Non-domiciled individuals who will become deemed domiciled in the UK from 6 April 2017 should seek urgent advice on how the proposed changes will affect them so that appropriate tax planning can be implemented on a timely basis.
Specific advice should be taken on the potential benefits of settling an offshore trust before 6 April 2017. This will be of particular benefit for individuals with assets or cash that are not required to fund living expenses whilst resident in the UK, or that can be set aside for future generations.
Provided the trust is structured and administered correctly, income or gains arising within the trust can be protected from UK taxation whilst the individual is resident in the UK and the assets can pass down to future generations free of UK inheritance tax.
For many non-domiciled individuals who have been resident in the UK for more than 15 years, they may find that, with the right planning, the new rules can place them in a more favourable position than the current rules, since a trust can now be used to shelter income and gains from UK tax without the requirement to pay the remittance basis charge of £90,000 per year.
On Friday 18th August 2016 the government released a further consultation document on the proposed changes to the taxation of non-domiciled individuals first announced at Summer Budget 2015.
It is proposed that, from 6 April 2017, individuals who have been resident in the UK for 15 out of the past 20 tax years will be regarded as ‘deemed domiciled’ for all UK tax purposes from their 16th year of residence, even though they may remain non-UK domiciled under general law.
Part years of residence count towards the 15 year rule, so individuals who have been in the UK for just over 13 years could be caught by these rules.
Under the new rules, a deemed domiciled individual will be liable to UK tax on all overseas and income and gains on an arising basis. The remittance basis of taxation will no longer be available.
For individuals who have already been in the UK for 15 years and will therefore become deemed domiciled as at 6 April 2017, creating an offshore trust is likely to be an effective means of sheltering income and gains from taxation, as well as providing protection from inheritance tax.
However, only assets settled into trust before 6 April 2017 will be protected, so individuals affected by the new rules will need to act fast.
The new proposals introduce the concept of a ‘protected trust’. A trust created before the settlor becomes
deemed domiciled in the UK will have protected status once the settlor becomes deemed domiciled. Whilst protected, the deemed domiciled settlor will not be liable to tax on any overseas income or gains arising within the trust.
The protection will be lost, however, if any property is added to the trust or if a benefit is received by the settlor, his spouse or a minor child after the settlor has become deemed domiciled.
Capital Gains Tax
For capital gains tax purposes, a trust will either be protected or not protected as far as the settlor is concerned. Whilst protected, any gains arising within the trust will not be taxed on the settlor.
Where a trust loses its protection, for example, where a distribution is made to the settlor, his spouse or a minor child, or where further funds are added to the trust after the settlor has become deemed domiciled, any gains arising within the trust become taxable on the settlor.
For deemed domiciled settlors, therefore, there is either complete protection from capital gains tax, or, once protection has been lost, liability to capital gains tax on any trust gains (including gains of underlying companies attributed to the trustees) as they arise. The distribution basis of taxation will only apply to non-settlor beneficiaries.
The tax treatment of a capital distribution made to a non-settlor beneficiary will depend on their residence and domicile status, as under current rules.
If the non-settlor beneficiary is themselves deemed domiciled under the 15 out of 20 year rule, the distribution will be taxable on that beneficiary to the extent it can be matched to untaxed trust gains that have arisen in the past. This is regardless of where the benefits are received.
The capital distribution will also trigger loss of protection for the settlor, who will then be taxable on future gains on an arising basis. Where protection is lost, it would appear that subsequent capital distributions to a non-settlor beneficiary will be matched to any untaxed gains that arose before the trust lost its protection.
Trustees will need to exercise particular care when considering distributions to non-settlor beneficiaries, not only to determine the potential tax implications for the beneficiary, but also to assess the tax impact this may have on the deemed domiciled settlor. Professional advice should be taken before any distribution is made.
Income Tax Treatment
The tax treatment of income will depend on whether it has a UK source or non-UK source.
UK source income arising within a settlor-interested trust will continue to be taxable on the deemed domiciled settlor on an arising basis.
Any overseas income arising within the trust will not be taxed on the settlor whilst the trust is protected.
Once protection is lost, it would appear that distributions will be taxed to the extent that they can be matched with foreign income arising in the trust, although it is still not entirely clear how this will work in practice.
Although many of the details of the new rules are still awaited, it is essential that non-domiciled individuals who have been resident in the UK for more than 15 years (or who are approaching 15 years of residence) take professional advice as soon as possible. They have a unique window of opportunity before 6 April 2017 to carry out tax planning and implement structures in order to mitigate future income, capital gains and inheritance taxes.