The Finance Bill introduced in March 2017 provided for a number of significant changes to the taxation of non-UK domiciled individuals and non-UK trusts. These changes were withdrawn from the Finance Bill as a result of the General Election, leading to frustration for many of our non-dom clients, especially for those who have implemented planning on the basis of the proposed new rules.
On 13 July 2017, the government announced that it expects to introduce a Finance Bill as soon as possible after the summer recess, re-enacting the withdrawn-provisions. This will take backdated effect from 6 April 2017.
This move towards certainty is welcome and, based on the government’s announcement, it seems very likely that any planning implemented prior to 6 April 2017 was well timed and will be effective.
Until the Finance Act becomes law, most likely in October or November, it is still possible that further changes could be made, however we think that this is unlikely. If further changes are made, they are not expected to be significant and will hopefully focus on clarifying some areas of ambiguity in the existing drafting.
In most cases, it should now be safe to proceed with planning on the basis that the changes will come into effect. We look at what trustees and individuals can do to prepare.
Deferred anti-avoidance provisions
It is important to remember that some of the proposed anti-avoidance provisions relating to offshore trusts were not included in the Finance Bill 2017. The government has stated that it is the intention to include these in the following Finance Bill to take effect from 6 April 2018.
The measures which have been deferred include the following:
- Rules preventing the pool of accumulated gains in an offshore trust being reduced or “washed out” by a distribution to a non-UK resident.
- Onward gifting rules which will tax UK individuals who receive gifts from non-UK residents made out of distributions received by beneficiaries of an offshore trust who are non-UK resident or non-UK domiciled, in circumstances where the ultimate recipient would have been taxable had he or she received the distribution directly from the trust.
- Provisions which will tax a settlor on gains matched with distributions to close family members who do not pay tax as they are either non-UK resident or non-UK domiciled.
- Matching of trust level income against distributions to the settlor or a close family member of the settlor so that tax will be payable even if the motive defence applies.
What should trustees be doing now?
1. Review residential property holding structures
The new rules affect any offshore structure which derives its value from:
- UK residential property
- loans used to acquire, maintain or improve UK residential property
- collateral provided for such loans.
In many cases, residential property holding structures are now positively disadvantageous for tax purposes. In light of the new UK trusts register, non-tax advantages, such as confidentiality, have also significantly reduced.
We recommend that any trustees who have not yet done so, seek advice on whether their structure will be caught by the new rules. Where a structure is caught by the new rules, it will no longer provide any inheritance tax benefits. If the annual tax on enveloped dwellings (ATED) is payable, there is a strong case for dismantling the structure, although this is likely to come at a tax cost, potentially including an inheritance tax exit charge, capital gains tax and stamp duty land tax.
Any inheritance tax exit charge will increase quarter-by-quarter so action should be taken sooner rather than later.
Trustees will also need to review offshore structures which have made loans, or provided security for loans, which have been used in relation to UK residential property.
2. Beware of tainting protected trusts and loans
Where offshore trusts are established prior to an individual being deemed domiciled in the UK under the new 15 out of 20 year rule, they enjoy certain protections so that the settlor will only be subject to tax when benefits are received from the trust by the settlor or by close family members.
However, the protected trust status will be lost, for both income tax and capital gains tax purposes, if further property, income or value is added to a protected trust by a settlor who has become deemed domiciled. The protections will be lost if the addition of property is by the settlor, or by the trustees of any other trust of which the settlor is a beneficiary or settlor. Given the importance of protected trust status there are concerns over what constitutes an addition to trust property, particularly in the context of loans as it is often difficult to know whether a loan is on arm’s length terms.
There is a 12 month grace period, for those settlors who became deemed domiciled on 6 April 2017, during which loans made to a trust, and which would otherwise cause the trust to be tainted, to be looked at. During the grace period, any offending loans will either need to be repaid or put on arm’s length terms.
