A person's domicile status is one of the key connecting factors applied in the UK to determine the tax treatment of an individual. The concept of domicile links a person to a particular territory for the purpose of determining questions of law (including tax law) that apply to him or her. A domicile is different from a person's nationality or place of residence. Under English Law, no-one can be without a domicile.
Different ways one can acquire a domicile
Domicile of origin
Everyone acquires a domicile of origin at birth by reference to his parentage.
Normally, a child takes his father's domicile at the child's date of birth but, if his parents are unmarried, or his father dies before he is born, the child takes his mother's domicile.
A domicile of origin can be replaced with a domicile of dependence or a domicile of choice but is never lost completely.
Domicile of dependency
The domicile of a child under the age of 16 depends on the domicile of the parten from whom they initially acquired their domicile of origin. If the relevant parent acquires a new domicile while the child is under 16, the child's domicile will also change at the same time.
Before 1 january 1974, domicile of dependency applied to married woman who acquired their husband's domicile on marriage and whose domicile changed when their husband's did. This rule is abolished but may still have consequences for women who married on or before 31 December 1973.
Domicile of choice
It is possible to replace a domicile of origin (or dependency) with a domicile of choice and later to replace a domicile of choice with a different domicile of choice.
The key elements for acquiring a domicile of choice are:
- physical presence in the territory concerned and
- an intention to remain there permanently or indefinitely.
If one of the two elements is missing, a new domicile of choice will not be acquired.
For inheritance tax purposes it is possible for a person to be deemed to be domiciled in the UK, regardless of his actual domicile status under the general law.
A person who has been tax resident in the UK for at least 15 out of the preceeding 20 tax years (which run from 6 April to the following 5 April), will be treated as domiciled in the UK. In order to reset the deemed domicile clock, the person would have to become non-resident for at least four complete tax years.
It should be noted that because of the overlap of the tax years and calendar years, a person who has been resident in the UK for just over 15 years could be affected by this deemed domicile rule.
Persons who are domiciled in the UK and then emigrate abroad will remain deemed domiciled in the UK for three calendar years after they acquire a new foreign domicile.
However, from April 2017, anybody who has been resident in the UK for more than 15 of the past 20 tax years will be deemed UK-domiciled for all tax purposes and subject to the same rates of tax on any income.
There are substantial tax advantages for non-doms who become tax resident in the UK.
Non-doms have the choice to either pay tax on their worldwide income and gains as they arise, known as “the arising basis” or alternatively they can elect to pay tax on the “remittance basis”. Under this alternative, they pay tax on their UK income and gains as they arise but only on their foreign income and gains to the extent that they are remitted to the UK.
Non-doms are also able to benefit from Overseas Workday Relief and, when claiming the Remittance Basis, Business Investment Relief. These can represent further significant tax savings.
The ‘non-dom’ tax rules are being significantly changed to ensure that “those who choose to live in the UK for a long time pay taxes here like everybody else”. From April 2017, anybody who has been resident in the UK for more than 15 of the past 20 tax years will be deemed UK-domiciled for all tax purposes and subject to the same rates of tax on any income. As part of this shake up, it will also no longer be possible for somebody who is born in the UK to parents who are UK domiciled to claim non-domicile status if they leave but then return and take up residency in the UK, effectively bringing an end to the current ‘permanent non-domicile’ status.
In addition, from April 2017 the ability for ‘non doms’ to avoid inheritance tax (IHT) by holding their property within an offshore structure is also being removed. This applies to all UK properties owned by a non-dom, regardless of value and whether the property is let or occupied.
However, there is good news on the IHT front, as with effect from April 2017 a ‘family home allowance’ is being introduced. Initially this starts at £100,000 and will increase to £175,000 by April 2020. The aim is that eventually estates with a value of up to £1m will be able to be passed to immediate family without an IHT liability. As with the existing nil rate band of £325,000, any unused allowance can be passed onto a surviving spouse. It should be noted that where the value of the Estate exceeds £2m, there will be a clawback of the allowance.
Some rather complicated new tax rules have been introduced which affect individuals who are non-UK domiciled and which broaden the scope of those who are required to pay UK inheritance tax on their worldwide assets. These will have an impact on anyone who considers themselves to be non-UK domiciled and has either:
- been a resident in the UK for a long time;
- owns a home in the UK through a company registered overseas; or
- was originally born in the UK and has a UK domicile of origin.
The changes will become effective from 6 April 2017, which leaves a small window available for taking mitigating action. Anyone who thinks they may be affected should understand the new rules and their potential implications, so they can take the necessary steps to reduce future tax liabilities where possible.
Who is affected by the new tax rules for non-UK domiciles?
- Impact for long term UK resident non-domiciles
Anyone who has been resident in the UK for 15 out of the past 20 years will not be eligible to be treated as non-domiciled for tax purposes. This means they will no longer be eligible to claim the remittance basis of taxation for income tax and capital gains tax purposes, and assets held overseas will come within the charge to inheritance tax in the UK.
