IN161 - Changes in the way that Non Domiciled Resident Individuals will be taxed in the UK

With effect from 6th April 2008 many individuals who in the past paid little or no UK tax, due to their status as being non domiciled in the UK, will have significant UK tax bills to pay. In addition those who had previously ensured that they were not resident in the UK will find it harder to maintain this position. It is important to recognise that much detail remains uncertain and draft legislation has not yet been published but it is vital that the key issues are considered now.

Main Implications of the Draft Legislation

The main effect of the draft legislation for the majority of non domiciled individuals is that once they have been resident in the UK for seven years they will have to:

• Pay tax on their worldwide income and capital gains
  OR
• Pay a lump sum annual levy of £30,000 plus UK tax on any income or capital gains remitted to the UK (as a general guide only individuals whose unremitted foreign source income and capital gains are in excess of £80,000 per annum will find it beneficial to opt to pay the annual levy).

In addition many non domiciled individuals, who have in the past not needed to complete annual tax returns in the UK, will now find that they have to do so. Due to the complexities of the hybrid legislation, professional advice with its associated costs is likely to be needed.

Criteria to Determine Residence in the UK

Whilst, technically, the major changes relate to the position of non domiciled individuals, the new regime concerns non domiciled individuals who are also resident in the UK. Residence in the UK is determined by being in the UK in excess of 182 days in any tax year (6th April to 5th April) or by being resident in the UK for an average of 91 days in any tax year, taking the average of the tax year in question and the three previous tax years.

The major change in assessing whether an individual is resident in the UK or not is the method used to calculate the days of residence:

• In the past, days of arrival and departure were excluded when counting days of residence.
  
• It is intended, with effect from 6th April 2008, that days of arrival and departure will count as days of residence in the UK.

Frequent visitors to the UK will therefore find that they are significantly more likely to be designated as UK resident under the new regime than they were under the previous regime.

The Seven Year Residence Rule

Having determined whether or not individuals are resident in the UK for tax purposes, non domiciled individuals will need to consider whether they have been resident in the UK for seven years. It is unclear how this will be calculated. Press speculation has suggested that this may be based on being resident in the UK for seven out of the previous ten tax years.

It is, however, certain that the years prior to the tax year commencing on 6th April 2008 will be included in the count, with the effect that those who have already been in the UK for seven years will be affected by the new rules from 6th April 2008.

• Those who have not been resident in the UK for seven years can continue to be taxed in the UK only on income and capital gains remitted into the UK. They will not have to pay an additional tax levy of £30,000. They will, however, lose the annual personal allowance for income tax and the annual exempt amount for capital gains tax unless the foreign income is less than £1,000 per annum.
  
• Individuals who are not domiciled in the UK, but have been tax resident here for seven years (however this will be calculated), have a stark choice. They can elect to pay an annual levy of £30,000 and lose the entitlement to certain personal allowances, if they wish to continue with the remittance basis OR they can elect to be taxed on their worldwide income and capital gains. This will create a number of disclosure obligations due to the need to complete annual tax returns and may well generate queries from HM Revenue & Customs.

The Removal of “Anomalies”

Changes to the taxation rules are essentially a fundraising exercise by the British Government. At the same time a number of established practices which have now been termed “anomalies” are to be modified:

• Income generated from a source that has ceased to exist before the beginning of the tax year in which it is remitted to the UK will remain taxable as income. In the past it was common practice to ensure that, for example, bank accounts that gave rise to bank interest were closed before the start of a tax year, so that in the following tax year that bank interest could be remitted into the UK without any UK tax liability.
  
• Legislation will be introduced to ensure that non domiciled residents can no longer avoid tax on gains accruing in non resident trusts or companies. No details have as yet been published, but well established anti-avoidance legislation already applies to UK domiciled individuals. We can anticipate that the legislation will be similar and that any gains made by an offshore trust will create a tax liability for non domiciled resident beneficiaries as those gains arise. The UK tax authorities have stated: “Where people taxed on the remittance basis bring foreign income or gains into the UK, that income or gain will be taxed, whatever structure or mechanisms are put in place.”
  
• An attack on the current position where a gift by a non domiciled individual which takes place outside the UK and which has “no strings attached”, can be remitted freely by the donee to the UK without any tax liability. This applies equally to gifts to spouses and closely connected individuals, as well as to gifts to third parties.
  
• Legislation will be introduced that will treat importation of assets, other than cash, as remittances. It is the intention of the British Government that anti-avoidance measures which currently apply to UK domiciles with offshore investments will also be enforced for UK non domiciles.

Inheritance Tax

There is no suggestion of a change to the status of non domiciled individuals with regard to UK inheritance tax. The current position is that non domiciled individuals are liable to UK inheritance tax only on UK situs assets, unless they have been resident in the UK in seventeen out of the preceding twenty years. If this is the case, they will be deemed to be domiciled in the UK and liable to UK inheritance tax on their worldwide assets.

Structures that have been established by non domiciled individuals with a view to minimising both UK income tax and UK inheritance tax may still be of value for inheritance tax purposes, even if mitigation of income tax will be negated by the new legislation. It is very important for individuals and their advisers to review their specific situation.

Required Action

• All non domiciled individuals who visit the UK frequently or are permanently resident in the UK, and their advisers, must review their situation and make choices. This is made more difficult by the fact that the British Government has not yet published the detailed rules that will apply. Many non domiciles will consider the option of an alternative location of residence other than the UK, to entirely avoid the proposed UK tax complications and associated administrative burden. Consultation with a professional adviser is highly recommended.
  
• UK domiciles who are not resident in the UK, but who visit the UK frequently, will need to re-assess their situation if they wish to ensure that they continue to remain UK non resident.

Additional Information

Please contact Laurence Binge or Joe Dunne in the UK office for additional information, or contact us.