ARE THE PROPOSALS TO REFORM THE TAXATION OF NON DOMS STILL RELEVANT

FOR BREXIT BRITAIN?An extract from the International Comparative Legal Guide to Private Client 2017

The tax rules covered in this article were up to date at the time the article was written in November 2016. The tax analyses contained in the article are for illustrative purposes only and should not be treated as advice. Proper professional advice should be sought in all cases.This publication is not meant as a substitute for advice on particular issues and action should not be taken on the basis of the information in this document alone.

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INTRODUCTIONThe tax rules covered in this article were up to date at the time the article was written in November 2016. The tax analyses contained in the article are for illustrative purposes only and should not be treated as advice. Proper professional advice should be sought in all cases.This publication is not meant as a substitute for advice on particular issues and action should not be taken on the basis of the information in this document alone.

On 8 July 2015, the United Kingdom (UK) Government, led by David Cameron, announced a series of reforms to the tax regime for people who have a foreign domicile (non doms) to take effect from 6 April 2017. No one predicted at the time that less than a year later the UK would vote to leave the European Union (EU) (or Brexit) and the prime ministerial career of David Cameron would be consigned to history.

Yet, despite the political fallout following the UK’s decision to Brexit, the Government says that it remains committed to creating a tax system that 'balances fairness and international competiveness', and for the non dom reforms to take effect from 6 April 2017.

Despite its commitment to the non dom reforms, the Government has been less than forthcoming with the details of the new rules. We, therefore, find ourselves in the parlous position at the time of writing this chapter (November 2016) where, with only a matter of months to go before the rules are implemented, we still do not have clarity on a number of key aspects of the new rules. In this, we take a look back over the key developments in relation to the non dom reforms over the last year, and how the unprecedented political events which have unfolded during this time have changed the context against which these reforms are to be judged. The starting point though is to give some context against which the reforms were originally introduced.

THE UK’S CONCEPTS OF DOMICILE AND RESIDENCEIt is important to understand that the UK recognises the distinct concepts of domicile and residence in its taxation of individuals.

DOMICILEA person is, in general, domiciled in the country in which he is considered by English law to have his permanent home. No person can be without a domicile, but an individual may sometimes be domiciled in a country although not have his permanent home in it.

No person can at the same time for the same purpose have more than one domicile. An existing domicile is presumed to continue until it is proved that a new domicile has been acquired.

Every person receives at birth a domicile of origin. A legitimate child born during the lifetime of his father has his domicile of origin in the country in which his father was domiciled at the time of his birth. Every independent

person can acquire a domicile of choice by the combination of residence and intention of permanent or indefinite residence, but not otherwise. A person abandons a domicile of choice in a country by ceasing to reside there and by ceasing to intend to reside there permanently or indefinitely, and not otherwise.

When a domicile of choice is abandoned, either a new domicile of choice is acquired or the domicile of origin revives.

The domicile of a dependent person is, in general, the same as and changes (if at all) with the domicile of the person on whom he is, as regards his domicile, legally dependent. The domicile of a legitimate and unmarried child under 16 is, during the lifetime of his father, the same as and changes with the domicile of his father. There are exceptions to this rule where the parents of such a child are living apart or were living apart at the death of the child’s mother.2

RESIDENCEResidence refers to the individual’s tax status on a year by year basis. The Statutory Residence Test is the formal residence test for individuals in the UK and came into force on 6 April 2013. The residence of individuals for earlier years is determined by reference to case law, limited statutory rules and HMRC practice.

Under the basic rule, an individual is treated as UK tax resident for a tax year if he meets the automatic UK residence test for that tax year or has 'sufficient ties' to the UK for that tax year under the Statutory Residence Test. However, if an individual satisfies at least one of the automatic overseas tests, the individual is not UK tax resident for that tax year, i.e. the automatic overseas residence test takes priority over the automatic UK residence and sufficient ties tests.

THE CURRENT TAX LANDSCAPE IN THE UK FOR NON DOMSINCOME TAX AND CAPITAL GAINS TAX (CGT)An individual who is UK resident but non dom will be subject to tax on his UK source income and gains but is not automatically subject to UK taxation on his worldwide income and gains.

Non dom status allows UK resident individuals to claim to be taxed on the remittance basis. If a non dom claims the remittance basis his foreign income and gains are taxable only if remitted here.

The idea of taxing anybody on this remittance basis was introduced when income tax was first imposed in 1799 in order to allow those who owned land in King George III’s dominions to escape tax on their colonial wealth unless they brought it back to England.

For the first seven tax years of UK tax residence, a non dom can claim the remittance basis, without incurring an annual remittance basis charge. Individuals who have been tax resident in the UK for more than seven tax years with unremitted foreign income or gains of less than £2,000 in the current tax year are also not liable for the charge.

