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Counting down the years

Lisa Cornwell warns that all is not as it seems when counting years for tax purposes.

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This prompted an increasingly lively discussion as to whether 2009 marked the end of the “noughties” decade, or 2010. (For the record, my argument was 2009.)  As you can see, life in my household is never dull.

However, this did also make me think about an often-encountered, surprisingly basic concept that could easily scupper the most sophisticated planning….counting years.

Whether you have to write out the years on a piece of paper, or resort to counting on your fingers and toes, it is amazing how practitioners and clients alike can have difficulties when it comes to counting.

Counting years (and indeed days) is very important to tax practitioners dealing with clients who are not resident in the UK, or resident and not domiciled. 

Take, for example, the client who is becoming non-resident – I won’t touch on the difficulties of actually being considered non-resident here for we simply don’t have enough space – their day counting in the UK can be critical in determining when they become resident here.  Similarly, an individual returning to the UK after a prolonged break will find their UK tax position dramatically altering depending on when they return. 

However, where I have recently seen the same counting problem with three different clients is that of counting years in relation to becoming deemed domiciled in the UK for IHT.

There are two main areas where counting years are relevant for UK resident, non-domiciled individuals – firstly for income tax and capital gains tax purposes, and secondly for inheritance tax purposes.

Deemed domicile

For income tax and capital gains tax, the rules changed in 2008 such that “long-term” UK residents who have more than £2,000 income or gains arising overseas in a tax year must pay £30,000 to be taxed on the remittance basis (i.e. only paying UK tax on money that they bring into the UK.)  Otherwise, their worldwide income and gains are subject to UK tax on an arising basis. 

Here, “long-term” means those who have been resident in the UK for at least seven of the previous nine tax years.  Given the amount of publicity that this change received, my experience is that nearly all clients who are at or around this period of time in the UK have been well-advised as to their exact position.

Where there is more room for error is in terms of longer term domicile planning.  Thanks to the ubiquitous “mate down the pub” who is a font of all planning knowledge, most UK resident, non-domiciled clients are aware of the “deemed domicile” rules.  I choose my words carefully – while they are aware of them, it is the simplest part of the planning, the counting of years that they have been in the UK, where they most often come unstuck.  All too often, the client knows that “after 17 years I’ll be deemed domiciled” without realising that in the tax world, counting is never that easy.

As we know, for inheritance tax purposes in England and Wales, the concept of “deemed domicile” means that even if you are not domiciled in the UK under general law, you will be treated for inheritance tax purposes as if you are domiciled here if you were resident in the UK in at least 17 of the 20 income tax years of assessment ending with the year in which a transfer is made.  The consequence of this is that instead of having a potential UK inheritance tax liability on only UK situs assets, the individual will be liable to UK inheritance tax and probate laws on their worldwide assets.  Not only is this an administrative nightmare, it can have a very significant impact on the net assets available to pass on to heirs.

A very common mistake is to assume that one becomes resident from the tax year after arrival or to simply miscount using a calendar year basis.  The reality is, the individual who arrives on 1 April 1995 and is treated as UK resident in the 1995/96 tax year would  be deemed domiciled here on 6 April 2011 – only 15 years in the real world, but sufficient to breach the deemed domicile rules in the tax world.

Some solutions

Careful planning can ensure that clients who are approaching this point can act to protect their non-UK assets from the scope of UK inheritance tax.  A common way of doing this is for the individual to establish an “excluded property trust” prior to becoming deemed domiciled in the UK. 

So long as the assets that the trust is funded with are (and remain) non-UK situs property, the trust acts as a barrier to protect these non-UK assets from UK inheritance tax.  Clearly, consideration must be given to any costs incurred in order to establish the planning.  However, for those clients who are approaching deemed domicile status, it is worth consideration at the least.

Alternatively, taking out a life assurance policy to cover a vastly increased liability and to provide liquidity in the event may be appropriate.

As the end of the 2010/11 tax year fast approaches, for those clients who have been resident in the UK since the mid/late 90s, it is worth them spending a few minutes double checking when they actually became resident here.  Any planning necessary will take some time to implement as the window of opportunity to protect non-UK assets from UK IHT closes when the 17-year point is breached. 

And if anyone has any light to shed on why 2010 would be considered part of the “noughties” I’m keen to hear it.

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