In order to know whether you are caught by these rules where you are uncertain of your UK residence status, it is also necessary to understand and apply the statutory residence test which came into force from 6 April 2013.
Many people who are unaware of this residence test may not appreciate that they have become UK resident over a period of years, and have therefore potentially also become UK domiciled for tax purposes. This may affect individuals who have attended university or boarding school in the UK for certain time periods, and who may be deemed UK domiciled sooner than they expected.
To ascertain the correct position and mitigate the risk of incurring UK tax it may be necessary to:
- Verify tax residence status over the past 20 years;
- Consider the longer term implications of becoming UK domiciled and whether it would be advisable to break UK residence to remain non-UK domiciled;
- Rebase foreign assets to reduce the amount of tax potentially payable in the future. This has strict qualification criteria and requires specialist advice.
- Impact for non-domiciled UK home owners
Currently non-domiciled residents in the UK who own a UK property through an overseas company are excluded from inheritance tax (IHT) charges because shares held by an overseas company are exempt. This will change from 6 April 2017, after which the normal rate of inheritance tax (40%) will apply. If the property is held in trust, trustees could incur an IHT liability every ten years.
If you are non-UK domiciled and own a UK property within an overseas structure, it will be important to review your tax position and potentially restructure the property holding as soon as possible. After April 2017, the cost of restructuring will be higher. The government intends to implement a targeted anti avoidance rule against anyone who tries to mitigate the impact of these new rules and there will be no special tax relief period available.
In addition, special powers are being awarded to HMRC giving them the right to postpone a property sale until any IHT due is paid in full. Other restrictions being implemented include preventing loans between connected parties when determining the value of a property for IHT purposes, and removing the tax relief available on loans unless they are exclusively related to the property in question.
- Impact for those born in the UK with a UK domicile of origin
From 6 April 2017, anyone who was born in the UK and has a UK domicile of origin will be deemed to be UK domiciled for tax purposes when they are living in the UK. This means they can no longer claim the remittance basis of taxation and will also be liable for IHT in the UK at 40% on worldwide assets. This has implications for individuals and also trustees of trusts holding overseas assets on behalf of a settlor, who may or may not be UK domiciled. Given that it may be difficult to ascertain the exact domicile status of a settlor depending on their movements, the tax status of a trust may change from year to year.
Further consultation on tax rules for non-UK domiciled individuals (non-doms) which will impact both UK resident and non-UK resident individuals and their structures was published recently. From April 2017 UK residential properties owned through non-UK companies will be within the scope of UK inheritance tax (IHT). Long term UK resident non-doms will be taxed on worldwide income and gains as they arise (not the remittance basis) with both foreign and UK assets subject to IHT. There is a one year window from 6 April 2017 to tidy so called ‘mixed funds’. In certain circumstances, rebasing of foreign assets to market value on 5 April 2017 is possible and there are special tax rules for non-UK resident trusts established by non-dom settlors. Individuals with UK domicile of origin who were born in the UK, but left and acquired a domicile of choice elsewhere, will have UK domicile of origin for all tax purposes on their return.
The Government’s proposals will affect all UK resident but non-UK domiciled individuals and also non-UK residents holding UK residential property. All of the proposed changes are subject to a consultation period and could be further amended before being implemented.
UK resident non-doms have often found their offshore ‘clean’ capital trapped outside the UK by the application of the current remittance rules. The Government proposes a one year window from 6 April 2017 for the separation of the income, capital gains, and ‘clean’ capital elements of existing non-UK funds into separate accounts to manage future remittances to the UK. To use this facility individuals need to identify the different elements of an offshore account at 6 April 2017.
From April 2017, any non-doms who have been a resident in the UK for more than 15 out of the past 20 tax years, will be deemed domiciled (DD) for all UK tax purposes. Individuals becoming DD in April 2017 should be able to rebase their foreign assets to market value on 5 April 2017. Special rules for non-UK resident trusts established by non-dom settlors will broadly allow for income and capital gains to roll up within such trusts without UK tax charges, so long as there are no additions to the trust, or the settlor and close family members do not receive any income or benefits from the trust.
Revived UK domicile of origin
Individuals with a UK domicile of origin and born in the UK, who have left the UK, will be treated as having a UK domicile for all tax purposes on their return. However, they will not be able to benefit from the rebasing, mixed funds reorganisation and special tax rules for trusts.
UK residential property
In the past non-UK resident individuals and UK resident non-doms (and their trusts) have been able to shield the value of UK residential property from IHT by holding property through a non-UK company. From April 2017 the UK scope of IHT is extended to all UK residential properties that are owned by non-doms, whether the non-doms and any companies that own the properties are resident in the UK or not.
If you are claiming the remittance basis or are a non-dom owning or seeking to acquire UK residential property, these changes could have an impact on you. It is time to take stock of offshore bank accounts and structures and have a clear understanding of the effect of the new rules.