Deemed domicile reform: consultation published

Practical Law UK Legal Update 8-619-1297 (Approx. 13 pages)

Deemed domicile reform: consultation published

by Practical Law Private Client

Background

Current deemed domicile rules and UK tax implications

Currently, non-UK domiciled individuals pay inheritance tax (IHT) only on their UK assets and can claim the remittance basis for income tax and capital gains tax (CGT). UK domiciled individuals pay IHT on their worldwide assets and pay income tax and CGT on worldwide income and gains on the arising basis.

For IHT purposes, an individual is deemed to be UK domiciled if they have been UK domiciled within the three calendar years immediately preceding the relevant time (three-year rule) or if they have been UK resident in at least 17 out of the 20 tax years ending in the tax year in which the relevant time falls (17 out of 20 rule) (section 267(1), Inheritance Tax Act 1984 (IHTA 1984)). There is no deemed domicile status for income tax and CGT.

For more information about the concept of domicile and its UK tax implications, see Practice notes:

July 2015 Budget announcements

At the July 2015 Budget, the government announced that it would publish consultations following the 2015 summer recess on the following measures:

New deemed domicile rules to prevent UK-resident individuals from benefiting from non-UK domiciled status indefinitely for UK tax purposes. The new rules would provide that:
- individuals who are resident in the UK for at least 15 out of 20 tax years will become deemed domiciled in the UK for all tax purposes from their 16th tax year of residence (15 out of 20 rule); and
- individuals who have a UK domicile of origin but acquire a domicile of choice elsewhere will be deemed domiciled in the UK for all tax purposes at any time when they are subsequently tax resident in the UK (returning UK dom rule).
Deemed domiciled individuals will be subject to income tax, CGT and IHT in the same way as UK-domiciled individuals, with limited exceptions. The new rules will not affect the individual's domicile under the general law (actual domicile) for other purposes.
Charging IHT on UK residential property owned indirectly by non-UK domiciled individuals.

Both measures will have effect from 6 April 2017, but the new deemed domicile rules will be included in the Finance Bill 2016 (FB 2016) and the IHT measure in the Finance Bill 2017.

HMRC also published a technical briefing (HMRC technical briefing) on each measure. For details of the proposals as announced, see Legal update, July 2015 Budget: key private client tax announcements: Permanent non-domiciled tax status abolished and IHT on UK residential property owned indirectly by non-domiciled individuals.

Post-Budget developments

The Institute of Chartered Accountants of England and Wales (ICAEW) has published a consolidated report of meetings held by HMRC and HM Treasury (HMT) to discuss the two measures with stakeholders on 23 July, 13 August and 25 August 2015 (see ICAEW: Initial meetings on non-domiciliary announcements made at Summer Budget 2015 (TAXGUIDE 08/15)) (ICAEW report). The report makes clear that:

The parameters of the reforms have been set down by the Chancellor so the overall policy will not change.
HMRC and HMT thinking was at a very early stage at the time of the meetings and that views they expressed at the meetings might not be reflected in the consultation documents.

On 21 September 2015, HMT published a consultation on deemed domicile reform but withdrew it the same day.

For further background, see Private client tax legislation tracker 2014-15: Permanent non-domiciled tax status abolished and IHT: UK residential property owned indirectly.

Development

On 30 September 2015, HMT republished the consultation on deemed domicile reform.

The only change to the version of the consultation published on 21 September 2015 is that the consultation period runs from 30 September to 11 November 2015 rather than from 21 September to 28 October 2015. The six-week consultation period is shorter than the usual 12-week period because of the anticipated publication date for draft Finance Bill 2016 legislation. (The date of publication has not yet been announced, but the ICAEW report suggests that it will be in early December as usual.)

The consultation document provides some detail that was not announced at the Budget. It also includes draft legislation for:

The new deemed domicile tests that will be incorporated in the Income Tax Act 2007 (ITA 2007) and the Inheritance Tax Act 1984 (IHTA 1984) (see Changes to remittance basis, IHT: changes to current deemed domicile rules and Individuals born in UK with UK domicile of origin (returning UK dom rule).
Amendments to transitional provisions for the statutory residence test (SRT) in the Finance Act 2013 (FA 2013) (see Interaction of 15 out of 20 rule with residence rules).
An amendment to the election that can be made by non-UK domiciled spouses and civil partners for IHT purposes (see IHT: changes to other provisions).

Long-term UK residents (15 out of 20 rule)

Chapter 3 of the consultation document provides additional information about the 15 out of 20 rule. The government will consider other references to domicile in tax legislation and there will be further consequential amendments.