Trustees need to be extra vigilant in reviewing any arrangements or transactions, with settlors who are about to become deemed domiciled, and with other trusts of which the settlor is a beneficiary or settlor. In particular they should consider the following:
- Ensure that they understand exactly when a settlor is going to become deemed domiciled and encourage the settlor to obtain an up to date domicile report if they do not have one on file.
- Ensure that procedures or safeguards are put in place so that no additional settled funds (unless covered by an exclusion) are received from settlors once they become deemed domiciled.
- Review the terms of all existing loans (made to and by the trustees) to check whether these might taint the trust once the settlor becomes deemed domiciled.
- Think very carefully before agreeing the terms of any new loans.
- Ensure that all interest is paid when due.
3. Make trust distributions to non-UK resident beneficiaries before 6 April 2018
Trust distributions to non-UK resident beneficiaries made before 6 April 2018 will be matched against, and therefore “wash out” the pool of capital gains in the trust. Distributions made after 6 April 2018 will not be matched and therefore will not reduce the pool of gains. If you are considering making a distribution to a non-UK resident beneficiary it makes sense to get on with this and do so before 6 April 2018.
4. Review benefits from offshore trusts
Any on-going benefits received from offshore trusts in the form of loans, moveable property (such as artwork or yachts) and land (such as accommodation), will need to be reviewed in light of the changes to the valuation of trust benefits. These changes apply to all offshore trusts and not only benefits granted to deemed domiciled beneficiaries.
What should individuals be doing now?
1. Obtain a domicile report
If you do not have a recent domicile report, consider obtaining one so that you understand your domicile status under the general law and your deemed domicile status. If you are not domiciled under the general law and not yet deemed domiciled, you can then take advice to optimise your UK tax position before you become deemed domiciled.
2. Identify which assets qualify for rebasing
Anybody who became deemed domiciled on 6 April 2017 can start identifying which assets qualified for rebasing and whether this provides opportunities for tax free remittances to the UK. In some cases it may be sensible to consider "banking" rebasing relief by making a disposal, as there are a number of circumstances in which rebasing may subsequently be lost.
3. Separate mixed accounts
All non-domiciliaries should consider whether they can take advantage of the ability to separate out mixed accounts before 5 April 2019. There is still some uncertainty surrounding the details of these rules and HMRC have indicated that they will be producing guidance on how they will apply the provisions. For those who need to bring funds into the UK our view is that there is now sufficient certainty to enable unmixing to start. But if you don't yet need funds in the UK it may be worth waiting slightly longer to see the guidance before taking action.
4. Make any gifts to UK resident individuals before 6 April 2018
If a non-UK resident or non-domiciled recipient of a trust distribution is intending to make any gifts to a UK resident individual, they should do so before 6 April 2018.
5. Take advantage of business investment relief
Consideration should be given to taking advantage of this business investment relief which is now more attractive and can continue to protect overseas income and gains which are invested in the UK even after an individual becomes deemed domiciled.
6. Review loans and collateral in relation to UK residential property
You will need to review any loans you have made, or security you have provided for loans, which have been used in relation to UK residential property.
7. Ensure historic tax affairs are accurate
Under separate legislation – known as the "requirement to correct" (RTC) due to be re-introduced, anyone with any offshore element to their tax affairs, will need to ensure that their historic tax affairs are in pristine order before 30 September 2018. After that date any errors – which could be as simple as getting your residence or domicile position wrong, or failing to remember a particular bank account – will generate a penalty of between 200% and 300% of the tax due. In many cases a penalty of a percentage of the underlying asset may also be charged.
These new rules apply not just to deliberate and careless mistakes, but even to innocent ones. The only defence is reasonable excuse – but having taken advice does not amount to a reasonable excuse unless it is from someone whom you reasonably believe to be competent to give it and where the advice is addressed specifically to your circumstances.
It will be sensible for anyone with offshore elements to their affairs to undertake a full review to make sure that everything is up to date. Even if this misses something, there is a much stronger chance that it will count as a reasonable excuse.
For further advice contact John Barnett or Suzanna Harvey.