• HMRC issued a consultation document on the reform of non-doms on 19 August
• The document introduces the concept of ‘deemed-domicile’ for income tax and capital gains tax
• There will be no ‘de-enveloping’ amnesty for residential properties owned by companies
• The rebasing of assets at April 2017 will be available in certain circumstances
• There will be an 12 month grace period from April 2017 for the cleansing of mixed funds
After a long wait, further details of the reform to non-dom taxation were finally published by HMRC in a consultation document on 19 August.
The condoc confirmed and clarified a number of points that had been announced previously but it also contained a few surprises. In this article we provide a brief summary of the clarifications that were announced and focus in more depth on 3 key areas: taxation of settlors of offshore trusts, the 12 month window for “cleansing” of mixed funds and rebasing of assets.
The core “15 out of 20” rule for deemed domicile remains unchanged but it has been confirmed that “split years” during which an individual was UK resident for part of a tax year are included in the 15 year count. Despite lobbying, the government has decided that the years of UK residence whilst a child will also count towards the 15 years.
Again, despite lobbying, there has been no retreat from the concept of “boomerang” non-doms (those who were born in the UK with a UK domicile of origin) re-acquiring UK domicile if they become UK resident again in the future. This is disappointing as it is a particularly harsh rule that will catch those who spent a minimal amount of time in the UK as a child.
IHT and residential property
It is also disappointing that there is to be no “de-enveloping amnesty” to allow UK residential properties to be removed from company ownership without an ATED-related capital gains tax charge. The effect of this is that although IHT protection for UK residential property owned via an overseas company will disappear from 6 April 2017, many non-doms will continue to suffer ATED charges as the CGT cost of de-enveloping to avoid the ATED will be unaffordable.
Another important point to be aware of is that the value of UK residential property for IHT purposes will only be reduced by debt from unconnected parties. Therefore, for example, a loan from a trust to a company owned by the trust won’t be effective in mitigating IHT.
Taxation of overseas trusts
It had already been announced that the settlors of excluded property trusts would not be taxed on the retained income and gains of the trust on an arising basis once the settlor became deemed domiciled. Although this was confirmed, the condoc provided a sting in the tail in relation to capital gains tax. If any distributions are made from a “protected” trust to the settlor, their spouse or minor children, the trust will lose its protected status for CGT purposes forever. Interestingly, this means that distributions to grandchildren will not result in a trust losing its protected status.
Although, even a small distribution to a “family member” will expose the settlor to CGT on the gains of the trust on an arising basis for the rest of their life, that won’t be the case for income tax purposes. Instead, a distribution will only result in the distribution itself being taxed on the settlor and there will be no ongoing exposure of the settlor to income tax on an arising basis on the income within the structure.
At this stage it is difficult to see the policy justification for this distinction between CGT and income tax. However, it seems likely to result in trustees exploring the options for dividing funds into separate vehicles, one where gains can arise but no distributions can be made to “family members” during the settlor’s lifetime to avoid exposing the settlor to CGT on gains of the trust. Another vehicle might be used to make distributions, with an investment strategy designed to avoid chargeable gains.
For beneficiaries of trusts who aren’t settlors, HMRC has decided to retain the existing system of matching gains and income of the trust structure to distributions received. The taxation of beneficiaries will be secondary to the taxation of settlors, who will be primarily liable when a family member receives a benefit.
Rebasing of assets
The good news is that individuals who become deemed domiciled in April 2017 will be able to rebase overseas assets to their value at 5 April 2017 for CGT purposes and, potentially, create clean capital that can be brought to the UK via the disposal proceeds. However, it will be critical to establish how the asset being rebased was originally purchased. If it was purchased using income or gains of the non-dom that arose during a period of UK residence, there will be a taxable remittance of the original income or gains when the sales proceeds are brought to the UK.
Whether assets are being sold or not, it will be prudent to obtain valuations at 5 April 2017 of non-listed assets, such as property, to minimise the potential for future arguments over valuation.
Unfortunately, rebasing will not be available to individuals who become deemed domiciled any later than 2017.
Rebasing will also not apply to assets owned by trusts or companies, so careful consideration will need to be given to assets not owned personally.
It has also been confirmed that rebasing will only apply to assets that were outside the UK at the date of the original Budget announcement of non-dom reform, 8 July 2015. This will prevent assets such as valuable paintings being moved out of the UK by 5 April 2017 to achieve an increase in base cost.
Once an individual becomes deemed domiciled and taxable on their worldwide income and gains as they arise, they will of course be able to benefit from any overseas capital losses that arise. However, there will be no relief for CG losses on offshore assets that arose while the individual was taxed on the remittance basis, despite the fact they will be taxed on any remitted gains that arose in the same period.
Cleansing of mixed funds
There was a surprise and very welcome announcement of an effective amnesty on mixed funds. Mixed funds contain a combination of clean capital, income and gains and are the result of failing to segregate these categories of funds on an ongoing basis. Income is always treated as being remitted first to the UK from a mixed fund, followed by gains and finally, clean capital. This maximises the tax liability suffered.
The condoc announced that there will be a 12 month period from April 2017 during which non-doms will have the opportunity to effectively turn back the clock and segregate mixed funds into their constituent parts. This opportunity will be available to all non-doms, not just those who become deemed domiciled at 6 April 2017 and represents a golden opportunity to segregate clean capital that can be brought to the UK free of tax. In our experience, many non-doms have problems with mixed funds and very substantial future tax savings will be achieved if the exercise is undertaken correctly.
The restrictions on mixed fund cleansing are relatively limited. You must be able to identify the composition of the mixed fund but it isn’t yet clear if this means you will need to be able to identify the amounts of both income and gains compared to clean capital. For example, if a specific amount is known to have been inherited (which will be clean capital) but the investment growth can’t be broken down between income and gains, will HMRC accept that if all of the growth is treated as income that the clean capital element can be segregated and brought to the UK free of tax?
Trusts will not benefit directly from the cleansing opportunity in the way that individuals can. However, it may be possible to distribute and re-settle assets in some cases to create separate pools of funds in separate trusts that will provide future tax efficiencies for income, gains and inheritance tax. This form of restructuring will need to be done before 6 April 2017 in all cases and the inheritance tax efficiencies will not apply to settlors who have already been UK tax resident for 17 of the last 20 years and are deemed domiciled for IHT purposes under the existing rules.
Finally, we need to remember that these proposals are still under consultation and much of the draft legislation has still to be published. The condoc itself makes it clear that planning should not be undertaken based on its contents. However, there are clearly elements to these proposals that will not materially change and early preparation will be needed to provide a realistic chance of implementing restructuring ahead of 6 April 2017 in view of the complexities involved.Updated deemed domicile legislation published Last Chance to Act Before the Requirement to Correct Window Finally Slams Shut! HMRC issue guidance on cleansing mixed funds 31 August 2017 – A key date for the diary HMRC tax investigations – the yield dichotomy?