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Domicile Confusion Could Result In Unplanned IHT

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Unplanned IHT Image

A leading Island tax advisor has warned that many businessmen and women currently working in the Isle of Man could be unintentionally within the scope of UK Inheritance Tax (IHT) – because they haven’t grasped the difference between tax residence and tax domicile.

UK IHT potentially applies just as much to Manx born residents holding UK investments as it does to those originating from the UK.

That’s the stark message from Kevin Loundes, Associate Director at Abacus, one of the Island’s longest established corporate service providers, where he heads up the firm’s dedicated, in-house tax team, providing comprehensive tax services.

“Simply ceasing to be tax resident in the UK isn’t the same as relinquishing a UK domicile. It’s an individual’s domicile position which is the key to establishing whether there’ll be a UK IHT liability on death,” explained Kevin, who has a wealth of experience advising high net worth individuals on residence and domicile issues.

“If an individual relocating to the Island were to displace a UK domicile of origin with a domicile of choice in the Isle of Man, it could result in considerable UK IHT savings.”

The key to UK IHT is an individual’s domicile at the time of their death and domicile is a very different concept from tax residence. “You may have moved from the UK and been living and working in the Isle of Man for many years, but that doesn’t automatically mean you’re no longer UK domiciled and free from the clutches of UK IHT,” he observed, adding that “people born in the Isle of Man may also not be totally free from UK IHT if they hold UK assets, such as property or shares in UK companies.”

Current UK IHT legislation has a nil rate band up to £325,000 on an estate. Anything above that figure is potentially taxed at 40%. By comparison, there is no IHT in the Isle of Man.

Kevin continued: “Briefly, each person is born with a domicile (a domicile of origin). An individual’s domicile of origin continues throughout their life, but may be displaced by a domicile of choice. As such, if an individual relocating to the Island were to displace a UK domicile of origin with a domicile of choice in the Isle of Man, it could result in considerable UK IHT savings,” he said. “In this scenario, simple tax planning could be undertaken to protect any UK assets (other than UK residential property) from UK IHT, without the need to sell such assets.”

“Proving an individual’s intention is notoriously difficult and requires significant evidence.”

“Adopting an Isle of Man domicile of choice would, generally, require an individual to relocate to the Island with an intention to remain on the Island permanently or indefinitely and to reside here as an inhabitant. Proving an individual’s intention is notoriously difficult and requires significant evidence,” said Kevin.

The onus of proof rests with the taxpayer or the executor of the estate – and not HMRC. “So individuals should take steps to ensure family members or executors are aware of evidence supporting a non-UK domicile claim in the event of HMRC challenge,” Kevin advised.

He also pointed out that changing your domicile to the Isle of Man from the UK wouldn’t bring immediate respite. In the eyes of the UK tax authorities, a person would still be deemed UK-domiciled for a further three years.

“It can be tricky demonstrating evidence of intention and, given someone’s estate would continue to be subject to UK IHT even if they died within that initial three-year period, it can really pay to consider the issue of domicile alongside the location of an individual’s assets sooner rather than later,” he concluded.

Double exposure businessman

Non-Domiciliary Reform: Where Are We Up To And What Action Can Be Taken Now?

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HMRC and the UK Government are in the middle of a balancing act: weighing up media and political pressure to ensure everyone pays their “fair share of tax” with the economic benefit of a competitive tax regime.

It is crucial to the UK economy that Britain remains “open for business” and maintaining a competitive tax regime plays an integral part in attracting new business. The potentially favourable tax regime available to non-UK domiciliaries has historically played its part in attracting wealthy individuals and business owners to the UK.

The rules on the tax treatment of non-UK domiciliaries are currently in a state of flux and it would perhaps be understandable to be of the view that any changes are likely to be unfavourable from the taxpayer’s perspective. However, HMRC appear to acknowledge the importance of non-UK domiciliaries to the UK economy. This acknowledgement was evident in the foreword by David Gauke, Financial Secretary to the Treasury, to HMRC’s consultation document setting out the proposed changes which stated:

The government wants to attract talented individuals to live in the UK who will help to contribute to the success of this country by investing here and creating jobs. The long-standing tax rules for individuals who are not domiciled in the UK are an important feature of our internationally competitive tax system, and the government remains committed to that aim.

So what are the changes to the taxation of non-UK domiciliaries and is it all bad news?

HMRC published a consultation document setting out their proposed reforms to the taxation of non-UK domiciliaries back in September 2015. The new regime will be effective from 6 April 2017 and legislation was to be included in Finance Bill 2016. Publishing draft legislation has been pushed back to 2017; however, it would appear that HMRC continue to be committed to a new regime being in place in April of next year.

Numerous articles have been written on the technicalities of the new proposals and how they may impact on taxpayers depending on their current and historic UK residence and domicile position. Explaining the possible changes and potential implications requires an article by itself and once you have ploughed through the possible implications it is easy to miss the fact that these changes potentially present opportunities for certain taxpayers. Whilst we do not have published legislation (and therefore, the position continues to be uncertain), HMRC have confirmed certain matters and this may allow taxpayers to take action now before the new rules are introduced. Such action could present long term tax benefits.

Long term non-UK domiciled individuals

One of the main changes is that, with effect from 6 April 2017, individuals who are non-UK domiciled will be deemed to have a UK domicile for tax purposes if they have been resident in the UK for more than 15 out of the past 20 tax years. Once the individual has become deemed UK domiciled, they will no longer be able to claim the remittance basis and, consequently, will be subject to UK tax on their worldwide income and gains. Furthermore, all of the individual’s worldwide assets would be within scope of UK inheritance tax.

What are the potential benefits?

If you anticipate becoming deemed UK domiciled under the new regime from 6 April 2017, now is the time to act in order to benefit from an offshore trust structure. If you set up an offshore trust now (ie before you become deemed UK-domiciled under the new regime) you should not be taxed on foreign income and/ or chargeable gains which are retained in the trust. Furthermore, the trust should also provide an effective shelter from UK inheritance tax (even if you subsequently become UK deemed domiciled under the new regime in the future). There are, of course, certain asset types that would need to be excluded, UK residential property for example. However, an effective deferral of income and capital gains tax could potentially be achieved with the added benefit of protection from UK inheritance tax.

What action should I be taking now?

Timing is crucial. If you anticipate becoming deemed UK domiciled under the new regime, any steps to establish an offshore trust in order to potentially benefit from tax savings must be taken before the new rules are introduced. We would recommend taxpayers in these circumstances take action now to establish their offshore structure.

If you would like to discuss either the proposed new rules for non-domiciliaries or any practical aspects of establishing an offshore trust structure feel free to contact one of our team.

Kevin Loundes, Senior Tax Manager –

Stewart Fleming, Group Managing Director –

Stephen Colderwood, Business Development Manager –