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23 August 2016

Reform of the taxation of non-doms: transitional rules

On 19 August 2016, the Government released a further consultation paper on the taxation of non-UK domiciliaries.  This includes information on a couple of rather surprising transitional rules, originally floated in the 2016 Budget, which the Government proposes to incorporate into the 2017 Finance Act.  These proposed new rules are intended to soften the transition to being taxed on a worldwide basis, for those who will become deemed domiciled under the new regime.

The new consultation paper represents the latest chapter in the saga of the non-dom tax reforms which are scheduled to become law in April 2017.  The paper covers a lot of ground, including revised proposals for the treatment of non-resident trusts with deemed domiciled settlors/beneficiaries (which we have addressed in a separate briefing note). 

However, for many readers, the most interesting aspect of the new paper is its coverage of proposed new rules which are intended to ease the transition of long-term resident non-doms to deemed domiciled status.  There will be two main transitional rules, one dealing with the rebasing of foreign assets for CGT purposes, and the other allowing “mixed funds” comprised of a combination of clean capital and foreign income/gains to be unmixed.  Clean capital can of course be brought into the UK without triggering any tax charge, whereas foreign income or gains that date from a tax year in which the remittance basis was used will, generally, trigger tax if they are remitted to the UK.  In principle, this will still be the case even if the non-UK domiciled taxpayer has acquired a deemed domicile for all UK tax purposes.

Both of these transitional rules will be limited in scope to non-doms who do not have a domicile of origin in the UK, i.e. those who will become deemed domiciled in the UK under the proposed “15 out of 20 years” rule.  By way of reminder, this is the new rule under which a non-UK domiciliary will become deemed domiciled in the UK for all tax purposes, typically at the beginning of the 16th tax year of residence in the UK, or on 6 April 2017 if more than 15 tax years of UK residence have already been clocked up.

The Government does not think it is appropriate to provide any transitional reliefs to non-doms with a domicile of origin in the UK and a UK place of birth, who will also become deemed domiciled in the UK if they are UK resident in 2017/18 or any later tax year.  It is questionable whether this stance is fair, but there seems to be little chance of a change of heart about this.

Rebasing of foreign assets

Rather unexpectedly, a technical document that accompanied the 2016 Budget announced that the legislation for the non-dom tax reforms would include a transitional relief for the rebasing of foreign assets.  This would allow non-doms who will become deemed domiciled on 6 April 2017 by reason of long-term residence in the UK to rebase their foreign assets for CGT purposes to their market value on that date. 

The document indicated that if an individual took advantage of this relief, the taxable gain on a subsequent disposal of an asset affected by the rebasing would be limited to any increase in its value since 5 April 2017.  It seemed to say that this would be the case even if the sale proceeds were remitted to the UK.

This announcement was received with enthusiasm in some quarters but scepticism in others.  It seemed very unlikely that the Government actually meant what it seemed to be saying.  Surely it was too good to be true?

Many suspected that what the Government actually intended was a more limited, although still very useful relief, which would limit the immediate tax charge on the sale of a rebased asset to the post-5 April 2017 increase in value, but which would entail further tax for the deemed domiciliary if the proceeds of sale were brought into the UK, on the pre-6 April 2017 appreciation of the asset.

However, there is now no room for doubt that the Government did mean what it said in the 2016 Budget document.  The latest consultation paper confirms that if a foreign asset is rebased by virtue of this proposed relief, the taxable gain realised on a post-5 April 2017 sale will be limited to any increase in value between 5 April 2017 and the date of sale.  Tax on the pre-6 April 2017 gain will be foregone, even if the proceeds of sale are remitted.  In effect, the pre-6 April 2017 gain element will be treated as clean capital.

This does not guarantee that there will be no tax at all on a remittance of the proceeds of sale of an asset that is rebased to its 5 April 2017 value.  If the asset was purchased using foreign income or gains, and all proceeds of sale are remitted to the UK, there may be a tax charge for the deemed domiciliary on the foreign income or gains that will be comprised within the proceeds. 

However, depending on the precise circumstances, the taxability of those historic income or gains may be affected by existing transitional reliefs that were enacted when the non-dom tax rules were subject to their last major overhaul in April 2008.  And even if these older transitional reliefs are not applicable, it seems likely that the existing “mixed fund” rules will have the effect that, with the benefit of expert advice, the deemed domiciliary will be able to remit the non-taxable gain element of the proceeds, without bringing the historic income or gains into charge to tax. Alternatively, for assets sold in the course of 2017/18, there may be scope to take advantage of the proposed unmixing relief which is discussed in the second half of this note.

