UK Tax Update: Major Changes on the Way

On July 8, 2015, the Chancellor of the Exchequer, George Osborne, presented the UK Summer Budget to Parliament.

While there were many reforms included in the budget, our discussion here will be limited to the following changes that are of particular interest to our existing high net worth individual clients with UK connections:

  • The abolishment of the non-domiciled (non-dom) status for long-term residents;
  • A change in the taxation of UK sourced dividends; and
  • Inheritance tax on all real property situated within the UK irrespective of ownership form.

Permanent Non-Dom Status Abolished, Effective April 2017

Non-dom taxpayers in the UK were historically given the option of using a remittance basis of taxation by paying a remittance basis charge (RBC), which could be as high as £90,000 for long-term residents (defined as individuals living in the UK for 17 or more years out of the most recent 20 tax years). The remittance basis of taxation is an alternative to being taxed on an arising basis under UK tax rules, which is similar in concept to U.S. taxation of worldwide income of its citizens and green-card holders. For non-dom individuals with significant income sources and gains outside of the UK, it may have been advantageous to annually pay the RBC rather than paying tax on worldwide income on an arising basis.

However, starting in 2017, individuals who have been UK residents for more than 15 of the past 20 tax years but are foreign domiciled under general law will be deemed domiciled in the UK for all tax purposes (i.e. income, capital gains, inheritance taxes). As part of this new regime, once a taxpayer acquires domicile (or is deemed to be domiciled) in the UK, the individual will only be able to lose their UK domicile by exiting the UK for a period of more than five years prior to re-acquiring residency in the UK. If at a later date (having spent more than five tax years abroad) the non-dom returns to the UK for a period of time but does not intend to permanently stay, they will remain foreign domiciled under general law and will be able to spend another 15 years as a resident for tax purposes before again becoming deemed domiciled in the UK. The following tables illustrate the changing RBC guidelines:

Taxation of UK Dividends

Starting April 6, 2016, the dividend tax credit system will be replaced by a dividend income allowance of £5,000. New rates will also be introduced as part of this new regime. The new dividend tax rates in effect next year will be higher: 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers, and 38.1% for additional rate taxpayers. While these rates remain below the main rates of income tax, those who receive significant dividend income will pay more according to the Budget Report submitted.

Inheritance Taxes on Real Property Situated Within the UK

Under current rules, if a non-dom individual dies owning UK property directly, their estate is subject to inheritance tax (IHT) at 40% on the value of that UK property. It is irrelevant whether the deceased was resident in the UK. Once a non-dom becomes UK domiciled or deemed domiciled for IHT purposes, their worldwide assets become  subject to the IHT unless those assets have been settled into an excluded property trust prior to the individual becoming domiciled or deemed domiciled.

No IHT is charged on the transfer of foreign assets into the trust or at any later date in the life of the trust provided the trust is funded before the non-dom becomes deemed domiciled and the trust does not at any relevant time hold any UK assets directly. As a result of these rules, excluded property trusts tend to hold UK property through an offshore company. The shares in the non-UK holding company, and not the underlying UK property, constitute the settled property of the trust. Since there is no current provision to look through the company, the underlying UK property is effectively shielded from IHT.

However, per the proposal announced in the Summer Budget, the UK government intends to amend the rules on excluded property so that trusts or individuals owning UK residential property through an offshore company, partnership or other opaque vehicle will not be able to shield the UK residential property from IHT. The measure will apply to all UK residential property whether it is occupied or rented, and it is expected that this proposal will make direct ownership of residential real estate the most attractive form of ownership on a prospective basis.

Next Steps

Many questions remain open with respect to the changes to the RBC and the abolishment of the permanent non-dom status (for instance, how will split years of residence be counted?). For U.S. persons that have been long-term residents in the UK, it is hoped that the U.S. /UK tax treaty will address which convening country has the right of taxation for most major categories of income. However, the devil is always in the details. Her Majesty’s Revenue and Customs is expected to issue a technical update in September 2015, which should start to address the details and mechanics of how this regime change will be implemented in the coming years.