According to the results of the 2001 census, there were 4.3 million UK resident individuals who were born elsewhere. This represented 7.53% of the population. The comparative figures for the 1971 census were 2.4 million individuals representing 4.55% of the population.
The final census results for 2011 are not yet available, but preliminary figures indicate that the population of England and Wales has increased by 3.7 million, of which 55% are immigrants.
There is no doubt that individuals are becoming more internationally mobile and that the UK is becoming more ethnically diverse.
The UK has a tax system that offers advantages to residents who are domiciled outside the UK. While being born abroad does not automatically mean that an individual is domiciled outside the UK, it should be a starting point in any review of a client’s tax affairs.
Advisers will be able to help those clients potentially domiciled outside the UK in two main ways:
- Planning to avoid or reduce the impact of inheritance tax.
- Planning to take advantage of the remittance basis of taxation.
Advisers will only be able to help if they are familiar with the basic principles of domicile.
Why is domicile important?
It is essential to have a way of establishing which system of law and which country’s courts governs questions relating to an individual’s civil status (such as marriage, divorce and legitimacy) and some aspects of property ownership.
What is domicile?
Domicile is the concept in international law which links every individual to the particular legal system in their permanent home or domicile.
In addition to the basic principles outlined so far, the law of domicile is used by many jurisdictions to determine an individual’s liability to tax. This may be of more interest to advisers.
Domicile of origin
When an individual is born they acquire a ‘domicile of origin’. This is the domicile of the child’s father or if the parents are unmarried, their mother.
Domicile of choice
On reaching 16, the individual can shed their domicile of origin and acquire a ‘domicile of choice’.
The individual can retain this domicile of choice indefinitely. Alternatively, they could acquire another domicile of choice. If an individual abandons their domicile of choice without acquiring a new domicile, their domicile of origin is revived.
Acquiring a domicile of choice involves satisfying a two-pronged test.
- The individual must physically reside in the new jurisdiction.
- The individual must form the intention to live permanently or indefinitely in the new jurisdiction having no real intention of living anywhere else.
The first part of this test is easy to ‘prove’, the second is very difficult.
The UK courts have adopted the approach that the acquisition of a foreign (to the UK) domicile of choice is only to be imputed to an individual on the basis of clear and unequivocal evidence.
Case study 1
IRC v Bullock: Mr Bullock had a domicile of origin in Nova Scotia. He’d lived in England for 40 years and his wife didn’t want to live in Nova Scotia. Mr Bullock hoped to return there one day should he persuade his wife to change her mind or should he survive her. It was held by the courts that he had a real determination to return rather than a vague aspiration. Accordingly, he retained his Nova Scotian domicile of origin and did not acquire an English domicile of choice.
Case study 2
Furse v IRC: Mr Furse, an American, expressed a wish to live in England for the rest of his life. The only contingency was that he would like to return to the US should he cease to be physically able to take an active interest in his farm in England. The Courts decided that this intention was so vague and imposed no limit on his intention to remain in England. Accordingly, he acquired an English domicile of choice.
Case study 3
Peter’s father has a domicile of origin in Scotland. He was a university lecturer at the University of Berlin and Peter was born there, spending the first 12 years of his life in Germany. His father then moved to Finland, having been appointed professor at the University of Helsinki. He retired to Scotland earlier this year as had always been his intention.
Peter went to school in Germany and is currently at university in Munich. When he graduates, he intends to do voluntary work in either Africa or Asia before deciding on a career. Where is he domiciled?
Peter is domiciled in Scotland even though he was born in Germany and has never set foot in Scotland. His father never lost his Scottish domicile of origin because even though he spent many years in Germany, he never intended to stay there permanently and was always going to retire to Scotland.
At birth, Peter acquired his father’s domicile of origin. He has not acquired a domicile of choice as he has not made up his mind where he wants to permanently and indefinitely reside, so he has kept his father’s domicile of origin.
Domicile of dependency
Children who have not yet reached 16 years old have the domicile of their father, or mother if the child’s parents are unmarried.
Deemed domicile
An individual can become deemed domiciled in the UK for inheritance tax purposes only in certain circumstances. This deemed domicile overrides the general principles stated so far. It covers two situations:
- An individual who was UK domiciled, but has ceased to be so on general principles. Such an individual would be deemed to be UK domiciled for three years from the change of ‘real’ domicile.
- An individual who is not UK domiciled on general principles, but who is a long-term resident. Such an individual becomes deemed domiciled once they have been resident for 17 out of the last 20 income tax years.
The 17/20 years rule can also impact those losing UK domicile.
How does an individual’s domicile impact on their exposure to inheritance tax?
Individuals who are domiciled (actually or deemed) in the UK are liable to inheritance tax in respect of worldwide assets. Individuals domiciled elsewhere are liable to inheritance tax only in respect of assets situated in the UK.
What is ‘excluded property’?
Excluded property is property (such as assets) excluded from the scope of inheritance tax. Non-UK assets held by individuals neither domiciled nor ‘deemed domiciled’ in the UK are excluded property.
Additionally, certain UK assets including Authorised Investment Funds (Oeics and unit trusts) have been determined as constituting excluded property when held by an individual domiciled elsewhere.
What is an ‘excluded property trust’?
Any trust where the settlor was not UK domiciled/deemed domiciled when the trust was established and which holds excluded property is an ‘excluded property trust’.
What are the benefits of an excluded property trust?
The trust fund is forever outside the ambit of UK inheritance tax. Addition¬ally, the ‘reservation of benefit’ rules do not apply so the settlor can be a beneficiary. The inheritance tax status of the trust is maintained in the event that the settlor later becomes domiciled or deemed domiciled and following the settlor’s death.
How could an excluded property trust work in practice?
Case study 4
Carol was born in Latvia and came to the UK in 1998 to take a post-graduate degree in medicine. She specialised in cosmetic surgery and soon developed a lucrative private practice. She boosted her professional profile by becoming a part-time lecturer at a number of medical schools both in the UK and abroad.
Carol is a saver not a spender, and quickly accumulated an investment portfolio of £1.5m. She has recently become engaged to Xavier, a Spanish orthopaedic surgeon. The couple intend to set up home in London, but in the long run are thinking about moving to Russia.
Carol’s adviser is concerned that she might become deemed domiciled in the UK – she has already been tax resident for 14 years. Carol arranges for her lawyer to establish a discretionary trust. She will be in the class of beneficiaries as will Xavier and their children and grandchildren. Carol, Xavier and Carol’s lawyer will be trustees.
The initial trust fund will be £1m – 75% in offshore life assurance bonds and 25% in Oeics.
Should Carol become deemed domiciled, the trust fund will not be included in her estate for inheritance purposes (despite the fact that she is a beneficiary). The trustees will not be liable to inheritance tax on ten yearly anniversaries, as the trust fund will consist of excluded property.
Establishing the trust has reduced Carol’s inheritance tax exposure by £400,000. There is no need to wait for seven years for this ‘protection’ to materialise.
After Carol’s eventual death, the remaining trust fund will remain forever outside the scope of UK inheritance tax and could be used to benefit her children and grandchildren.
