This article addresses the changes to taxation for non-UK domiciliaries coming into force on 05 April 2017. Non-doms be aware of these rules: you may become deemed domiciled earlier than you had expected. Knowledge and understanding is paramount to not being unexpectedly caught out by these changes.
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What is the issue?
Fundamentally that UK assets, which may not previously have been subject to Inheritance Tax (IHT) because of the way in which they were held, will now very likely be brought into your estate for IHT purposes.
The number of years spent in the UK before you are deemed domiciled has been reduced from 17 out of 20 years to 15 out of 20 years. In addition, a new category of Formerly Domiciled now exists and extra care is needed if you are relocating to the UK as, if this applies, you can be immediately domiciled.
Certain structures that are involved in the development of UK property will now be subject to UK Corporation Tax on their development profits.
What does it mean for you?
Where UK assets were previously held in an offshore company they were not caught for IHT purposes. This protection will be removed from 6 April 2017 so that UK assets, including property, investments, loans etc., will be subject to IHT on the death of the Settlor as the offshore company will essentially be ‘looked through’ for the purposes of IHT.
The change in the rules means that you may very well become deemed domiciled earlier than you had expected. This will have implications for IHT and on the way in which you are taxed on your worldwide assets and on receipt of benefit from any structures that you may have settled, or even upon receipt of benefit by another beneficiary from a structure that you may have settled.
It is of particular importance to note that the change to the IHT rules will catch not only a UK-based property itself but also any loans related to the purchase, maintenance or repair of UK residential properties whether through a non-UK company or not, as well as collateral which may have been used for these loans. Additionally, individuals deemed UK domiciled will no longer be able to benefit from the remittance basis.
The good news
What will be the impact of the changes on offshore structures?
The impact of these changes will be wide reaching as they affect not only the rules around domicile but also the rules around UK property held in offshore structures.
Impact on residential properties
UK assets held in offshore structures were, broadly speaking, not subject to IHT where they were held in an offshore company which in turn was owned by a trust settled by a non-domiciled individual.
From 6 April this will change and any interest in a close company, partnership or loan will no longer be excluded for IHT if attributable to UK residential property.
From 6 April individuals will be deemed UK domiciled for IHT and CGT from an earlier date i.e. 15 out of 20 years as opposed to 17 out of 20 years. In order to ‘reset’ this you would need to have left the UK for six clear tax years. On becoming deemed domiciled with the Settlor being UK resident, you will be taxable on all income and gains on an arising basis.
After 6 April if the Settlor is formerly domiciled they will become taxable on all income and gains on an arising basis, regardless of the number of years spent in the UK.
Will we see a lot of restructurings and the establishment of new trusts?
In light of the changes around IHT, we are seeing some de-enveloping of property structures, although not ‘a lot’ by any means. The structures that we look after are typically not driven solely by the objective to mitigate IHT exposure and there are many more factors being taken into account such as succession planning, the wider assets held, the consequences (i.e. gain on the property) of de-enveloping, and future plans of the beneficiaries. We are therefore only seeing one or two clients extracting the property from their structures.
More so we are seeing clients strip out some of the gains from the structure to take advantage of them before the changes or restructuring of loans made to purchase UK property are tidied up. The changes are more subtle but there are things that need to be done to ensure that structures are not caught out unexpectedly. This appears to be being done as part of clients’ personal tax restructuring on becoming deemed domiciled.
It should be noted that while the changes are fundamental in the sense that they are very broad, they really only affect a small percentage of our clients given that they relate to those who specifically hold UK residential real estate or those individuals who have been resident in the UK for a long period of time. While there is therefore some movement, typically when our clients review their advice and weigh up their options there has not been the same level of restructuring that perhaps was expected when the changes were first announced.
What is incredibly important is that the client understands their domicile and is aware of how the changes may affect the structure that they created or are able to benefit from. Opening discussions with the tax advisor is essential and those discussions should take place as quickly as possible to determine whether or not individuals may be affected.
What should you do now?
Understand your domicile position.
If you are a non-dom you need to know the rules, particularly if you intend to spend any time in the UK or if you are returning to the UK after establishing a domicile elsewhere. Knowledge and understanding is paramount to not being unexpectedly caught out by these changes.
If you think you will be deemed domiciled when the rules change there is some structuring available to you now. Trusts created by individuals before they are deemed domiciled have certain protections and so you may wish to consider the settlement of a new trust.
You can look to take a distribution of capital from the structure now, to utilise the gains position prior to 6 April. There is a temporary window available to rearrange any ‘mixed funds’.
You may look to de-envelope a property held by an offshore company. This will need to be reviewed on a cost/benefit basis as there may be Capital Gains Tax (CGT) to pay on the transfer, subject to any rebasing provisions; however, on de-envelopment, there will be no further Annual Tax on Enveloped Dwellings (ATED) to pay on the property. This is also a good time to review the structure to reduce ongoing administration costs by streamlining the structure.
The most important thing is to obtain tax advice so that you understand how these changes might apply to you. Even if no restructuring action is recommended, the changes could affect the way in which the beneficiaries or the Settlor are taxed on benefits from trusts if there is a UK link, no matter how small.
Please speak with a member of our team in conjunction with your tax advisor so that we can work together to ensure the smooth running of your structures under the new rules.
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