Reforms to the tax rules for non-domiciled individuals from 6 April 2017: Finance Bill update

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Summary: On the 5th December 2016, the government provided some much needed clarity on the changes to the tax rules for non-doms, in particular on how offshore trusts will be taxed, which will take effect in April 2017. Non-doms can now finally start planning for the changes.

Key points:

  • Protections confirmed for offshore trusts set up before a non-dom becomes UK deemed domiciled – but no protections for directly held offshore companies
  • Beware loans between connected trusts – they could result in a UK deemed domiciled settlor being taxed on all the UK and non-UK income and all the gains of the recipient trust
  • Positive steps can be taken before 6 April 2017
  • Period for segregating mixed offshore bank accounts extended to two tax years
  • Rebasing not extended to non-doms who will become UK deemed domiciled after 6 April 2017 or to asset held in trust – but assets acquired between now and 5 April 2017 could qualify
  • Inheritance tax (IHT) charge on UK residential property extended to loans made to acquire, maintain or enhance UK residential property 

With the publication of the draft Finance Bill and the government’s responses to the August 2016 consultation we now know:

Taxation of offshore trusts set up by non-doms before becoming UK deemed domiciled

A non-dom who is UK resident, who set up an offshore trust before becoming UK deemed domiciled, and who will become UK deemed domiciled on 6 April 2017 (as a result of being UK tax resident for 15 out of the last 20 tax years):

  • will be taxed on the offshore trust’s UK income as it arises (at trust or underlying company level)
  • will not be taxed on foreign income arising to the offshore trust (or an underlying company) after 5 April 2017 as it arises, or while it remains in the trust (as long as no benefits are provided to close family members of the settlor) even if that foreign income is brought to the UK by the trustees (or an underlying company)
  • will be subject to income tax if a ‘close family’ member receives a distribution or benefit from the trust (if there is relevant foreign income in the trust structure) unless the close family member is themselves subject to income tax on the distribution/benefit (wherever the benefit/distribution is received)
  • will not be subject to capital gains tax (CGT) on UK or non-UK gains realised in the offshore trust (or by an underlying company) as they arise
  • will be subject to CGT if a close family member receives a distribution or benefit from the trust (if there are gains in the trust) unless the close family member is themselves subject to CGT on that distribution/benefit (wherever the benefit/distribution is received)
  • the non-UK assets of the trust (subject to the new rules in relation to UK residential property and the ‘tainting’ rules – see below) will not be subject to UK IHT. 

The settlor’s ‘close family’ include his spouse/civil partner/cohabitee, his minor children and the minor children of his spouse/civil partner/cohabitee, but not adult children or any grandchildren.

So the UK resident UK deemed domiciled settler will, broadly, be subject to tax on distributions/benefits received by close family members who are either:

  • non-UK resident; or
  • UK resident non-dom remittance basis users who do not remit the distribution/benefit to the UK. 

Distributions/benefits to adult children (or grandchildren) who are non-UK resident will not be subject to tax on the settlor or the recipient.

However, if an offshore trust set up by the non-dom before he became UK deemed domiciled is ‘tainted’ (see below):

  • he will be subject to tax on all the UK and non-UK income of the trust (and underlying entities) and all the gains of the trust on an arising basis in that tax year and all subsequent tax years in which he is UK resident (even if he ceases to be UK deemed domiciled and then later returns to the UK)
  • the added funds (and anything which derives from them) will not be protected from IHT. 

A trust will be ‘tainted’ if, at any time after 5 April 2017 when the settlor is UK deemed domiciled, funds are added to the trust by the settlor, or by the trustees of any trust of which the settlor is either a beneficiary or the settlor.

Changes which impact on all offshore trusts set up by a non-dom (whether or not UK deemed domiciled)

  • A UK resident non-dom settlor of an offshore trust will not be taxed on foreign income arising to the offshore trust after 5 April 2017 as it arises, or while it remains in the trust (as long as no benefits are provided to close family members of the settlor) even if that foreign income is brought to the UK by the trustees (or an underlying company).
  • From 6 April 2017, where a non-UK resident beneficiary receives a distribution or benefit from an offshore trust set up by a non-dom that distribution/benefit will not reduce the pool of trust gains unless the settlor is UK resident and UK deemed domiciled and is subject to tax on the distribution/benefit. This means that the trust gains will remain available to match against distributions/benefits to UK resident beneficiaries and be taxed on them. 

Inheritance tax (IHT) on UK residential property holdings 

  • From April 2017, all interests in UK residential property held by a non-dom, whether directly or indirectly, including UK residential property interests held by offshore companies, offshore trust and company structures and non-UK partnerships will be subject to IHT. The changes will affect all UK residential property of any value whether it is owner occupied or let.
  • In addition, loans made to fund the acquisition, maintenance or enhancement of UK residential property will be subject to UK IHT. 

So: if X (a non-dom) lends money to the trustees of a trust who lend that money to a non-UK company to purchase a UK residential property, both the equity value of the UK residential property and the loan will be subject to UK IHT.

In addition:

  • if a non-dom sells shares in a non-UK company that holds UK residential property the proceeds of the sale (and any property acquired with those proceeds of sale) will remain within the charge to UK IHT for two years from the date of the disposal. This anti-avoidance rule will only apply where the sale occurs after 5 April 2017.
  • likewise, where a non-dom has lent money to another person and the loan is used to buy, maintain or enhance UK residential property any repayments of that loan will remain within the charge to UK IHT for two years. Again, this anti-avoidance rule will only apply to loan repayments made after 5 April 2017. 

Action needed

Non-doms who will be affected by these changes should now consider what steps they should take before 6 April 2017. Depending on the particular facts some or all of the following may be appropriate:

  • receiving dividends from non-UK companies
  • gifts to adult children
  • taking distributions outside the UK from offshore trusts for non-UK expenditure
  • splitting offshore trusts to provide for different family members and different investment strategies
  • setting up new offshore trusts (if not already deemed domiciled for IHT purposes under the current rules), possibly to hold existing non-UK companies
  • restructuring UK residential property held in corporate vehicles
  • re-structuring or repaying loans to or from offshore trusts/companies
  • identifying different elements within offshore mixed bank accounts with a view to segregating out clean capital. 

This is a general guide only and should not be relied on; it is not a substitute for specific legal and tax advice. If you require advice on any of the issues raised by these changes please get in touch.

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