From April 2008, non doms who have been resident in at least seven out of the previous nine tax years are required to pay a charge of

£30,000 a year to claim the remittance basis. For non doms who have been resident in the UK for 12 of 14 tax years, an annual charge of £60,000 is payable. A further level of charge (£90,000) was introduced from 6 April 2015 for even longer term residents, but this will cease once the new rules (detailed below) are introduced with effect from 6 April 2017.

INHERITANCE TAX (IHT)Non doms will only be subject to IHT on their assets situated in the UK. In general IHT, is payable on the value of a person’s estate on death, including the value of gifts that had been made within seven years of death, or upon the transfer of assets into trust during lifetime.

The current IHT rules operate to deem non doms to be UK domiciled in the UK for IHT purposes in two situations:• if they were domiciled in the UK at any

point within the three years immediately preceding a relevant transfer (ie the date of gift or the date of death); or

• if they were resident in the UK in any part of 17 of the 20 tax years immediately preceding the year in which the relevant tax event falls.

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THE BACKGROUND TO THE REFORM OF THE NON DOM RULESTo explain the rationale for the non dom reforms requires us to consider the political events which unfolded following the Conservative Party’s victory in the General Election in May 2015, led by David Cameron. Such was the public interest stirred by the Labour Party’s key manifesto commitment to abolish the concept of non dom tax status, in the interests of creating a fairer tax system, that the new Conservative Government felt duty-bound to consider its own position and to reform what were widely perceived to be archaic rules.

In the 2015 Summer Budget, the then Chancellor, George Osbourne, acknowledged that a more robust response to the issue of taxation of non doms was required to address the mounting public concern. A raft of reforms

were announced to come into force on 6 April 2017. Broadly the proposals are:• to end long term non dom status: those non

doms who have been resident in the UK for more than 15 out of 20 tax years will be deemed domiciled in the UK for all tax purposes in their sixteenth year of residence;

• to treat non doms who were born in the UK with a UK domicile of origin as deemed domiciled upon their return to the UK; and

• that all UK residential property is to be subject to IHT, whether held directly or indirectly by offshore companies and other entities (the practice of ‘enveloping’) by non doms or offshore trusts set up which are otherwise excluded property for IHT purposes. Consideration of this aspect of the non dom reforms is beyond the scope of this.

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Two technical papers were issued immediately following these announcements, and in September 2015, a consultation document was published giving further details as to the likely shape of some of the new rules, particularly in relation to the deemed domicile provisions. Questions still remained though as to other aspects of the reforms, including the future taxation of offshore trusts created by deemed domiciled settlors. The Government indicated that a further consultation document would follow which would provide answers to these questions. At the time, it was widely anticipated that this further consultation document would follow in early 2016. The 2016 Budget in March delivered very little in the way of substantive tax reforms, perhaps unsurprising following the reforms announced in the Summer Budget, a little over eight months before. Buried in the detail of the Budget statement though was reference to the non dom reforms and a single paragraph statement that non doms will be able to rebase their foreign assets to their market value as at 6 April 2017. No further information on this provision, nor the further consultation, were forthcoming.

The publication of the ‘Panama Papers’ in April 2016 (arising from the data leak at international law firm Mossack Fonseca in Panama, which exposed some less than legitimate practices) and the subsequent media reaction led to increased public scrutiny that wealthy foreign individuals should be paying their fair share of tax.

On 23 June 2016 the UK went to the polls to vote on the UK’s continued membership of the EU. The referendum itself was a manifesto promise made by David Cameron during the 2015 General Election to appease factions within his own political party and to garner votes from supporters of the increasingly popular UK Independence Party, led by Nigel Farage, with its single policy objective of taking the UK out of the EU.

Few anticipated the result of the EU referendum, least of all David Cameron, who had taken a political gamble and lost, resigning immediately. The swift appointment of Theresa May as Prime Minister within a matter of weeks and her dismantling of the Cameron cabinet (mostly notably the sacking of George Osbourne from the office of Chancellor) and the formation of her own,

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with the primary aim of navigating the UK out of the EU, meant that the non dom reforms seemingly took a back seat.

We, like other professionals, speculated that in light of the unprecedented political upheaval the non dom reforms were likely to be postponed, at least until 2018. Others even went as far as to suggest the reforms could even be shelved entirely in light of the changed political landscape the UK was now facing following a vote to Brexit, and the need to continue to appear open to international investment. At the very least, we did not expect to see the further consultation

document on the subject until the autumn following Parliament’s summer recess.

