HMT: Reforms to the taxation of nondomiciles. The Law Society's response November The Law Society. All rights reserved.

HMT: Reforms to the taxation of nondomiciles The Law Society's response November 2015 2015 The Law Society. All rights reserved.

1. The Law Society is the professional body for solicitors in England and Wales, representing over 160,000 registered legal practitioners ( the Society ). The Society represents the profession to parliament, government and regulatory bodies and has a public interest in the reform of the law. This response has been prepared by the Society s tax committee who are formed of practitioners with relevant expertise and experience in this field. 2. The Law Society welcomes the opportunity to respond to HMT s consultation document entitled Reforms to the taxation of non-domiciles 1, released on 30 September 2015. 3. The consultation document was preceded by a Technical Briefing published on 8 July 2015 in conjunction with the 2015 Summer Budget on the same day ( the Briefing ). 4. The consultation document has been both preceded and followed by consultation meetings many of which attended by our representatives, including a working group meeting on 9 th October 2015 which offshore trusts established by those becoming deemed domiciled on being UK resident for 15 or more out of 20 tax years. 5. The proposals contained in the Briefing included (as summarised by the Society): 5.1 Concerning long-term UK resident non-doms : (a) (b) They should pay UK tax on personal assets, income and gains as UKdomiciles (with special rules for particular types of income/ capital gain). Offshore trusts established before the settlor became deemed domiciled: (1) Income and gains would be taxed on a receipts basis; (2) Excluded property status for IHT would be retained; and (3) This status would not be inherited. 5.2 In relation to those with a UK domicile of origin born in the UK and becoming UK resident with a non-uk domicile of choice: (1) IHT, CGT and income tax will be payable as if they are UK-domiciled on: (1) Personally held assets; and (2) In relation to any trusts established by them before returning to the UK. 5.3 A 6 year tail to lose both actual and deemed domicile on leaving the UK and for lapsing of spousal domicile elections for IHT. 5.4 Abolition of the 90,000 remittance basis charge. 5.5 They formed part of a package including changes to IHT on UK residential property held through offshore companies and similar structures. 5.6 They would take effect from 6 th April 2017 with some transitional rules. 1 Available at: https://www.gov.uk/government/consultations/reforms-to-the-taxation-of-non-domiciles

6. The consultation document set out further detail of the Government s proposals and also contained 9 questions, 1, 2, 3 and 5 in relation to deemed domiciles and 4, 6, 7, 8 and 9 in relation to returning UK doms. 7. None of the 9 consultation questions in the consultation document directly address the proposals for taxation of offshore trusts established by non doms before they become deemed domiciled in the UK under the 15 year rule. 8. Before commenting more specifically on those 9 questions, the Society makes the following general comments concerning those proposals: 8.1 The Briefing contained the following statement (at 3.2): Non doms who have set up an offshore trust before they become deemed domiciled here under the 15 year rule will not be taxed on trust income and gains that are retained in the trust and such excluded property trusts will have the same IHT treatment as at present (subject to the announcement made at Budget 2015 on UK residential property held through offshore companies and similar vehicles). However, such long term residents will, from April 2017 be taxed on any benefits, capital or income received from any trusts on a worldwide basis. The government will consult on the necessary changes to the transfer of assets regime and Capital Gains Tax trust provisions. The government recognises that this is a significant change to the current rules and that changes to trust taxation are complex and will need to be considered carefully. Certain transitional provisions relating to trusts were introduced for non-doms in 2008 (in particular rebasing). The interaction of these rules with the new regime after the non-dom becomes deemed domiciled here will be subject to consultation. 8.2 This statement, and in particular the words consult on the necessary changes to the transfer of assets regime and Capital Gains Tax trust provisions, was not reflected by the fundamental change indicated by the following extract from the Consultation document (at 3.2): The government intends to base the new rules on the taxable value of benefits received by the deemed domiciled individual without reference to the income and gains arising in the offshore structure. 8.3 During consultation meetings after the consultation document, the Society s representatives observed that HMT and HMRC s interpretation of this extract from the consultation document (at 3.2) was that this benefit charge was only to apply to the settlor alone with other beneficiaries continuing to be taxed by reference to income and gains arising to the offshore structure. 8.4 The Society believes that the government s aims as set out in the introductions to the Briefing and consultation document respectively could be addressed by reforming the existing system of taxation of offshore structures and at the same time significantly simplifying it. Any new regime replacing it would require an entire new statutory code with complex transitional provisions with the existing provisions. 8.5 The Society understands that HMT and HMRC wish to consult further with our representatives and those of other professional bodies on proposals for taxation

of offshore trusts established by non doms. The Society proposes to confine our response here to those to the following general comments: (1) A single set of rules should apply except Section 86 TCGA 1992 should continue to apply to UK resident and domiciled settlors. (2) There are particular difficulties in applying benefits charge to settlors of dry structures such as those holding residential property and art; for example: (1) Clean capital being taxed, and (2) The interaction between this charge and any charge on capital benefits conferred on other beneficiaries based upon actual income and gains of the structure. (3) Remittance basis taxation should continue to apply to capital benefits enjoyed offshore in respect of non-domiciles who are eligible for and (who elect for) that status including concerning any dry benefits charge. 9. The Society comments as follows in respect of the 9 questions in the consultation document: Question 1 Do stakeholders agree that the approach outlined in this document is the best way to introduce the test for deemed-domicile status? 10. Section 267 (1) (b) IHTA 1984 already uses the concept of being resident for more than a certain number of tax years to acquire deemed domicile for inheritance tax purposes. Whilst, and particularly before the Statutory Residence Test ( SRT ) came into force in April 2013, a person s residence has not always been easy to ascertain, the approach adopted follows a long-established and thus familiar practice. Furthermore, our view is that there is no practical alternative approach. 11. In straightforward cases (such as where a person is UK resident for 15 consecutive tax years) acquisition of deemed domicile for inheritance tax ( IHT ) would align with that for income tax and capital gains tax ( CGT ). 12. Where an individual s residence pattern is more complex, and especially in the case of a SRT split year or temporary non-residence, liability for IHT under deemed domicile may not align with liability as a UK resident for income tax and CGT. 13. The split year legislation in Schedule 45 Finance Act covers 7 pages (not counting the consequential amendments). Establishing whether there is a split year can be complex as can be the date marking the divide between the UK and overseas part of a split year, particularly given the priority ordering rules for the eight split year cases. In addition, split year treatment under the SRT does not apply to all types of income or gains. 14. Not having split year treatment for IHT would have the benefit of simplicity and certainty. It is likely the number of cases of deemed domiciles fulfilling the split year criteria would be modest. 15. To align the periods of non-residence to lose deemed domicile and temporary nonresidence for income tax and CGT would require: 15.1 Split year treatment (or not) for both; and

