayers will be able to separate the various parts of the account, such as capital gains, income, and invested capital. Any identified “clean capital”, once it is isolated, will be allowed in the UK and not face taxes.

This relief is an opportunity for taxpayers using remittance basis to have access to capital brought into the UK, but without facing taxes. The rules concerning Mixed Fund Cleansing are complex, and they require any offshore account transfers to occur within the same day. Taxpayers may want to wait for the final rule before taking action since they cannot cleanse their accounts incrementally.

Offshore Trusts

These new rules allow offshore trusts to be sheltered from taxes if they were set up before the taxpayer became “Deemed Domiciled”, assuming the trust was not “tainted”. If the trust is tainted, taxes are imposed on the “settlor” on both gains and income.

Trust income is not automatically treated as belonging to a settlor. The rules provide that taxes are imposed when any distribution is paid to the settlor that is matched to trust income. Any distributions of capital to a settlor are matched to accumulated gains.

Additionally, rules to determine the non-cash value of trust benefits are also planned. These rules provide clearer guidance for valuing benefits like use of assets in the trust.

Residential Property & Inheritance Tax

If UK residential property is held (even indirectly) through closely held partnerships or companies overseas, will also be subject to IHT (link above). This is a change from prior classifications that considered this property excluded from inheritance tax.

Ines Zemelman, EA
founder of Taxes for Expats