The government acknowledges that in some circumstances there will be different outcomes for taxpayers who are affected only by the 15 out of 20 rule or only by the returning UK dom rule, or who are actually domiciled in the UK. However, the consultation document does not set out how much difference there will be. In practice, it seems likely that many of the proposals about the effect of deemed domicile under the 15 out of 20 rule will also apply in relation to deemed domicile under the returning UK dom rule (for example, those set out in Changes to remittance basis), but this will not be clear until draft legislation is published for each proposal.

Interaction of 15 out of 20 rule with residence rules

For tax years before the SRT was introduced on 6 April 2013, individuals will have to use the previous common law-based rules to determine whether they were UK resident.

Although not stated in the consultation text, the draft legislation makes clear that if an individual makes an election to apply the SRT for tax years before it came into effect on 6 April 2013, the election will not have effect for the purposes of the new deemed domicile rules. However, the first tax year in which the new deemed domicile rules will apply (2017-18) is the last year in relation to which it is possible to make an election in respect of a previous tax year. (Paragraph 154, Schedule 45, FA 2013, as it will be amended by FB 2016.)

For the purpose of counting years of residence, the government intends to include any tax year in which the individual is resident even if split year treatment applies, because this is more straightforward. (The extent to which split year treatment itself will apply is unclear: see Changes to remittance basis and Individuals born in UK with UK domicile of origin (returning UK dom rule).)

The government does not propose to align the 15 out of 20 rule with the temporary non-residence rules because it considers that this would be too complex. However, for a non-UK resident individual, deemed domicile status will only be relevant for IHT purposes, not income tax and CGT purposes.

Residence status under double tax treaties will not affect the deemed domicile test.

For the current and previous rules on residence, see Practice notes:

Deemed domicile of minors

As the status of children will be assessed separately from that of their parents, the consultation document confirms that a child can become (and cease to be) deemed domiciled before reaching 18 on the basis of their own periods of residence in the UK.

Changes to remittance basis

For the purposes of the remittance basis, an individual who is not actually domiciled in the UK in a particular tax year will be deemed domiciled in that tax year if either of the following conditions is met:

He was born in the UK and his domicile of origin at birth was in the UK.
He has been UK resident for at least 15 out of the 20 tax years immediately preceding the tax year concerned.

(Sections 809EA and 828A(2), Income Tax Act 2007 (ITA 2007) as they will be inserted by FB 2016.)

Subject to further amendements, these provisions will automatically apply for CGT purposes as well as income tax purposes (section 809F(4), ITA 2007 and section 12(1), Taxation of Chargeable Gains Act 1992).

No grandfathering provisions

The 15 out of 20 rule does not include the grandfathering provision that was promised in the HMRC technical briefing for those who leave the UK before 6 April 2017.

The briefing made clear that there would be no grandfathering for those resident in the UK on 6 April 2017.

Remittance basis: de minimis threshold

The consultation document asks for views on whether non-domiciled individuals whose unremitted foreign and income and gains are less than £2,000 in a particular tax year should continue to benefit from the remittance basis for that year without needing to claim it. It sets out arguments for and against retaining the de minimis threshold without making a proposal.

For information about the threshold, see Practice note, Remittance basis: what individuals need to know: overview: Exceptions: when you do not need to claim.

Remittance basis: other provisions

The document also states that:

Earnings relating to a period when an individual was neither actually domiciled nor deemed domiciled in the UK that are paid after the individual becomes deemed domiciled will still be eligible to be taxed under the remittance basis if all the applicable conditions are met. This will include earnings and other income from employment-related securities.
Individuals who become deemed domiciled will not be able to use the rules for non-UK domiciled employees claiming tax relief for travel expenses where duties are performed in the UK (sections 373 to 375, Income Tax (Earnings and Pensions) Act 2003). They will be subject to the same rules on claiming tax relief for business travel as UK domiciled employees.
Deemed domiciled individuals will not be able to claim the remittance basis on foreign pension payments. Those who are UK resident will still be able to claim a 10% deduction on these payments.
The government will consider how best to legislate in a way that minimises the compliance burden, particularly in relation to historic information, for individuals who lose access to the remittance basis on becoming deemed domiciled. It recognises that avoiding the compliance burden of reporting income and gains on a worldwide basis is a significant benefit of the remittance basis.
Deemed domiciled individuals will be able to use foreign capital losses in the same way as UK domiciliaries. Currently, non-domiciled individuals can only claim foreign loss relief if they make an irrevocable election to do so from the first year for which a claim to the remittance basis is made (section 16ZA, Taxation of Chargeable Gains Act 1992).

