Following a false start, the non-dom and offshore trust changes originally set out in the March 2017 Finance Bill have now been enacted as part of the Finance (No 2) Act 2017.
The changes include the following, all taking effect from 6 April 2017:
A. Deemed domiciled status
- Reduction in the start of deemed domicile status from ‘17 out of 20 years’ to ‘15 out of the previous 20 years’ – this effectively means a non-dom becomes deemed domiciled in their 16th year of UK residence.
- Extension of deemed domicile status to income tax and capital gains tax (previously only relevant for inheritance tax purposes). This means that any individual who is deemed domiciled can no longer access the remittance basis of assessment after 5 April 2017.
- A new ‘formerly domiciled resident’ status takes effect from 6 April 2017 for UK resident non-doms who were born in the UK with a UK domicile of origin. For IHT purposes, the definition refers to an individual who was born in the UK with a UK domicile of origin and who is UK resident for the relevant tax year plus at least one of the two preceding tax years.
- Formerly domiciled residents cannot benefit from any of the offshore trust protections; the capital gains tax rebasing, offshore account cleansing (see below), or the remittance basis of assessment.
- It is confirmed that a capital loss election previously made by a non-dom will fall away once deemed dom status takes effect. This will allow foreign capital losses to be claimed in the normal way if the disposal takes place when the individual is deemed domiciled.
B. Capital gains tax rebasing
- Non-doms who are treated as becoming deemed domiciled on 6 April 2017 may benefit from an uplift in the capital gains tax base cost of their foreign assets to the value on 5 April 2017 where:
- The asset was held by the non-dom on 5 April 2017
- The disposal is on or after 6 April 2017
- The asset was not situated in the UK between 16 March 2016 (or the date of acquisition if later) to 5 April 2017
- The non-dom paid the remittance basis charge for any tax year before 2017/18, and;
- Factual non-dom status continues up to and including the date of the asset’s disposal.
- The rebasing is automatic where the conditions are met but may be disapplied by making an irrevocable election when reporting the disposal. This may prove beneficial if the asset gives rise to a capital loss.
C. Cleansing of mixed offshore accounts
- A non-dom who has previously claimed the remittance basis and who has an offshore account holding mixed funds (income, capital gains, capital) has the opportunity to cleanse the account at any time up to 5 April 2019.
- Cleansing can only apply to money (although it is possible to realise offshore assets and deposit the sale proceeds into the account before the account is cleansed).
- A mixed offshore account can be cleansed only once.
- At the time of cleansing, the non-dom must specify the income and capital in a nomination. The nomination must not exceed the specified description.
Many non-doms will have mixed offshore accounts even where they have tried to operate segregated accounts. This provision allows a valuable one-off opportunity re-establish one or more clean capital offshore accounts from which the non-dom may remit without creating a UK income tax or capital gains tax charge. Unfortunately, there is still uncertainty regarding the mechanics of calculating the underlying funds in the account especially for accounts held in non-sterling currencies. It is hoped that HMRC guidance will be released soon to provide further clarification.
D. Offshore trust protections
- A non-resident trust settled by a non-dom (before he or she becomes deemed dom) and which is regarded as settlor-interested for tax purposes will qualify for certain trust protections as follows:
- Non-dom settlors are no longer taxed on foreign trust income as it arises but instead as and when they receive income from the trust (UK income continues to be taxed on the UK resident settlor when it arises to the trust).
- The settlor is no longer taxed on foreign source trust income paid to his or her minor child (but will continue to be taxed on UK source income paid to the minor child).
- The settlor is not taxed on capital gains as they arise to the trust but as and when they are matched with capital distributions (this continues the existing treatment).
- A UK resident settlor is taxed on income or capital distributions made to his or her spouse, civil partner or minor children if they are either non-UK resident or remittance basis users.
- Non-dom settlors may claim the remittance basis of assessment for distributions from the trust if paid offshore and they are not yet deemed domiciled.
- Inheritance tax protection will continue to apply to foreign held property of the trust settled by a settlor when non-domiciled (before a deemed domicile status takes effect).
It should be noted that all income tax and capital gains tax trust protections will cease if the trust is tainted eg funds are added by the settlor after becoming deemed domiciled) or the settlor takes a factual UK domicile.
- Transfer of assets abroad anti-avoidance legislation:
- Non-dom settlors will no longer be taxed on the foreign income of a non-resident company owned by their offshore trusts as the income arises (but they will continue to be taxed on the UK source income of the non-resident company unless the motive defence applies).
- Capital benefits provided to a settlor of the offshore trust may now be matched with undistributed foreign income not previously assessed on the settlor – previously the settlor was not taxed on the capital benefit if provided out of a source not containing income.
- The transfer of assets abroad charges for transferors will continue as before in respect of foreign companies that are not held by an offshore trust.
E. Wrapped UK residential property held in foreign companies
- UK residential property owned by foreign close companies is now within the scope of inheritance tax for both excluded property trusts and non-dom shareholders if the shareholding is at least 5% (taking into account connected persons).
- If the settlor has retained a benefit, anti-avoidance legislation referred to as ‘gift with reservation of benefit rules’ applies such that the value of the property is treated as forming part of the settlor’s estate for inheritance tax as well as being within the inheritance tax relevant property regime for the trust. This applies to settlors regardless of their domicile status so any settlors in that situation need to carefully consider their options.
- Currently, these provisions only refer to wrapped UK residential property but the latest consultation document issued on 22 November 2017 to extend non-residents capital gains tax to UK commercial property from April 2019 may be an indicator that wrapped UK commercial property is due to receive the same inheritance tax treatment.
In addition to the Finance (No 2) Act 2017 changes, new legislation is due to come into effect from 6 April 2018 as follows:
- Capital distributions made to non-resident beneficiaries will no longer deplete the stockpiled gains pool of the offshore trust.
- Capital payments and distributions provided to the settlor’s close family (spouse, civil partner or minor child) will be taxed on the UK resident settlor if the recipient is either non-UK resident or a remittance basis user.
- Onward gift provisions are to be introduced if distributions or benefits are made to a non-resident beneficiary with the intention to pass it on to a UK resident recipient directly or indirectly. The legislation will essentially treat the distribution to the UK recipient as being made from the offshore trust. UK recipients receiving an onward gift after 5 April 2018 will need to consider the legislation.
And finally, the new ‘requirement to correct’ (RTC) legislation means that any non-disclosure of an offshore interest in tax years up to and including 2015/16 is potentially exposed to penalties of 200% (in some cases up to 300% and 10% of asset values) if not advised to HMRC by 30 September 2018. The harsh penalties mean it is absolutely essential that anyone with an offshore interest ensures that they have been fully compliant and bring any tax irregularities up to date as soon as possible. Even innocent mistakes are potentially liable to these harsh penalties so if there is any doubt whatsoever, individuals and non-resident trustees are recommended to review the tax position as soon as possible.
In addition, HMRC will consult in spring 2018 on extending the assessment time limits for non-deliberate offshore tax non-compliance so that HMRC can always assess at least 12 years of back taxes without needing to establish deliberate non-compliance.
The legislation in this area is extremely complex and we have consultants who specialise in advising non-doms, offshore trusts and individuals with offshore interests – please contact us if you have any concerns or wish to consider your options taking into account the changes and new proposals.