The further consultation on non-dom reforms

Thomas Barker

Janet Pierce

Speed read

Initial draft legislation on some aspects of the proposed non-dom changes, together with some related policy plans have now been published. There is also further consultation on IHT for UK residential property in offshore structures and for business investment relief. Many of the changes are going ahead as planned, but the proposed benefits charge to offshore trusts has been dropped and replaced with reliefs for such structures, effectively enabling pre deemed domicile trusts to now have ‘protected’ status. An interesting one-time relief will also enable non-doms with mixed offshore accounts to ‘clean’ these up and release clean capital to remit to the UK that was otherwise ‘buried’ under subsequent years’ income and gains. A rebasing possibility as at April 2017 is also something of a gift – albeit there are a number of strings attached.

Thomas Barker and Janet Pierce (Charter Tax Consulting) explain the bad news and good news from the latest condoc on non-dom reforms.

Where are we now?

In his Summer 2015 Budget, Chancellor George Osborne announced a raft of reforms to the taxation of non-doms, including a cap on the number of years someone can claim non-dom status in the UK for all tax purposes, and the charge to IHT on UK residential properties held in offshore structures.

With the surprise of the referendum result and the ensuing change of government, we were left to speculate as to whether the reforms would be introduced by the intended date of 6 April 2017, or if they would be shelved for the time being.

On 19 August, a further consultation document was published, along with a summary of responses from the previous Summer 2015 consultation. The government has confirmed its commitment to the reforms, and asks for further comments on the proposed changes. In particular, this further consultation looks at IHT on UK residential property and business investment relief.

What has changed as a result of the previous consultation?

The new announcements confirm a number of points:

The 15/20 deemed domicile rule will be introduced from 6 April 2017, such that individuals will become deemed domiciled for all tax purposes when UK resident for 15 out of 20 years.
Individuals born in the UK with a UK domicile of origin will not be able to claim non-dom status if they return to the UK. There will be a grace period for IHT, but not for other taxes.
The proposed ‘benefits charge’ on distribution from offshore trusts set up by non-doms will not be introduced.
There will be a rebasing of overseas assets for non-doms becoming deemed domiciled as a result of the changes on 5 April 2017.
There will be a one year window for any non-dom in the UK to clean up their mixed accounts and separate them for ease of remittance.
Non-doms with offshore income and gains from structures will be able to exclude such income and gains from charge to UK tax after they become deemed UK domiciled, if certain conditions are met.
The TCGA 1992 s 16ZA foreign losses election will not apply once an individual becomes deemed UK domiciled.

Cleaning up mixed fund accounts

The proposal is to provide all non-doms (not just those becoming deemed domiciled from April 2017) with a chance to clean up their mixed accounts. This one year window from 6 April 2017 will provide many taxpayers with an opportunity to free up funds that were otherwise locked up because of the prohibitive cost of remitting the income and gains in the same account. If the taxpayer separates the income, gains and capital from the mixed account, future remittances will be simpler and cheaper.

Advisers should be aware that the treatment is only available for bank accounts and not for assets bought with mixed funds. However, if the asset is sold, the funds can be separated to make use of the relief. The taxpayer must be able to identify the source of the funds and so detailed analysis of historic bank statements will be needed to provide the best level of service to the client. The importance of this window should not be underestimated by advisers with non-dom clients wishing to bring funds to the UK.

CGT rebasing for deemed domiciliaries

Individuals who become deemed domiciled in the UK in April 2017 as a result of the new 15/20 year test will have the opportunity to rebase directly held foreign assets to their April 2017 market value. There is no requirement for the funds to remain offshore, meaning that if an offshore asset was bought with taxed funds or clean capital, the entire sale proceeds can be remitted without further charge to UK tax.

The consultation document advises that this protection will be available only ‘to those who had paid the remittance basis charge in any year before April 2017’. This means that individuals who did not have sufficient income and gains in prior years to justify the remittance basis charge will not be eligible.

It should be noted that this proposal could be changed as a result of further consultation and that draft legislation is not yet available. However, if clients have offshore assets with a large latent gain but have not paid the remittance basis charge, it could be worth doing so in 2015/16 or 2016/17 if this means a larger CGT charge is eliminated. The protection will not be available to individuals born in the UK with a UK domicile of origin, or to individuals becoming deemed UK domiciled after April 2017.

What are the new proposals for offshore structures?

