An abbreviated version of this article is featured in the CityWire’s Tax Matters column.
Definition and types of domicile
Domicile is an old English Law concept which has a bearing on how your clients are taxed. There are four basic types of domicile:
- Domicile of Origin
Everyone has a domicile of origin; it normally comes from your father and his father, back up the male line of your ancestors. It is the country (or State in a federal system) where your client heralds from what they consider as their mother country. It is not necessarily relevant where your client was born.
- Domicile of Choice
It is possible to displace a domicile of origin with a domicile of choice, however this requires severing ties with the country of your origin and putting down roots in a new country sufficient to dislodge the domicile of origin. I normally use the following analogy:
Imagine that you cover your hand in rubber based glue like Evo-Stik, put your hand on a table and wait for the glue to go off. Now raise your hand off the table and you will see stringy bits of glue connecting your hand to the table. To be able to release your hands, you will have to cut your hands free from those strings. Your domicile of origin is as adhesive as this.
- Domicile of Dependency
If during one’s childhood the parents move and settle in a different country, thereby changing their domicile of origin to a domicile of choice (see above), one will acquire a domicile of dependency in that new country. Upon reaching adulthood one’s domicile of origin will displace the domicile of dependency, unless it can be argued that one has changed their domicile by choice.
- Deemed Domicile
HM Revenue & Customs have had a deeming rule for many years which originally impacted Inheritance Tax (IHT) only. This original deeming rule came into play when one had been UK tax resident for seventeen out of the last twenty years.
When explaining the concept of domiciles, I often use the analogy of a 1,000 piece jigsaw puzzle. On one side of the puzzle there is a picture and on the other side it is blank. If one throws the puzzle pieces up in the air and looks at the pieces when they land, there will be some that are blank and some with a picture face up. Each piece is a different fact about your client. The more pieces have landed with pictures face up, the better. These are in favour of your client whereas the ones showing the blank side face up are in favour of HMRC. The job of the adviser is to examine each of the facts to see if they should be showing a picture (for the client not domiciled) or blank (for HMRC UK domiciled).
Basis of Taxation of Non-Domiciled Clients
Successive governments have for many years thought about and discussed how they could change the rules regarding the taxation of non-domiciled people. The first major change happened in April 2008 and there has been minor tinkering since then. In April 2017 we will see a significant reform of the rules.
Pre April 2008 a taxpayer who was not domiciled in the UK, could be tax resident in the UK and could by careful planning minimize their income and capital gains tax liability, in relation the their offshore wealth. One was also able to arrange matters using offshore companies and trusts to minimize one’s exposure to tax including IHT, whilst being able to remit money and or assets to the UK. This basis of taxation is known as the remittance basis.
From 6 April 2008 a new regime was introduced, to reduce the income tax and capital gains tax benefits UK resident non-domiciled people could enjoy. This was achieved by introducing a charge to continue to use the remittance basis, based on how long one had been UK tax resident; this is known as “The Remittance Basis Charge” (RBC). The figures are as follows:
|Tax Year||Years in the UK||Charge|
|2008-09 to 2014-15||7 out of the previous 9||£30,000|
|12 out of the previous 14||£50,000|
|2015-16 onwards||7 out of the previous 9||£30,000|
|12 out of the previous 14||£60,000|
|17 out of the previous 20||£90,000|
These rules only related to Income Tax and Capital Gains Tax and did not reflect on IHT.
Changes from April 2017
From 6 April 2017 there are major changes lined up which will affect all taxes. The same remittance basis charges apply as in 2015-16 for the first two brackets of years of UK residence. However once your client has been UK tax resident for 15 out of the previous 20 tax years, he/she will become DEEMED DOMICILE for ALL taxes. This will mean that long stay non domiciled taxpayers will now be taxed on exactly the same basis as UK resident domiciled individuals; i.e. on their WORLDWIDE income and gains for all future years.
There are a number of planning points to consider:
- Mixed Funds
There is a one off opportunity to unravel and separate out pure capital, income and capital gains from a mixed fund. One needs to be able to establish accurately the split between pure capital, income and gains. Once this is done the various elements of the mixed fund can be segregated into separate accounts. This will therefore allow historical pure capital to be remitted without a charge to tax.
- Golden Trusts
Prior to becoming deemed domicile as above it is possible to set up what is known as a Golden Trust. Such trusts if correctly constituted AND maintained can effectively continue the remittance basis. This is a specialist area which needs careful planning and great discipline from advisors, clients and trustees to prevent the trust from becoming tainted in the future.
- UK Residential Property
HMRC will in future be able to subject the value of UK residential property to IHT. The method of taxation depends on how the property is held:
a. Personally Held Property
This has always been subject to IHT as it is a UK-sited asset. Care needs to be taken over any debt taken out to acquire the property, or indeed subsequently following the introduction of IHT anti-avoidance legislation in July 2013, for debt acquired post 5 April 2013.
b. Property held via a company
Post 5 April 2017 any value of a company which is attributable to UK residential property will be liable to UK IHT. As an example, if a company (UK resident or overseas) owns a UK residential property valued at the date of death of the beneficial owner of the company at £1m, without any loan against it, plus a non UK property worth £2m without a loan against it, then 1/3 of the value of the company would be liable to IHT.
The position becomes more difficult when debt is involved as it might not be deductible for UK IHT purposes, see above.
One may wish to isolate the UK residential property by transferring it to a new clean company or by moving it into personal ownership. Then the other assets owned by the company do not need to be returned to HMRC and therefore the apportioned value can be worked out.
Where UK residential property is owned by a company one also needs to take into account both the Annual Tax on Enveloped Dwellings (ATED) regime and the Benefit in Kind regime.
Transfers of ownership may lead to a Stamp Duty Land Tax (SDLT) liability and great care needs to be taken not to fall foul of anti-avoidance rules.
c. Property owned by Trusts
Almost all trusts created during lifetime post 21 March 2006 are within what is known as the relevant property regime and subject to:
i. an entry charge at up to 20%
ii. Ten yearly charges at up to 6%
iii. Exit charges at up to 6%
From 6 April 2017, any trust irrespective of its residence or the domicile of the person creating it (the settlor), will be liable to the above charges at ii and iii in relation to the value of UK residential property. The trust will be required to complete UK IHT forms which will need to declare the full assets of the trust. However any tax liability will only arise on the value of the UK residential property. Relief may be available for any loan secured on the property, see above.
As mentioned above, if the trust owns other non UK assets the trustees may want to consider isolating the UK residential property in order not to have to report the other assets of the trust to HMRC.