On 19 August, the Government took us all by surprise and published the further consultation document together with some draft legislation, noting that its 'aspiration for a tax system that balances fairness and international competitiveness remain[ed] the same'. By publishing the further consultation document, Theresa May sent out a clear message that her Government continues to remain committed to the non dom reforms and for their implementation on 6 April 2017; it was business as usual.

THE DEEMED DOMICILE RULESIn the further consultation document, the Government does helpfully clarify a number of aspects of the new rules, particularly in relation to the deemed domicile provisions. The consultation document also (purportedly) sets out the Government’s position in relation to the tax treatment of benefits from offshore trusts created by deemed domiciled settlors. It is widely understood though that the consultation document is outdated in this regard and does not reflect their current thinking. The Government’s commitment to the non dom reforms is seemingly at the expense of clarity. Against this backdrop we take a look

at what we now know in respect of the key aspects of the new deemed domicile rules.

Broadly, the deemed domicile rules will operate in two distinct ways depending on domicile status:• non doms who have been resident in the UK

for 15 of the past 20 tax years (the so called ‘15/20 Test’) will be treated as domiciled in the UK for all tax purposes; and

• non doms who were born in the UK with a UK domicile of origin, and who become UK resident (Returning UK Domiciliaries) will be subject to different (more punitive) rules.

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THE 15/20 TESTNon doms who satisfy the 15/20 Test will become deemed domiciled in the UK for all tax purposes. As a consequence, non doms who become deemed domiciled will be taxed in the UK on their income and gains on the arising basis and their UK and foreign assets will be subject to IHT. They will no longer be able to claim the remittance basis of taxation and the £90,000 remittance basis charge will fall away.

To determine a year of residence, it will be necessary to have regard to the residence rules in force during the tax year in question. In other words, it will not be possible to apply the statutory residence test for tax years before the test was introduced (ie for tax years before 2013/14).

Tax years where a non dom is able to claim split year treatment (ie during part of a year a non dom can be treated as UK resident and part when they are treated as non-UK resident) will count for the purposes of the 15/20 Test. Consequently, a non dom could become deemed domicile if they have actually been in the UK for less than 15 years. Years of residence whilst an individual is under the age of 18 will also count for the purposes of the 15/20 Test.

A person will be deemed domiciled in the UK in year 16 even if they left the UK during year 15. This does not matter for income tax and CGT purposes because they are not resident during year 16 but this is relevant for IHT purposes as it means an individual will become subject to IHT on their worldwide estate during a year they are not actually UK resident. A non dom will lose their deemed domiciled status for IHT purposes once they have been non-resident for four consecutive tax years.

A non dom who leaves the UK but later wishes to return to the UK will have to remain outside the UK for six tax years in order to reset their domicile clock under the 15/20 Test. They would then have a further 15 years in which they could claim the remittance basis before becoming deemed domiciled again.

As previously indicated in the 2016 Budget, non doms who will become deemed domiciled under the 15/20 Test from 6 April 2017 will be

able to elect to rebase their foreign assets to their market value as at 5 April 2017 for CGT purposes provided they have paid a remittance basis charge in a previous tax year. Rebasing will apply to foreign assets owned on 8 July 2015 (the date of the 2015 Summer Budget). Any further increase in the value of assets from 6 April 2017 will then be chargeable to CGT in the usual way. The ability to rebase will only apply to non doms who are set to become deemed domicile on 6 April 2017 and not those who will acquire such status in subsequent tax years (nor Returning UK Domiciliaries).

A transitional rule will also be introduced to allow non doms with mixed funds a period of one year from 6 April 2017 to bring such funds into the UK by enabling them to rearrange them in order to separate out those funds into their constituent parts. Unlike rebasing, this relief will be available to all non doms, not just those who will become deemed domiciled from 6 April 2017.

The tax treatment of non-resident trusts settled by non doms who are set to become deemed domiciled is perhaps the most complex area involved in the reform of the deemed domicile rules. The final detail of the rules is far from certain at the time of writing this chapter but the following points can be gleaned from the further consultation document and professional opinion at this stage:• in general, non doms who become deemed

domiciled will only pay tax on income and gains within offshore trust structures (other than UK source income on which they will be taxed on the arising basis) when they receive benefits from the structure. Such trusts will not be subject to the IHT regime and will retain their 'excluded property' status for IHT purposes;

• the Government has moved away from the original – more punitive position – originally detailed in the September 2015 consultation that it would base the taxation of offshore trusts on the taxable value of benefits received by the deemed domiciled individual, without reference to the underlying income and gains within the structure;

• the further consultation document outlines a tax charge with reference to the underlying income and gains realised by

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trusts through the modification of existing anti-avoidance provisions applicable to UK resident and domiciled settlors and UK resident beneficiaries;

