Changes to the UK tax rules concerning individuals who are not
domiciled in the UK but are either resident in the UK or own
property here were announced in the Summer Budget. This was
followed by the publication of the consultation paper "Reforms to
the Taxation of Non-Domiciles" on 30 September 2015 and further
details are expected in the December Finance Bill.
Readers will be aware that assets situated outside the UK, and
held in a trust set up by a non-UK domiciled settlor, do not
attract the usual IHT charges applicable to trusts - the trust has
excluded property status. A recent decision of the High Court in
Barclays Wealth Trustees (Jersey) Ltd v HMRC  EWHC 2878 (Ch)
has confirmed some important points on how HMRC interprets
legislation affecting such trusts. This month we will look at
excluded property trusts as well as the latest proposals affecting
Take care with your excluded property
One of the key planning strategies for non-UK domiciled
individuals, who are likely to become deemed domiciled because of
their residence in the UK and who are keen to protect their
offshore assets from IHT, is to create an excluded property trust
(EPT). As long as the property remains excluded, even if the
settlor is one of the beneficiaries (as would normally be the case)
the trust property will remain outside of the UK IHT net even after
the settlor has become UK domiciled.
The above-mentioned case was an appeal by Barclays Wealth
Trustees (Jersey) Ltd and Michael Dreelan (the settlor of the trust
in question) against a determination by HM Revenue and Customs
pursuant to section 222(3)(b) of the 1984 Inheritance Tax Act of a
liability for inheritance tax said to arise in relation to the
ten-year charge applicable to trusts.
The facts were as follows. The property in the Michael
Dreelan Trust ("MDT") was "excluded property" for the purposes of
the Act, settled by a non-domiciled settlor, and would have been
free from the ten-year charge had it remained there. Some of the
property was transferred from MDT to another trust, the Dreelan
Bros Joint Trust, which had the same settlor but who, by the time
of that transfer, had become domiciled in the UK. The property was
no longer excluded at that point. It was then transferred back to
the MDT. The basic issue was whether that property re-acquired
excluded property status.
The judge decided that at the time of the transfer back into the
MDT trust the property had lost its status as excluded property for
the purpose of the ten-year charges and rejected the appellants'
arguments that what mattered was only the domicile of the settlor
when he created the first settlement and the fact that the property
was situated outside the UK at the time of the ten-year
anniversary. Their appeal was dismissed albeit that leave to appeal
was granted so we may not have heard the last of this. The
important conclusion from this case is that great care needs to be
exercised when dealing with EPTs in order to ensure that their
excluded property status is protected.
Although, in the context of the proposed changes to the taxation
of non-domiciles, the Government has said that the assets of an EPT
will generally remain outside the scope of IHT, there are plans to
introduce an exception to this rule, for a particular type of
settlor, as explained below.
Proposed changes to the tax treatment of non-domiciled
Broadly, these changes consist of:
- amending the deemed domicile rule for long-term residents to 15
out of 20 (from 17 out of 20) tax years for all tax purposes from 6
April 2017, i.e. extending it to CGT and income tax;
- amending the "returning to the UK domicile rule" so that anyone
who returns to the UK will reacquire their UK domicile from the
date of return; and
- bringing UK residential property owned by a non-UK domiciled
individual into the IHT net.
The new rules, which are intended to take effect from April
2017, will mean that the remittance basis charge of £90,000 (that
currently applies to those who have been resident for at least 17
of the past 20 tax years) would no longer be applicable from the
tax year 2017/18; and an individual will become deemed domiciled
for IHT at the start of their 16th consecutive tax year of UK
residence, rather than at the start of their 17th tax year of
residence as is the case under the current rules.
In order to allow non-domiciles, who are internationally mobile,
to continue to benefit from "non-dom" status in a way that is not
appropriate for those who are firmly based in the UK, the
legislation will allow someone who has lived in the UK for 15
consecutive tax years and who then leaves the UK for 6 or more
consecutive tax years, to return here and claim non-dom status
again for another 15 years (assuming they still had a foreign
domicile status under general law).
However, this would mean that, while an individual who has
become deemed-UK domiciled and ceases to be resident in the UK will
continue to be deemed-UK domiciled for up to 6 years following
their departure, an individual who is domiciled in the UK who
leaves and acquires a domicile of choice in another country could
potentially become non-domiciled for IHT purposes more quickly.
This is because the current IHT rules provide that an individual
who ceases to be domiciled in the UK will only continue to be
treated as domiciled in the UK if they have been domiciled in the 3
years immediately preceding the chargeable event.
To address this disparity, the government is proposing to
introduce a rule which treats a UK domiciliary as non-domiciled on
the later of the date that they acquire a domicile of choice in
another country, and the point when they have not been resident in
the UK for 6 years. A similar situation arises in respect of
non-domiciled spouses of UK domiciles who elect to be treated as UK
domiciled for IHT purposes. Under the current rules, such an
election will cease to have effect if the electing spouse is
resident outside the UK for more than four full consecutive tax
years. It is proposed that this period is also aligned to 6 tax
years under the new rules.
What are the proposed rules for offshore trusts created
by non-domiciled settlors?
As indicated above, in principle the government does not intend
to change the rules which will apply to EPTs where a person has
become deemed-UK domiciled under the new rule. However, an
exception to this rule will operate as follows.
If someone with a UK domicile of origin acquires an overseas
domicile and sets up an offshore trust while non-UK domiciled then,
once that individual subsequently becomes UK resident (and their UK
domicile is revived) the assets in that trust will cease to qualify
as excluded property and will be liable to IHT charges. Since the
residence criteria will be based on the statutory residence test,
under which individuals are either resident or non-resident for the
whole year, this could create situations in which property will
switch from being excluded property to being liable to IHT under
the 'relevant property' regime for periods of one or more tax years
and trustees will therefore need to consider whether a ten- year
charge arises at any point during each period the settlor is UK
In addition, it is proposed that an individual with a deemed UK
domicile who had established an offshore trust (from which they can
benefit, i.e. a settlor-interested trust) would not be taxed on the
income and gains of the trust on an arising basis (as might be
expected, if the concept was that such an individual should be
treated in exactly the same way as a UK domiciliary). Instead,
fiscal impositions for the settlor in respect of the trust would be
limited to tax on any UK source income of the trust, and tax on any
benefits received from the trust. This, however, may give rise to
some peculiar consequences.
The consultation document suggests that a deemed domiciled
individual receiving a benefit from an offshore trust should be
taxed on the value of the benefit received, whether they receive
the benefit in the UK or not (which is to be expected), and
without any reference to the income and gains of the trust.
This would mean, for example, that a capital payment which had
not originated from income or capital gain (but, say, from the
original capital settled into the trust) would be taxed at income
tax rates on the settlor. This is a completely new approach
and it remains to be seen how this provision, if indeed it passes
into legislation, will translate into practice.
Clearly, we need to wait and see what the final shape of the
proposed legislation will be but, on the basis of the current
proposals, there should still be scope for offshore trusts to be
used as roll-up vehicles for the benefit of foreign domiciled
families and to protect excluded property from IHT. Any advisers
with clients falling into this category need to be aware of the
proposals and discuss them with their clients. As always
professional advice will be necessary in all such cases.