November 2017 will be remembered for the introduction of the Finance (No 2) Act 2017, which included sweeping changes to the taxation of UK resident non-domiciled (RND) individuals. This legislation was left out of last year’s pre-election Finance Bill because there was not enough time available for debate.
The delay to its inclusion was controversial, particularly as the changes were backdated to 6 April 2017. Given the uncertainty around their tax position and wealth, RND individuals were unable to plan confidently for the future and their advisers were unable to fully assess the effectiveness of existing structures.
Legislative changes
With the legislation now passed, we have clarity on the important legislative changes in effect, including the fact that RND individuals resident in the UK for 15 of the past 20 tax years become deemed domiciled in the UK for all tax purposes.
Returning doms, ie those born in the UK with UK domicile of origin that shed their UK domicile and subsequently return, are treated as deemed domiciled for all tax purposes while they are in the UK, subject to a one-year grace period for inheritance tax (IHT).
Two key items of transitional relief were introduced, other than for returning doms:
- rebasing – the transitional relief allows individuals who became deemed domiciled in April 2017 to rebase certain foreign assets to their value as at 5 April 2017; and
- cleansing – the government is allowing non-doms a one-off opportunity to segregate their ‘mixed funds’ to allow more tax-efficient remittances to the UK to be made in the future and to permit the isolation of clean capital. The relief permits the separation of mixed funds into their component items of capital, income and gains, but only until 5 April 2019.
Protected trusts – those established offshore by a RND prior to acquiring deemed domicile – will protect UK deemed domiciled individuals from tax in respect of trust income and gains.
However, the trusts can quite easily be tainted, for example, by additions. Protected trust status is not available where the taxpayer is a returning dom.
Interests in UK residential property held indirectly by non-domiciliaries, such as via non-UK trusts, companies and partnerships, are now within the scope of UK IHT. Overall, this is a major change for non-doms and it will be more difficult to manage.
Looking at IHT exposure on UK residential property, affected non-doms should review existing arrangements, including comparing the merits of maintaining or revising existing structures and, for example, paying the ongoing Annual Tax on Enveloped Dwellings charge against unwinding and paying any associated taxes at that point.
Finance Act 2018
The changes to RND taxation have not stopped with the introduction of Finance (No 2) Act 2017. The Finance Act 2018, passed on 15 March, brought in further amendments to the taxation of offshore trusts, including a prohibition on the washing-out of trust gains via payments offshore.
This means that from 6 April 2018, subject to limited exceptions, it is no longer possible to reduce the trust’s pool of capital gains by making capital payments to non-UK resident beneficiaries and so gains will continue to accumulate in the trust.
The act also extends a rule from the previous Finance Act that can shift an income tax charge, and since 6 April this year a CGT charge, to the settlor where benefits are received by a close family member.
A further trust loophole that closed on 6 April is the ability for capital payments or benefits to be made to non-residents or remittance-basis users.
The intention is that those payments or benefits later be transferred to a person who would have been taxed had they been the direct recipient.
The latest act ensures that, even if there are multiple onward gifts from the trust, the final recipient in the chain can be taxed. If the final recipient is also within the scope of the close family member rule then the tax charge shifts to the settlor.
Life assurance policies
Planning for the current tax year and arrangements for the future can now move forward. The effectiveness of current structures must be assessed, particularly in light of the extension of tax exposure for deemed doms and UK residential property being drawn into the IHT net.
That said, options such as life assurance policies can continue to protect policyholders from tax on underlying investments, maintaining tax deferral and preserving clean capital beyond acquisition of deemed domicile.
Life assurance policies can also protect wealth from the tainting rules applicable to trusts and can remain effective for clients with family, financial and other interests in multiple jurisdictions.
Offshore life insurance: benefits for UK residents
Deferral of taxation: tax on income and capital gains is deferred until a chargeable event occurs.
Withdrawal allowance: tax-deferred annual withdrawal up to 5% of the initial investment.
Allowance pooling: unused withdrawal allowance each year may be carried forward for subsequent years.
Flexibility: withdrawals may be taken at a time when income tax rates are at an optimal level.
Estate planning: can be combined with trusts, for example, to achieve efficient UK estate planning.
Reporting: no reporting obligations where withdrawals are <5% allowance.
Remittance alternative: a life insurance policy provides a potential alternative to the remittance basis and associated complexity and cost, including the remittance basis charge. No need to segregate income, gains and capital within a life policy.
Assignments: policies can be assigned in whole or in segments as gifts to individuals without immediate tax consequences.
Time apportionment relief: reduces gain on termination of a policy in proportion to time spent as non-UK resident.
Top-slicing relief: reduces the tax payable on surrenders of a policy by splitting the gain across the number of years the policy has been held or since the last chargeable event.
Clean capital: clean capital preserved within policy and is not tainted by investment growth
Case study: UK resident non-doms
A UK RND individual, Mr X, is a Spanish national who has been living in the UK for 12 years. His two children from a previous marriage are considering moving to the UK.
He has accounts abroad but while he has kept good records of account movements, he has not segregated them well and the result is a mixed fund.
If he brings sums to the UK from the mixed fund, he will be taxed in an unfavourable manner. He needs an efficient, long-lasting solution to simplify the holding of his wealth.
Under the rules of Finance (No 2) Act 2017, he can cleanse his foreign accounts and separate out clean capital. This can be invested in a foreign life policy, and other categories of income or gains might be invested in their own policies.
There is no need to segregate accounts within a life policy because the sums invested no longer belong to the policyholder. The policy can access UK-based investments without generating a taxable remittance.
Mr X can access 5% of his investment in the clean capital policy in the UK without immediate tax. Sums he withdraws from other policies can be used abroad. If all, or substantially all, of Mr X’s foreign wealth is invested in the insurance solution, there is no need for him to use the remittance basis or pay the £60,000 ($78,900, €68,200) annual charge.
Later, if Mr X decides to return to Spain, his policy will continue to be effective there, compared with some other structures, such as trusts, which may be treated disadvantageously.
Alternatively, if he remains in the UK the policies continue to deliver tax deferral beyond his acquisition of deemed domicile.
Prior to acquiring deemed domicile status, he may decide to settle a policy or policies on offshore trusts to exclude them from the scope of inheritance tax.
Policies settled in this way may also offer protection from the trust tainting provisions, providing further peace of mind. He may also decide to gift part or all of a policy to his children should they join him in the UK.
They can then benefit from the same advantages, and the gifts, while Mr X is non-domiciled, are not themselves taxable.
Further reading:
‘Once in a lifetime opportunity’ for UK non-doms
By Simon Gorbutt, director, wealth structuring solutions, Lombard International Assurance