Rebasing: when and how it will work

We now have a reasonably good idea of the proposed extent and the conditions attaching to the rebasing relief.  The key points are that:

  • Rebasing relief will only be available to non-doms who become deemed domiciled under the “15 out of 20 years” test on 6 April 2017.
  • Of those non-doms, only those who have paid the remittance basis charge in one of the tax years from 2008/09 (when the charge was introduced) up to and including 2016/17 will be entitled to the relief.  It is conceivable that the opportunity to rebase assets in 2017/18 will persuade some non-doms who have never paid the remittance basis charge that they should do so for the current tax year 2016/17 or the previous one.
  • Rebasing will apply on an asset by asset basis, so it appears there will be a possibility of rebasing certain assets but not others.  This may be beneficial where some assets have appreciated but others are standing at a loss.  The paper makes no attempt to explain how the asset by asset rebasing will work; but it seems most likely that taxpayers using the relief will be required to submit an election form including details of all assets that are to be rebased.
  • It appears that rebasing will only apply to directly held foreign assets, which would seem to exclude assets held by personal holding companies and the like.
  • Rebasing will only be available for assets which are foreign on 5 April 2017 and were also foreign on the date of the 2015 Summer Budget, which was 8 July 2015.  Clearly, this may prevent non-doms from taking advantage of the rebasing relief in relation to chattels that are currently within the UK but could in principle be moved outside the UK before 5 April 2017.

Rebasing: our comments

The relief will be warmly welcomed by many, but we are concerned about the scope for it to protect some non-doms from tax and yet leave others, who are in an objectively similar situation, high and dry.

In particular, the limitation of the relief to non-doms who become deemed domiciled on 6 April 2017 seems arbitrary.  The irrationality is brought home if one compares the position of two long-term resident non-doms, both of whom hold a foreign asset purchased out of clean capital ten years ago. In each case the asset is standing at a gain of £1 million.  Both individuals have consistently used the remittance basis since 2008/09.  If non-dom A becomes deemed domiciled on 6 April 2017, and non-dom B becomes deemed domiciled a year later on 6 April 2018, their tax positions will be very different, despite the similarity of their circumstances:

  • Non-dom A can wait until 6 April 2017, can then sell the asset and bring the entire proceeds of sale into the UK with no tax at all.
  • If non-dom B sells the asset after he has become deemed domiciled on 6 April 2018, he will be subject to CGT on the entire gain, resulting in CGT of £200,000.  Alternatively, he can sell the asset before he becomes deemed domiciled, avoiding CGT on the sale, but he will be unable to bring the proceeds into the UK without a tax charge.  A remittance of the proceeds will trigger a £200,000 CGT liability.

This seems at odds with the Government’s stated objective of a fair tax system.  The answer is surely to grant the option of rebasing assets not only to the cohort of long-term resident non-doms who will become deemed domiciled in the tax year 2016/17, but also to those cohorts who will pass that milestone in subsequent years, without any “sunset clause” for this relief.

In our view there is also a strong case for allowing rebasing in relation to assets held by non-UK resident close companies, bearing in mind that such companies are often “tax transparent” for CGT purposes, vis-à-vis UK resident shareholders.

However, even if the relief is extended in these ways, we are concerned that it will still produce irrational outcomes.  For example, some non-doms who are due to become deemed domiciled on 6 April 2017 will undoubtedly have sold foreign assets outside the UK, realising large foreign gains that they will not now be able to remit without a substantial CGT charge; whereas others will be in the position of the hypothetical non-dom A discussed above, who have the ability to bring their foreign gains into the UK without any adverse consequences.

Unmixing of “mixed funds”

The other main transitional relief discussed in the consultation paper concerns “mixed funds” held outside the UK.  The paper explains the issue:

“… Those non-doms who have lived in the UK for a long time and who have a large pool of offshore funds [they mean: “mixed funds” outside the UK] containing capital as well as income and gains will, from April 2017 onwards, have to pay tax on any future growth in the fund as it arises.  However, they will still be unable to bring the pre-April 2017 capital into the UK until they have first paid tax on the pre-April 2017 foreign income/gains …”

The reason for this is that, under the existing “mixed fund” rules, a transfer to the UK of some of the money in a “mixed fund” is typically treated as a remittance of the taxable elements in the fund, i.e. foreign income or gains, in priority to any non-taxable elements, i.e. clean capital.  The “poison” is generally deemed to come out first.

