Introduction
Individuals who reside in the UK, but were born elsewhere and have foreign parents, or who may be thinking of moving to the UK, may not be subject to the full range of UK taxes. Special rules apply to persons who are not domiciled in the UK. A UK domiciled and resident person is subject to tax on worldwide income and capital gains and his worldwide assets are charged to inheritance tax on death. A person who is not so domiciled may be subject to tax on income and gains only to the extent that they are remitted to the UK and his estate liable to inheritance tax only on assets located in the UK.
This paper is intended to provide a general overview of the rules that apply to non-domiciled persons. However, it should not be taken as tax advice and reference should be made to a competent professional before setting up any structure referred to.
Domicile
In English law everyone is born with a domicile. This is generally the domicile of the father and is known as the domicile of origin. The domicile of origin is retained until, by his actions, a person demonstrates that he has broken his ties to his domicile of origin and established a domicile elsewhere – a domicile of choice. Moving from elsewhere to the UK and making that country the permanent home with the intention of staying can be such an event.
General principles that apply to UK taxation
Residence and Ordinary Residence
The general rule is that a person who resides in the UK for a period of 183 days in a tax year is regarded as resident for tax purposes. He can also be resident if UK visits over a four-year period average more than 90 days a year. The timing of residence status based on annual visits depends on whether or not he intends making such visits at the outset. If so, residence begins immediately; otherwise it starts from the fifth year.
A person who spends an average of 90 days a year in the UK is regarded as ordinarily resident. He is also ordinarily resident if on arrival he intends to stay in the UK for three or more years. Occupying a property for three years or more is evidence of such an intention.
Income Tax
Income from UK sources is chargeable to income tax, generally without regard to residence status. The worldwide income of residents is generally taxable. An individual who is resident but not domiciled in the UK will not be liable to UK tax on investment income unless that income is remitted to the UK. The tax rules on remittances apply from the date residence commences whether or not the taxpayer is regarded as ordinarily resident.
Capital Gains Tax
Profits on sales of UK assets are chargeable to capital gains tax if the taxpayer is either resident or ordinarily resident in the UK at any time in the tax year in which a disposal is made.
Individuals who are not domiciled in the UK are only liable to capital gains tax on profits from the disposal of assets located outside the UK. Where the asset is denominated in a foreign currency the gain must be calculated in sterling using the rates of exchange on the dates of purchase and sale respectively.
Inheritance Tax
Individuals who are not domiciled in the UK are liable to inheritance tax in respect of assets located in the UK. Indeed such assets are within the charge to inheritance tax by whomsoever they are owned and wherever resident. Persons who are not domiciled in the UK are not liable to inheritance tax in respect of assets located outside the UK.
A person domiciled outside the UK is treated as being domiciled, for inheritance tax purposes only, if he has been resident in the UK in 17 out of 20 tax years.
Tax Planning Opportunities
An individual who is not domiciled in the UK is able to take advantage of the special rules described above to limit his liability to taxation, even if he is resident in the UK. If he does not need to remit foreign income or capital gains he can completely eliminate liability to UK taxation. Such protection from tax can be achieved by using the following two-step procedure:
- Form an offshore company in a jurisdiction, which does not impose taxes. There are many such territories and those we recommend are described elsewhere on our website. Transfer the UK assets to the company in exchange for shares. For UK tax purposes the asset owned by the non-domiciled person is now the shareholding and not the underlying assets. Being an investment in a foreign company the shareholding is outside the charge to inheritance tax. Assets located outside the UK should also be transferred to the company. This will protect them in the event that the individual acquires a UK domicile or deemed domicile and from similar taxes in the countries in which they are situated.
- Donate the shares in the company to the trustees of a family trust established in the tax- free territory outside the UK. The assets of a trust settled by a person who was at the time domiciled outside the UK are, if they are not UK assets, outside the charge to inheritance tax in the death of the settlor or on the death of any other beneficiary, wherever resident at that time. The trust accordingly continues to provide shelter from inheritance tax even if the person who set it up becomes domiciled in the UK. It may provide similar benefits if he later decides to return to his country of origin, or elsewhere. Visit http://www.chesterfield-offshore.com/offshore-trusts.htm for more information on the types of trust in common use.
Taxation of the trust and company
Whilst neither the trust nor the company can be taxed directly there are circumstances in which an individual resident in the UK can be charged to tax on the income and capital gains arising to the structure. This generally depends on where the settlor is resident.
UK Resident but not domiciled
Capital Gains Tax
Gains made by the trust or the company will not be subject to capital gains tax. This applies to UK assets as well as non-UK assets.
Capital gains remitted to beneficiaries who are resident in the UK but not domiciled there will not be charged to capital gains tax. Any UK resident and domiciled beneficiaries are taxed on any gains that they receive.
Income Tax
Foreign income within the trust is not subject to income tax, unless remitted to the UK.
UK source income received by the trust or company is taxable. This liability can sometimes be reduced particularly for UK rental income. If the settlor or his spouse is UK resident and can benefit from the trust he will be taxable on the UK income as it arises, whether remitted or not.
Inheritance Tax
An offshore trust established by a non-UK domiciled individual is only subject to inheritance tax if it has UK assets. As described above, inheritance tax on UK assets is avoided by holding them within an offshore company owned by the trust.
Not resident or domiciled in the UK
Capital Gains Tax
Gains made by the trust or company will not be subject to UK capital gains tax.
Income Tax
UK source income receivable by the trust or company is taxable. The liability can sometimes be reduced, particularly in respect of UK source rental income.
Inheritance Tax
An offshore trust established by a non-UK domiciled individual is only subject to inheritance tax if it has UK assets. As described above, inheritance tax on UK assets is avoided by holding them within an offshore company owned by the trust.
A trap to avoid
Non-UK Domiciled Spouses
Where an estate passes on death to a surviving spouse it is exempt from inheritance tax, but only when both spouses are UK domiciled. Where the survivor has a foreign domicile this exemption is limited and without planning, can result in a liability. Couples in this position should consider transferring assets from the UK domiciled spouse to the foreign domiciled spouse. If the recipient survives for seven years the gift will be free of inheritance tax on the death of the donor. The non-domiciled spouse will however be able to establish an offshore trust and company structure with all the benefits described above.
Ref: CO070606
