Non-domiciles resident in the UK have been given something to think about in the pre-Budget report. Brendan Harper looks at the options available to those affected by the rule changes
Never has there been such a hot potato as the subject of non-domiciled individuals resident in the UK ('non-doms'). Year after year, current and past UK governments have dodged the issue; when they do say something about it, it is either a brief statement hidden deep in Budget material, or another consultation paper, neither of which ever says anything of substance.
Finally, Alistair Darling has grasped the nettle - with a little help from Gordon, and a lot of help from the Tories. But any change was bound, on the face of it, to be little more than tinkering at the edges, and that is what the proposals contained in this year's pre-Budget report seem to confirm.
The reason why change has been so long coming is due to the great difficulty facing any UK government - how do we keep wealthy foreigners living in the UK (buying property and eating in fancy London restaurants), and at the same time keep the press and the European Union off our backs? The rule changes appear to have achieved this - the press are claiming victory, while the tax planning community, apart from a few grumbles at the back from the offshore trust industry, are largely supportive of the proposals.
Few people would be unaware that the UK is one of the world's best tax havens for people who are resident but not domiciled here. This is because non-doms are allowed to claim the remittance basis of taxation, where overseas income and gains are only subject to UK tax if they are brought into the UK. Furthermore, with a little planning, income and gains can even be brought into the UK tax-free. Following the PBR, however, things are about to get tougher for non-doms.
In future, anyone who has been resident in the UK for more than seven years as at 6 April 2008 and beyond will have to pay an annual tax charge of £30,000 if they wish to continue benefiting from the remittance basis of taxation - this is an additional charge on top of their normal annual tax bill. If they wish to avoid this charge they will have to elect to be taxed on overseas income and gains on an arising basis. If you are a Russian billionaire, then the choice is a no-brainer, but what of those who are not so well off?
Based on a 40% tax liability, anyone with more than £75,000 a year in overseas income would potentially be better off electing to pay the £30,000 liability. This suggests if you have anything up to £1.5m in overseas capital producing income, then you need to think about paying UK tax on that income in future. An alternative approach could be to choose to be taxed on your overseas income, but then ensure that no overseas income is generated. This makes the use of offshore bonds a much more attractive proposition for those individuals.
Even those who have more than £1.5m in overseas capital could benefit from this structure, if they currently bring income or capital gains into the UK to live on. Under current rules, it is possible for non-doms to 'manage' the remittance basis so that tax is not payable in the UK on income earned overseas. As a first step, a non-dom is normally advised to segregate income and capital. For example, £100,000 is held in an offshore bank account (called the 'capital' account) and all interest earned (say, £6,000 a year) is credited to a second 'income' account. If the individual needs to bring money into the UK, then he can do so by taking a tax-free withdrawal from the capital account. When he is overseas, for example on holiday, he can make withdrawals from his income account, which will be tax-free as long as he spends the money while overseas.
But what happens if the individual needs to bring money from the income account into the UK? A tax-free remittance of this money is possible by using the 'ceased source' principle. This works by closing the capital account, and then remitting the money from the income account in the following tax year.
The PBR contains proposals to scrap the ability to make tax-free remittances in this way. Furthermore, existing anti-avoidance provisions that target income arising within offshore trusts or companies look likely to be extended to non-doms, as well as a tightening up of the definitions of what constitutes a remittance. For example, offshore income can currently be gifted to a spouse or family member who can then remit it to the UK tax-free; this is unlikely to survive the changes.
In relation to capital gains, it is not possible to segregate gains from the original capital, or to use the ceased source principle in the way that you can with income. However, if an asset is held in an offshore trust, the gains made by the trustees can be remitted to a UK resident non-dom completely tax-free under current tax rules. The PBR announcement contains a proposal to restrict this ability for non-doms to live tax-free on capital gains. In future, it is likely that UK gains made on UK assets in an offshore trust will be taxed on an arising basis, and gains made on non-UK assets will be taxed on a remittance basis.
This means that for both income and capital gains tax, it will not be possible for a non-domiciled individual to live tax-free in the UK. So, for those who currently bring income and gains into the UK using one of the techniques outlined above, it is pointless paying the £30,000 a year extra tax, as they will derive no benefit from it.
Instead, they should consider opting for worldwide taxation, and ensure that they shelter their overseas investments in offshore bonds. An offshore bond would allow these individuals to benefit from tax-free accumulation of overseas income and gains, tax-free remittances to the UK in the form of 5% withdrawal allowances and tax-free proceeds if they do not surrender the policy until they leave the UK.
Finally, no change was announced in the PBR on the inheritance tax treatment of resident non-doms. Therefore, the ability to create an excluded property trust with foreign assets remains a way for individuals to shelter their wealth permanently from IHT, even if they subsequently become UK domiciled or deemed domiciled.
But individuals should act now before it is too late. The PBR note contained a statement that "the Government will also be consulting on whether people who have been resident in the UK for longer than 10 years should make a greater contribution".
Could this be an early warning that IHT is next on the agenda for non-doms? n
Brendan Harper is technical services manager at Friends Provident International
This article contains general information only and is not intended to be taken as specific investment or tax advice and is based on the assumption that further information would be required and provides only a guide to some of the relevant routes that an intermediary could cover in advising the client.
Scope for change post-Brexit
To tackle liquidity issues
More than £100m in pipeline
DB data published last week
'Heavily influenced by Morningstar'