Although it is clear that a tax year in which split year treatment applies will count as a year of residence for the purposes of the 15 out of 20 rule, the consultation document does not state whether an individual who is subject to this rule will still be eligible for split year treatment. However, it does state that returning UK doms will be eligible (see Split years allowed for returning UK doms). The ICAEW reports suggests that split year treatment will continue to apply for income tax and CGT (and that there are currently no plans to introduce it for IHT).

IHT: changes to deemed domicile rules

The draft legislation published in the consultation document will amend the deemed domicile rules for IHT purposes so that:

The three-year rule will continue to apply as it does now. (However, see Three year rule may be amended.)
There will be a new rule for returning UK doms (see Individuals born in UK with UK domicile of origin (returning UK dom rule)).
A person not domiciled in the UK at any time (relevant time) will be deemed domiciled in the UK (and not elsewhere) if he was resident in the UK for at least 15 of the 20 tax years immediately preceding the tax year in which the relevant time falls.

(Section 267, IHTA 1984 as it will be amended by FB 2016.)

The 15 out of 20 rule replaces the 17 out of 20 rule. Under the 17 out of 20 rule, the minimum period of residence needed to become deemed domiciled is 15 calendar years and two days (if an individual becomes resident in the UK on the 5 April of the first tax year and remains resident up to and including the 6 April of the 17th tax year). Under the 15 out of 20 rule, the minimum period will be 13 calendar years and two days on the same basis.

However, under the 17 out of 20 rule, the individual becomes deemed domiciled at the start of the 17th tax year (because the 20 years end with the tax year in which the relevant time falls), whereas under the 15 out of 20 rule, the individual becomes deemed domiciled at the start of the 16th tax year (because the 20 years end with the tax year immediately preceding a chargeable event).

The consultation document confirms that an individual who is either actually or deemed domiciled in the UK and caught by the 15 out of 20 rule will need to become non-UK resident for at least six full tax years (and respectively acquire or retain a domicile outside the UK) to avoid being deemed domiciled in the UK. However, as noted above, once an individual has become non-UK resident his deemed domicile status will only be relevant for IHT, not income tax and CGT.

As for the remittance basis test, the promised grandfathering for those who leave the UK before 6 April 2017 is not included (see No grandfathering provisions).

Three year rule may be amended

In addition, the government proposes that the three-year rule for IHT should be amended to bring the position for individuals with an actual UK domicile who are not caught by the 15 out of 20 rule into line with the new rules.

Currently, UK domiciled individuals who are not caught by the 17 out of 20 rule can become non-UK domiciled for tax purposes three calendar years after losing their actual UK domicile. The government proposes that these individuals should become non-domiciled for tax purposes on the later of the date that they acquire a domicile of choice outside the UK or have been non-UK resident for six tax years.

The government recognises that this would be a significantly longer period for some people.

IHT: changes to other provisions

The consultation document also states that:

If an individual who is not UK domiciled makes a potentially exempt transfer (PET) of an asset that is excluded property before they become deemed domiciled, but within seven years of their death, the transfer will not be chargeable on death. This is also the current position (sections 3(2) and 3A(b), IHTA 1984) (and see also HMRC: Inheritance Tax Manual: IHTM27211 and IHTM27212).
The government proposes to amend the rules allowing non-UK domiciled spouses to elect to be UK domiciled for the purposes of the IHT spouse exemption. To align these with the 15 out of 20 rule, it proposes that an election should cease to have effect after a six-year period of residence outside the UK rather than the current four-year period, which is based on the existing 17 out of 20 rule (section 267B, IHTA 1984 as it will be amended by FB 2016).

For information about the current rules, see Practice notes:

Offshore trusts under 15 out of 20 rule

The treatment of offshore trusts is more generous for those deemed domiciled under the 15 out of 20 rule than it is for returning UK doms (see Offshore trusts under returning UK dom rule).

Offshore trusts under 15 out of 20 rule: income and gains

For individuals who become deemed domiciled in the UK under the 15 out of 20 rule, the consultation document states that offshore trusts that they created before they became deemed domiciled will be protected provided that none of the individual, the individual's spouse and the individual's children receive any benefit from the trust.

The HMRC technical briefing did not mention spouses and children. It is not clear whether references to children for this purpose include adult children, or only minors.

The income tax and CGT rules that would normally apply where the individual was the settlor of the trust, or a transferor under the transfer of assets abroad legislation, will not apply. Instead, individuals who become deemed domiciled under the 15 out of 20 rule will be taxed on any income, gains and other benefits that they receive anywhere in the world from any offshore trust or underlying entity. This confirms the Budget announcement, although the HMRC technical document did not mention underlying entities.

