• From April 2017, non-doms will be deemed UK domiciled for all tax purposes after 15 years of UK residence
• The Corporation Tax rate is reducing, but shareholders will lose the 10% dividend tax credit
• Offshore structures holding UK residential property will no longer prevent inheritance tax being charged on the property
• Tax relief available for financial costs on buy to let properties we be restricted to the basic rate of tax
• The pension lifetime allowance has been reduced to £1m and relief tapering has been introduced on the annual allowance for additional rate taxpayers.
We were promised a wide ranging and reforming Summer Budget and we certainly got one. In our view it was a Budget of contradictions; giving to business in the form of corporation tax cuts and taking away from shareholders in the form of income tax rises. Unfortunately, there seems to be little coherence to the underlying taxation policy, particularly when viewed in the context of the last two years of changes to the taxation of UK residential property, non-UK residents and non-doms. Here are our summaries and views on some of the key announcements.
The abolition of non-dom status after 15 years of UK tax residence is a major gamble by the Chancellor; will some of the UK’s wealthiest residents and wealth creators remain in the UK or go elsewhere?
The new “15 out of 20” rule will deem the non-dom as UK resident for all UK tax purposes, meaning that inheritance tax planning to establish excluded property trusts before 17 years of UK tax residence will have to be accelerated in some cases. The detail of the changes will be subject to consultation documents to be published in September and the new regime will have effect from 6 April 2017.
Interestingly, non-doms arriving in the UK will still be taxable on the remittance basis without having to pay the £30,000 Remittance Basis Charge for the first 7 years of tax residence before moving on to the £30,000 charge, increasing to £60,000 after 12 years. Despite what we all thought might happen, the new rule will not affect the children of those non-doms who are deemed domiciled after 15 years in the UK. Therefore, children can retain their non-UK domicile of origin and although they can become deemed domiciled by the age of 15, that won’t prevent them becoming non-dom again in future if they leave the UK for 5 years.
The deadline of April 2017 presents a reasonable window of opportunity for non-doms to restructure their overseas interests and with careful planning we anticipate it should still be possible for non-doms to remain in the UK on a relatively tax efficient basis. It will be essential for non-doms to review their personal, corporate and trust interests overseas to identify the action that will be needed to optimise their tax position by April 2017. In particular, non-doms may gravitate towards structures that don’t deliver taxable income or gains each year such as life assurance wrappers. The major issue is likely to be the restructuring that’s required to ensure funds contributed to a life assurance wrapper are “clean capital”, meaning that the 5% of capital that can be drawn each year won’t include any taxable element. However, there are likely to be a number of options in each case, depending on circumstances.
The new regime will mean major changes are also needed to the taxation regime for overseas trusts and companies, income tax anti-avoidance legislation and IHT, more of which below.
IHT on UK residential property
Aside from the rather modest and phased increase in the nil rate band to soften the IHT blow on the family home, the real headline grabber is the move to “look through” overseas trusts and companies in which non-doms have an interest to ensure that the UK residential property owned within these structures falls victim to IHT.
Very broadly, this means that IHT will be charged when a non-dom who owns shares in a property-owning offshore company dies, or if they die within 7 years of making a gift of the shares.
UK residential property held directly by an offshore trust or within an offshore company held by such a trust will become subject to the relevant property regime for trusts. This means there will be an IHT entry charge when the UK property itself or shares in an offshore company holding the UK property are settled into trust, on each ten year anniversary of the trust and when the property or shares in the company leave the trust. If the non-dom or their spouse retain an interest in a discretionary trust there will also be IHT charges when the non-dom dies, so there is a real danger of “double taxation”.
This is likely to make non-doms think about the alternative of direct ownership of UK property and perhaps insuring against the IHT risk or passing the property down to the next generation. But there may be a price to pay for any restructuring. These costs could come in the form of the ATED-related CGT charge, which applies to growth in property value since April 2013. The government has hinted that it may look at the costs of “de-enveloping” but it remains to be seen whether this will mean a relaxation of CGT charges that would otherwise arise.
Corporation tax and tax on dividends
The good news is that the rate of corporation tax will fall to 19% and eventually to 18%. But before anyone starts celebrating they should consider the new rates of tax for dividends. The government has trumpeted loudly the fact that the rate of income tax won’t be increased in this Parliament but they have been rather quieter about the abolition of the notional tax credit on dividends. Aside from a tax free allowance of £5,000 on dividend income, it means that basic rate taxpayers will pay 7.5% on dividends instead of zero, higher rate taxpayers will pay 32.5% instead of 25% and highest rate tax payers will pay 38.1% instead of 30.55%. If that isn’t a tax increase exactly what is it?
There are two interesting consequences of these changes. Firstly, it will mean that a UK company will pay less in corporation tax on rental profits (19%, falling to 18%) than an offshore company will pay in income tax at the basic rate of 20%. That, combined with the new exposure to IHT on residential property, might encourage some to bring overseas companies onshore by making them UK tax resident. In contrast, offshore companies will be become more attractive as UK shareholders will be taxed at the same rate on their dividends as they would from a UK company.
For UK shareholders the overall combined tax burden of corporation tax and dividends to extract profits for higher rate taxpayers will rise from 40% to over 45% and for highest rate taxpayers it will increase from 44.4% to just under 50%; not a very attractive proposition for business owners.
Buy to let relief
The restriction of tax relief for finance costs to the basic rate of income tax for individuals with buy to let properties will create some real anomalies. For example, a landlord who is a higher rate taxpayer will be taxed on income at their marginal rate of tax but will claim mortgage interest relief at only half that rate. Investments that generate little or no economic profits could therefore produce a tax bill for the owner. The government is, rightly, keen to stamp out artificial tax avoidance but isn’t creating a tax bill where there is no economic profit just the State version of this in reverse?
The lifetime allowance for pension contributions has been reduced from £1.25 million to £1 million.
The reduction will be mitigated by linking the allowance to inflation from 2018. The Chancellor stated this would only affect 4% of the population. However, the reduction must be seen against an increase in the retirement age of 67 and the Government’s push for employees to start contributing into pensions as soon as they begin work.
In addition, a tapered reduction in the amount of annual allowance available to individuals with income (including the value of any pension contributions) of over £150,000, has been introduced.
Currently the annual limit on tax relieved pension contributions is £40,000. From 6 April 2016 the annual allowance will be reduced by £1 for every £2 that the adjusted income exceeds £150,000, up to a maximum reduction of £30,000.
To provide certainty for individuals with lower salaries who may receive higher one off contributions to their employer pensions, a net income threshold of £110,000 will apply.
We have no doubt that there will be many more issues and problems to discover and resolve once the dust has settled on the Summer Budget and we begin to see the real detail behind the changes that have been announced. We will update you with our thoughts once the various consultation documents have been published.
If you would like to discuss any aspects of the Summer Budget please contact a member of the Trident Tax team.