The ‘benefits rule’ proposals for offshore trusts set up by non-doms have been scrapped – they were proposals that in fact never got off the ground! The planned replacement is a series of rules that in effect create a ‘protected trust’ status, concerning the application of the attribution rules for trusts for both income and capital gains tax purposes, after the taxpayer becomes deemed UK domiciled.

Capital gains tax

Currently, a non-domiciled settlor of an offshore trust is only taxed on gains if they receive a benefit from the trust (TCGA 1992 s 87). When the settlor becomes deemed domiciled, s 87 would no longer apply. Section 86 means they would be taxed on gains in the trust (or attributable to the trust by TCGA 1992 s 13) in the year they arise.

The proposed protection would prevent a s 86 charge on the settlor to the extent that no property is settled in the trust after the settlor becomes deemed domiciled and the settlor (or spouse or minor children) does not receive a benefit from the trust.

Income tax

Currently, foreign income in an offshore trust where the settlor retains an interest is taxable on the settlor under ITTOIA 2005 s 624, but where the remittance basis has been claimed, unremitted income is not charged to tax. Draft legislation would insert ss 628A–C after ITTOIA 2005 s 628. This would provide protection for income in such a trust after the settlor becomes deemed UK domiciled and effectively extend the s 633 provisions to deemed domiciled settlors. As with gains, if the settlor, their spouse or minor children receive a distribution, the protection is not available.

A similar protection will be included for ITA 2007 s 720 to prevent foreign income being taxed on the arising basis, if the offshore structure was created while the transferor was not UK domiciled.

What transitional reliefs are available?

During the previous consultation, scenarios were identified where an unfair charge to tax could arise. Fortunately, it seems as though some transitional provisions will now assist in this respect.

Assets sold during a period of non-residence

If a taxpayer left the UK and sold an overseas asset but returned to the UK within five years, the gain would be chargeable to tax on the remittance basis. If the individual returns to the UK after the rule change and is deemed domiciled, the remittance basis would not be available and the gain would be fully taxable in the UK. There is to be a transitional relief to ensure that this situation will not lead to an additional charge to UK CGT.

Gifts of non-UK property while non-UK domiciled

Protection will be available where a non-domiciled individual gifts non-UK property but dies within seven years of having become deemed UK domiciled.

Individuals who broke the current IHT deemed domicile rule

Under the existing rule (IHTA 1984 s 267), individuals can ‘reset the clock’ for IHT deemed domicile by remaining outside the UK for four tax years. With the new rule being 15 out of 20 years, such individuals will no longer have the protection they did under s 267.

No transitional relief is proposed for such individuals. However, the condoc does confirm that there was no policy intention to lengthen the time it would take to break UK deemed domicile, so being out of the UK for more than four consecutive years would break UK domicile under the new rules.

This is an oddity that could catch many practitioners out in the future, since someone who has broken UK domicile for tax purposes could nevertheless become deemed domiciled again immediately on their return to the UK.

How is IHT going to be charged on UK residential property from April 2017?

Currently, it is relatively easy for a non-dom or offshore trustee to avoid the IHT charges that would otherwise apply in relation to their direct ownership of UK property, by making sure that UK property ownership is through an offshore company.

In particular, a non-dom can own an offshore company which in turn owns a UK property; and, for IHT purposes, what they are considered to own is shares in an offshore company (a non-UK situs asset for IHT purposes), such that the asset may not attract an IHT charge on death, or on the settlement of the shares into trust.

Similarly, an offshore trust can avoid the collection of IHT charges that would otherwise arise on direct ownership of UK property, by owning such property through an offshore company. This can neatly sidestep the ‘ten year charge’ regime (including the exit charge regime) and also the charge on the death of the settlor that could otherwise apply under the gift with reservation of benefit provisions.

The Summer 2015 announcements therefore made it clear that, in relation to residential property, some sort of look-through provisions should be introduced so that these IHT charges cannot be avoided going forward, from April 2017. Note that no changes are proposed in relation to commercial property, only residential property.

How will the charge be implemented?

Draft legislation for the proposed change has been published. The excluded property rules are changed to the extent that the value of what would otherwise be ‘excluded property’ (e.g. shares in an offshore company) is attributable to an interest in land which consists of a dwelling at that time or in the last two years. The effect will be that the value so attributable will not, in fact, then qualify as excluded property.