• the rules would operate in such a way that the addition of assets to or the receipt of a benefit by a settlor or a close family member from a ‘protected trust’ (ie one settled before a settlor becomes deemed domiciled) would have the effect of tainting the protected nature of the trust. The effects will differ for income tax and CGT purposes:• for income tax purposes, any income of

the trust will also be treated as that of the settlor, although it is not clear whether this applies to all future income or just the income arising in the tax year in which tainting occurs;

• for CGT purposes, the implications are much wider and would have the effect of taxing a deemed domiciled settlor on all gains arising in the structure once tainting has occurred. This would appear to be at odds with the Government’s original proposal to impose a tax charge on benefits received by deemed domiciled settlors.

• at the time of writing it is now anticipated that the Government is considering a wider ranging review of the anti-avoidance provisions relevant to offshore trusts and is now favouring an alternative approach to the taxation of trusts settled by deemed domiciled individuals. This alternative approach moves away from the concept of protected trusts, that, if they become tainted through a distribution will cause all future income and gains are taxed on the settlor. Instead they are favouring a model that only taxes settlors upon the receipt of benefits having regard to the underlying income and gains within the structure. It remains to be seen though at the time of writing this article quite what the shape of these actual rules will look like. Indeed, given the gravity of the proposed reforms it is unlikely that we will see draft legislation of this aspect of the reforms until publication of the Finance Bill 2017 after the 2017 Budget – and potentially after 6 April 2017 when the rules have already come into force.

RETURNING UK DOMICILIARIESFrom 6 April 2017 Returning UK Domiciliaries will be deemed domiciled in the UK for income tax and CGT purposes when they return to the UK and become UK resident. There will be no transitional provisions available for Returning UK Domiciliaries. For IHT purposes a grace period will enable Returning UK Domiciliaries to return to the UK without being deemed domiciled for IHT purposes unless they have been UK resident for at least one of the two years prior to the year in question.

Returning UK domiciliaries will be deemed domiciled during the period they are living in the UK and are UK resident and non domiciled again at the point they leave the UK and become non- UK resident (provided they are still non-UK domiciled under the general law), unless they then satisfy the 15/20 Test.

Trusts set up by Returning UK Domiciliaries will lose their excluded property status for IHT purposes at the point the Returning UK Domiciliary becomes UK resident. Income and gains will also be taxable on the deemed domiciled settlor as they arise whilst they are UK resident.

If a Returning UK Domiciliary becomes non-UK resident again (assuming they are non UK domiciled under general law) trust income and gains will no longer be taxable on them as settlor and the trust’s excluded property status will revert after their first full year of non-residence.

The punitive nature of these rules to which the Government appears committed are likely to cause many non doms, who may have never lived in the UK during substantial periods of their lives, to reconsider whether they wish to return to the UK. For those who do, it would be imperative to attempt to establish their domicile of origin from the outset to determine whether they come with the scope of these rules or can rely instead on the 15/20 Test.

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BALANCING FAIRNESS AND STABILITYThe unprecedented political events that have unfolded in the UK during 2016 have had a destabilising effect, both economically and politically, and dented the UK’s safe haven reputation on a global scale. Theresa May’s Government has been at pains to impress a 'business as usual' approach in the interests of stabilising the country in the aftermath of Brexit, including pursuing the non dom reforms originally proposed under David Cameron’s premiership. What this approach seemingly ignores is that the political and economic backdrop against which these proposals were originally announced has changed significantly.

In addition, we find ourselves in a position where the detail and scope of the reforms is still not clear, with only months to go before the new rules are to take effect. Indeed, if the Government is intent on carrying out a wider ranging review of trust anti-avoidance provisions then it will be difficult to produce a body of rules in the limited time available that does not give rise to unintended consequences.

It is unlikely that the Government will consider a rewrite of the reforms but there is certainly a

rationale for it to take stock at this stage and review the proposals in light of the details of Brexit as they become clearer. A postponement would also prove timely to ensure that the taxing mechanism in relation to offshore trusts is properly thought through, providing much needed clarity to non doms and their advisors and create stability following a number of changes to the taxation of non doms since 2008.

Quite whether the Government should proceed with the non dom reforms in light of the UK’s decision to Brexit is a more fundamental question. There is certainly a need to create a fairer tax system as between UK domicile and non domicile taxpayers and a public desire to do so. The mechanism to achieve this must also balance the UK’s future role on the international stage and encourage wealthy and entrepreneurial foreigners to continue to come and live in the UK and set up businesses here. This can only be achieved with the benefit of the passage of time in light of the uncertain nature at this stage as to quite how the UK is to navigate its way out of the EU.

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