It is unclear whether benefits received by spouses and children will be taxed, or will only be relevant to whether the trust remains protected.

The consultation document also states that:

Because tax will be charged without reference to the income and gains arising in the offshore structure, it will not be necessary to establish historical information. (If this is so, commentators have pointed out that this may lead to a charge where a trust holds no untaxed income or gains.)
UK source income will be taxable on the arising basis in the same way as it would be currently under the settlements legislation or the transfer of assets abroad rules. (It is unclear whether any tax paid on UK source income will be taken into account if a deemed domiciled individual is taxed on benefits received without reference to income arising in the structure.) No statement is made about UK source gains.
The government is considering whether it should also apply this regime to individuals who are UK resident and neither actually nor deemed domiciled in the UK, rather than only to those who become deemed domiciled. Those who were not deemed domiciled would pay tax on benefits only if the benefits were remitted to the UK. This would avoid these individuals having to change from the current regime to the new regime if they become deemed domiciled under the 15 out of 20 rule.

Some of these statements appear to be add odds with the ICAEW report, although this may be because government thinking has moved on since the stakeholder meetings or because the statements are made in broad terms. For example, the ICAEW report suggests that tax will be charged on benefits by reference to foreign income (because UK income will be taxed on the arising basis) and that for CGT the beneficiary charge under section 87 of the Taxation of Chargeable Gains Act 1992 (TCGA 1992) will continue to apply.

The ICAEW report indicates that the government currently has no plans for anti-forestalling rules (for example, rules that would prevent the creation of offshore trust in the tax year before becoming deemed domiciled under the 15 out of 20 rule). However, the report suggests that HMRC is considering widening the existing benefit in kind rules.

For information about the current rules, see Practice note, Taxation of offshore trusts: overview: How income tax applies to offshore trusts and How CGT applies to offshore trusts.

Offshore trusts under 15 out of 20 rule: IHT

Excluded property trusts that a settlor created while domiciled outside the UK will remain outside the scope of IHT if the settlor becomes deemed domiciled.

The government will consider issues arising from the fact that the individual's worldwide estate will become subject to IHT.

For information about the current rules, see Practice note, Taxation of offshore trusts: overview: Inheritance tax.

Individuals born in UK with UK domicile of origin (returning UK dom rule)

Chapter 4 of the consultation document provides further detail about the returning UK dom rule. As noted above, it is unclear to what extent the treatment of individuals deemed domiciled in the UK under this rule and the 15 out of 20 rule, or actually domiciled in the UK, will differ (see Long-term UK residents (15 out of 20 rule)).

Deemed domicile test for returning UK doms

For IHT purposes, a person not domiciled in the UK at any time (relevant time) will be deemed domiciled in the UK (and not elsewhere) if all of the following conditions are met:

He was born in the UK.
He had a UK domicile of origin at the time of his birth.
He was resident in the UK for the tax year in which the relevant time falls.
He was resident in the UK for at least one of the two tax years immediately preceding the tax year in which the relevant time falls.

(Section 267(1)(aa), IHTA 1984 as it will be inserted by FB 2016.)

(For other changes to the IHT deemed domicile rules, see IHT: changes to deemed domicile rules.)

The equivalent test for remittance basis purposes includes only the first two of these conditions, although the third condition is effectively incorporated because the remittance basis is only relevant for tax years of UK residence (see Changes to remittance basis).

The condition of having been born in the UK was not mentioned at the Budget and the ICAEW report makes clear that it came as a surprise at the stakeholder meetings. The HMRC technical briefing published at the Budget stated only that the returning UK dom rule would apply to individuals with a UK domicile of origin.

The fourth condition of the IHT test incorporates a grace period, although the consultation text indicates that the government has not yet decided whether to allow this (see Possible grace period for IHT).

Individuals who have become deemed domiciled under the returning UK dom rule (and have not reacquired an actual UK domicile) will be treated as being non-domiciled again when they become non-UK resident, provided that they are not caught by the 15 out of 20 rule. (The ICAEW report indicates that the three-year rule will not apply in these circumstances.)

Split year treatment allowed for returning UK doms

If a year is split into a UK part and a foreign part under the SRT, a returning UK dom will be treated as not domiciled in the UK during the foreign part of the year. Foreign income and gains arising in that part will not be taxable in the UK.

In the light of the ICAEW report, it seems likely that these statements are intended to confirm that returning UK doms will be treated in the same way as those caught by the 15 out of 20 rule (that is, the statements are not intended to be confined to returning UK doms), although this is not clear from the consultation document itself (see Remittance basis: other provisions).