The Government’s response to this issue is to introduce a “temporary window” in which all non-UK domiciliaries who have a domicile of origin outside the UK will be able to segregate “mixed funds” within foreign bank accounts into their component parts, e.g. transferring any clean capital within a “mixed fund” to a clean capital account, any foreign gains to a capital gains account and any foreign income to an income account.  This window will be open for the duration of the 2017/18 tax year only. 

This will be a one-off opportunity to unmix “mixed funds”, without any obligation on individuals who take advantage of this relief to remit from any of the resultant segregated accounts in any particular order or within any particular timeframe.  In principle, this is a very valuable opportunity to create, in effect, new clean capital for use in the UK.

However, clearly, an individual’s ability to carry out this kind of exercise will depend on him or her having a reliable record of the amounts of income, gain and clean capital within the account, or a reliable record of all previous transactions within the account, so that the required tax analysis can be carried out.  In some cases, the necessary information will not be available, or the process of calculating the income, gains and clean capital amounts within the account will be too difficult and time-consuming for the exercise to be worth the candle.

The consultation paper makes it clear that the unmixing relief will be available to all non-UK domiciliaries who have a domicile of origin outside the UK.  It will not be restricted to those who will become deemed domiciled for income tax and CGT purposes in 2017/18, under the “15 out of 20 years” test.

Unmixing: our comments

This relief will, naturally, be greeted with enthusiasm by many of the non-doms who are preparing to become deemed domiciled for all UK tax purposes.  And the broad concept of the relief is undoubtedly a good one.  However, in our view the Government’s proposals do need some refinement.

It is hard to see the logic behind the proposed one year window for this relief. To some extent, confining the unmixing relief to 2017/18 will discriminate against non-doms who will become deemed domiciled for income tax and CGT purposes in later tax years, who – even if they utilise the unmixing relief in 2017/18 – may not be able to keep their accounts neatly segregated up to the time at which they become arising basis taxpayers. 

It is also strange that all non-doms with a foreign domicile of origin will have access to this relief, regardless of how long they have been resident in the UK, and indeed of whether they are UK resident at all.  This seems odd given that the “mischief” which has inspired the relief is the particular predicament of individuals becoming deemed domiciled, who will be taxable on an arising basis, but may have little or no clean capital that can be accessed for UK spending.  The proposals do not seem very well-targeted.

A fairer and more logical solution to the predicament of these individuals would be to offer the unmixing relief to non-doms who are in their first tax year as a deemed domiciliary under the “15 out of 20 years” rule, only, but for this relief to be available to such individuals not only in 2017/18 but indefinitely.

In addition, consideration should be given to extending the relief so that “mixed funds” within non-resident companies and trusts can be unmixed, rather than limiting the relief to personally held bank accounts.  There is arguably a need for this, because non-resident close companies with UK resident shareholders and non-resident trusts with living UK resident settlors are often “tax transparent” for income tax purposes.  If income within personally held bank accounts can be segregated, but income within company and trust accounts cannot, that will discriminate against non-doms who, in reliance on the existing tax legislation, have created non-resident asset-holding entities.

Overall conclusions

For a remittance basis user, becoming deemed domiciled for all tax purposes and becoming taxable in the UK on an arising basis, with respect to worldwide income and gains, is a major change of treatment.  Any measures that can soften this blow and ease the transition from one tax status to another are, in principle, to be welcomed. 

However, while the basic concepts behind the transitional reliefs in the consultation paper are good, these reliefs do not seem to have been considered very deeply.  There are significant defects in the proposals, which will mean that the relieving provisions will operate irrationally if they are enacted without amendment.  Fortunately, many of the flaws will be reasonably easy to rectify, provided that there is the required political will.

The consultation paper gives no indication that the Government is waivering in its commitment to bring the non-dom tax reforms into law with effect from 6 April 2017.  However, we are concerned that, if this to be achieved without mistakes being made, a lot of work will be required in refining the proposals for the new regime and turning them into law.  There is a real risk that the Government will run out of time and that the process will become chaotic, as happened with the April 2008 reforms.  Arguably, in view of the disruption caused by the “Brexit” vote, there would be no shame in the Government shifting the implementation date for these reforms back to 6 April 2018, to allow more time for discussion, development of policy and drafting of legislation.

Download this report as a PDF.

This article was written by Dominic Lawrance

For more information please contact Dominic on +44 (0)20 7427 6749 or via