This is a fairly neat way of giving effect to the Treasury’s plans. However, it does then beg the question as to any debt used to acquire the property. So far, this is not something on which we have draft legislation but the consultation document does make it clear that the treasury is looking at this point. It seems, though, that there is an intention to draw something of a narrow line in terms of what may or may not be allowed as a relevant debt that may be deducted against the value of the dwelling for this purpose.

Worryingly, the consultation document notes that: ‘The government intends that any loans made between connected parties will be disregarded when determining the value of the property which will be chargeable to IHT.’

So, for example, in the classic scenario where an offshore trust owns an offshore company and the offshore company owns UK property, with the offshore company having been funded by the offshore trust, potentially the loan from the trust may be ignored for the purposes of calculating the IHT exposure going forward.

Potentially there could be areas where a double charge may result; for example, if the loan to buy the property is regarded as a UK situs debt.

The consultation document, not satisfied with suggesting the curtailment of related party debt, also goes on to suggest that a targeted anti avoidance rule should be introduced, so that advisors are kept free from temptation.

Hopefully the forthcoming consultation process will, though, be put to good use in enabling the desired changes to be sensibly drafted without creating any risk of double charge or indeed uncertainty.

How will the charge be collected?

While the charging of IHT on UK property held in offshore structures seems like a relatively straightforward idea, the implementing of this proposal is far from simple. How will HMRC know when there has been a death of a beneficial owner of an offshore company holding UK residential property? The question has proved a headache for the treasury.

The proposed way forward for this appears to be additional checks when there is a change of ownership of the property. There may, of course, have been more than one charge to IHT in the intervening time (ten year charges on trust property, gift of shares in a company within seven years of death of the shareholder); and there will be many overseas advisers who will be unaware of the rules. It appears that the onus will be placed on the conveyancer to make all the necessary enquiries to establish whether correct IHT has been paid during the time the property was held in an offshore structure.

However, as something of a belt and braces, there is also a proposal for a new liability to be imposed on ‘any person who has legal ownership of the property, including any directors of the company which holds that property’. This is not something that will be welcome news to the many offshore corporate services providers providing offshore companies to own UK residential property.

How will this affect UK residential property ownership going forward?

The changes realistically mark the end of the use of offshore companies for the ownership of UK residential property in a large number of circumstances. Indeed, why would one want to both pay the ATED charge and now be in the IHT regime?

There was initially some hope of a de-enveloping relief to help encourage taxpayers to unwind from such offshore companies. However, for now it seems that the possibility of de-enveloping relief has been ruled out, subject to any unfair tax consequences being identifiable through consultation.

Of course, some situations may arise where offshore corporate ownership still makes sense, including where the property is let out and also where there may be debt on the property that cannot easily be renegotiated into a new ownership regime.

What are the next steps for business investment relief?

Business investment relief (BIR) has apparently introduced over £1.5bn to the UK economy, and the government wants to extend the scheme by seeking feedback on its operation and scope. In particular, the complexity of the scheme is being considered, so practitioners with experience in this area should use the opportunity to provide insight on the best way to both simplify the administration and encourage further investment.

BIR was, of course, a very welcome relief following the 2008 changes to the remittance basis. However, there are still numerous situations where non-doms are left unable to make UK investments on pain of a penal tax charge. This new Treasury desire to expand the BIR is very welcome indeed.

What should we be doing now?

Practitioners will need to review the situation of all their non-domiciled clients carefully to ensure they are best placed to advise them on the upcoming changes to the rules. There will be competing demands in some situations which will need particular care, such as the individual becoming deemed domiciled who has an offshore trust and wants to provide for his minor children without jeopardising his protection from tax on overseas income and gains.

Of particular importance is ensuring that any time limited opportunities are not missed, such as the mixed account ‘amnesty’, and ensuring that any income or gains in trusts that may be required are distributed prior to the application of the new protections.

Doubtless going forward, the new ‘protected trust’ regime will attract much interest – and potentially a lot of PII claims if the rules are not well understood!

For non-dom clients with UK residential property interests, seemingly there may not be a lot to be done going forward to keep the property interest out of the charge to UK IHT. However, serious consideration should be given to the timing of any ten year charges that may now arise and as to whether any ownership structures should be unravelled.

Advisers should also provide any insight and feedback on the consultation document. The consultation document is available via www.bit.ly/2bJBW0I. Comments are invited until 20 October 2016.

Issue: 1321
Categories: Analysis , Residence , Trusts & estates , CGT , consultation , IHT , investment trusts , non-dom , non-doms , non-doms campaign , offshore evasion , residential property

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