Possible grace period for IHT

Stakeholders have suggested that short periods of UK residence (possibly a year or two) should be disregarded for the purposes of the returning UK dom rule. The government is opposed to a grace period for income tax and CGT, but acknowledges that the IHT consequences of a short period of residence are more drastic.

The consultation text does not propose a grace period for IHT, but leaves open this possibility by asking for comments on circumstances in which a short grace period would produce a fair outcome. (The ICAEW report gives examples such as individuals who leave the UK shortly after being born and return many years later only to care for an elderly relative or for a short work secondment.)

However, the amendments to IHTA 1984 set out above incorporate a grace period by providing that returning UK doms will only be caught by the new rule for a tax year where they were also UK resident in one of the two previous tax years (that is, a two out of three rule). There is no equivalent provision in the draft legislation amending the remittance basis (see Changes to remittance basis).

Withholding requirements for returning UK doms

The government notes that HMRC may need to publish updated guidance for banks on withholding requirements for returning UK doms.

The ICAEW report suggests that this issue has been raised in relation to the UK/Switzerland tax co-operation agreement (see Practice note, UK/Switzerland tax co-operation agreement: Lifetime withholding tax).

Offshore trusts under returning UK dom rule

The consultation document confirms that there will be no protection for offshore trusts created by returning UK doms while they were domiciled outside the UK for income tax, CGT or IHT.

The ICAEW report suggests that for settlor-interested trusts the settlements legislation, transfor of assets abroad rules, settlor charge under section 86 of TCGA 1992 and IHT gift with reservation of benefit (GROB) rules will apply as they do for settlors with an actual UK domicile.

The consultation document acknowledges that these rules will result in some trusts switching between excluded property and relevant property status in different tax years.

The document states that it will only be necessary to establish historical information for periods of up to ten years preceding IHT charges in relevant property trusts and that this may be challenging but should not be impossible. However, the government invites views on whether there is a better way to ensure that individuals affected can comply with the new rules.

The document also states that:

If a ten-year anniversary charge arises in a relevant property trust where the settlor is deemed domiciled under the returning UK dom rule, the charge will be apportioned based on the settlor's periods of residence during the ten years concerned.
There will be no exit charge if the settlor becomes non-UK resident again (and has not reacquired an actual UK domicile).

The treatment of offshore trusts for returning UK doms is less generous than for those caught only by the 15 out of 20 rule (see Offshore trusts under 15 out of 20 rule).

For information about the current rules, see Practice notes:

Comment

This looks like a consultation that has been published at this time because the government was committed to doing so, rather than because it was ready to do so. The draft legislation provides the new deemed domicile tests for the remittance basis and IHT, but hardly any of the consequential changes that will be required to implement them. The discussion is at a very high level (and less detailed than that in the ICAEW report).

In particular, it is unclear to what extent consequential changes will distinguish between those who are deemed domiciled under the returning UK dom rule, those caught by the 15 out of 20 rule and those who are actually domiciled in the UK.

Consequential changes relating to offshore trusts will be particularly complex. The ICAEW report suggests that the drafting of these changes may not be finished by the time that draft Finance Bill 2016 clauses are published in early December. The report also covers a number of detailed issues not mentioned in the consultation document, such as stakeholders' request for a rebasing option as at 6 April 2017 for CGT purposes (see Practice note, Taxation of offshore trusts: the "rebasing" election).

Moreover, the draft legislation that has been published is likely to change before it is enacted, unless the government has changed its mind about grandfathering under the 15 out of 20 rule for those who leave the UK before 6 April 2017 and decides against extending the three-year rule for IHT.

There is no discussion of the implications of the reforms for the estate duty treaties with Italy, France, India and Pakistan, in relation to which the IHT deemed domicile provisions do not apply (see Practice note, Domicile: Deemed domicile). The HMRC technical briefing stated that the government would consult on this issue.

As commentators have already pointed out, making a UK birthplace a condition of the returning UK dom rule will cause some parents to reconsider where their children should be born, which may have implications for a child's nationality.

The government faces a difficult task if it is to include legislation that is fit for purpose in the Finance Bill 2016. However, if legislation is deferred to (or significantly amended in) the Finance Bill 2017, some individuals will find that their domicile status has changed on 6 April 2017 under rules that are not in their final form on that date.

No information is given about future meetings between HMT, HMRC and stakeholders. Practitioners interested in joining them could use the contact details in paragraph 7.1 of the consultation document or contact one of the professional bodies mentioned in the ICAEW report.

To follow the progress of the reforms, see Private client tax legislation tracker 2014-15: Permanent non-domiciled tax status abolished.

Source

Source: HM Treasury: Reforms to the taxation of non-domiciles (30 September 2015).

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