Non domiciled persons have a significant opportunity to structure their affairs efficiently for tax purposes. Legislation has been introduced to prevent long term residents from having the same opportunities to structure their affairs efficiently.
For inheritance tax (IHT) purposes, there was previously a deemed domicile rule, which prevented the creation of an excluded property settlement after becoming deemed domiciled. It was possible for an individual to settle an excluded property to hold non-UK situs assets outside the scope of IHT. Trustees would simply hold UK assets through offshore companies thereby protecting them from IHT.
Under the new legislation, foreign income and gains realised in non-UK resident trusts settled by a non-domiciliary prior to becoming deemed domiciled, are largely outside the scope of UK tax. Protected settlements are subject to a tax regime that is more favourable than the regime that applied to non-resident trusts created by UK resident and domiciled individuals.
The UK source income of a settlor interested trust is attributed to the settlor and taxed on the arising basis. The legislation, referred to as the transfer of assets abroad legislation actually taxes the income on the transferor where they retain a power to enjoy that income by virtue of the transfer (and/or associated operations). There is a exclusion where the transfer is made for commercial reasons and none of the reasons are for the avoidance of tax. The provisions are disapplied for protected foreign source income.
For capital gains tax purposes, trust and the gains of its underlying companies are not attributed to a deemed domiciled settlor.
These protections make the use of offshore trusts by non-domiciled and non-deemed domiciled persons attractive. However, their attractiveness may be lost if there is ‘tainting’ or if the settlor acquires a UK domicile of choice. Tainting is where property or income is provided directly or indirectly for the purposes of the settlement by the settlor, or by the trustees of any other settlement of which the settlor is a beneficiary or settlor, at a time when the settlor is domiciled or deemed domiciled in the UK.
Tax Planning with Trusts
Prior to 6 April 2017, if a non-domiciled person was approaching deemed domicile for IHT purposes, they might have to settle an excluded property trust to protect assets from IHT. Under the new rules, these benefits remain, although now would be within the protected settlements regime for income tax and capital gains tax (CGT) purposes. Furthermore, there is no necessity to pay the remittance basis charge of up to £90,000.
The trustees of existing trusts should consider the benefits of distributions ahead of a settlor interested beneficiary becoming deemed domiciled. For example, accelerating income or capital so they are taxed on the remittance basis rather than the arising basis may be beneficial. Trustees should also consider whether historic capital payments were matched at the time they were made: gains arising once a beneficiary is deemed domiciled may be matched to the historic benefits without the benefit of the remittance basis, resulting in an immediate tax charge.
Other considerations for those becoming deemed domiciled will include existing loan arrangements, whether tainting is unavoidable and the potential exclusion of the settlor and his spouse, the settlor’s children and grandchildren. It may also be worth considering whether UK resident trustees are appointed.
Segregated Accounts and Deemed Domiciled Taxes
Once the settlor/beneficiary is deemed domiciled they will be taxed on the arising basis. The previous benefit of segregating income and capital gains will be lost. Historic income and gains can be paid into a clean capital account. The existing accounts should be managed as before by avoiding UK situs investments.
Careful consideration of what accounts are maintained will be required.
Acceleration of Capital Gains
A settlor/beneficiary may also wish to consider rebasing: i.e. the sale of personally held assets standing at a gain so that the gain is eligible for the remittance basis.
Deemed Domicile Estate Planning
It would also be prudent to consider estate planning ahead of becoming deemed domiciled. Planning could involve planning with the trust or assets held personally.