15.2 Alignment of the periods of non-residence for both. 16. The proposed 15/ 20 tax year rule for deemed domicile is on an aggregate basis and temporary non-residence requires a single block of non-residence. The Society believes that it is unlikely any workable legislation could be devised to cover all the possible permutations. 17. The consultation document does not expressly deal with interaction of tax treaties and the proposed deemed domicile rules. The legislation should confer certainty on the position in relation to the following items: 17.1 Treaty non-residence (1) This does not currently over-ride residence under UK tax law (including under the SRT) for the purposes of counting tax years for the purpose of the current IHT deemed domicile rules. (2) It is assumed this principle will apply to the new deemed domicile rules as well. 17.2 Estate Duty treaties (1) These are those with India, Pakistan, France and Italy. (2) We understand the intention is for the UK to have priority taxing rights and to re-negotiate these treaties in the longer term. Question 2 Are there any difficult circumstances that might arise as a result of the intended approach which could be avoided with a different test? 18. Please see our replies to Question 1 above. Question 3 The government is interested in views from stakeholders about the need to preserve the 2,000 de minimis threshold for those non-domiciliaries who become deemed domiciled 19. The Society notes the reason stated in the consultation document in favour of this, namely minimising the administrative burden for HMRC and the taxpayer where non- UK income/ gains are modest. 20. The consultation document cites two arguments against this, namely exemptions and allowances available to those with modest income and gains and consistency of treatment with UK resident domiciles. We would add a third, which is simplicity. It is that factor which persuades us on balance that the de minimis rule should apply to those who eligible to be taxed on the remittance basis but not otherwise.

Question 4 Do stakeholders agree that the approach outlined in this document which will change the inheritance tax rules for those UK domiciliaries who are leaving the UK is straightforward and reasonable? or Do stakeholders agree that changing the rules in this way is a straightforward and reasonable approach? 21. The Society believes that in respect of personal tax compliance, once a person is deemed domiciled and thus pays UK tax on income and capital gains, this should not cause any substantial issues. Such persons should have available to them all tax reliefs and allowances of any other arising basis taxpayer (such as the 10% reduction of income tax on foreign pension income). 22. Please see the Society s comments in relation to Question 7 below on compliance issues for offshore trusts established by those become deemed domiciled and also for such trusts established by returning UK domiciles. 23. Concerning those who have made a capital losses election when remittance basis users, our view is that any unused carried forward losses should be able to be set against all capital gains realised following acquisition of deemed domicile for IHT. 24. We understand the Government s expressed wish and reasons in support of that at 3.4 of the consultation document for consistency on the period required to lose IHT domicile for all those who have acquired it and who then leave the UK. 25. Please see the Society s comments in response to Question 5 below why we feel the current 3 year tail is fair and reasonable. 26. If the Government wishes to extend that to 6 years, our submission is that 6 years of non-residence alone should be sufficient to lose IHT domicile. 27. Such a rule would be simpler to understand and administer than one requiring in addition to an acquisition of a non-uk domicile of choice. It still leaves a substantial period before IHT domicile is lost. Such a rule would also be consistent in approach to that by which those who are UK resident for 15 or more years in any 20 become deemed domiciled. 28. It is unfair for taxpayers to have to make decisions now which depends on legislation not yet published even in draft form, and which will not enter into force until April 2017. Nor do we feel those who in good faith took steps on the basis of current IHT domicile legislation (and which will remain in force until then) should have their position changed merely because the threshold for being IHT domiciled falls from that date. 29. The legislation should expressly state those who meet requirements under current IHT deemed domicile are not caught by the 15/20 year rule if that would otherwise be met on 6 April 2017 where: 29.1 they have already left the UK (or who do by 5 April 2017) and who have met (or then meet), or by that date 29.2 re-set their deemed domicile clock for IHT under the current rules by 4 or more years of non-uk residence. The 15 years of residence for deemed domicile should run from their first year of resumption of UK residence after that absence. 30. In relation to the proposals mentioned at 3.4 of the consultation document concerning taxation of offshore trusts established by deemed domiciles before acquiring that status please see our responses at 8 above.

31. The Society supports the proposal at 3.4 of the consultation document concerning gifts which were of excluded property when made but within 7 years prior to the death of the person who made them who died deemed domiciled. Question 5 Do stakeholders agree that the period a spouse needs to remain nonresident before the inheritance tax spouse election ceases to have effect should be amended to 6 years? 32. Without wishing to detract from the consistency point which could be made for switching to 6 years, the fact remains a number of largely practical issues militate against this exist already with the 3 year (or in the case of the inheritance tax spouse election 4-year) tail but are magnified to a point of absurdity by extending it, for example: 32.1 Most resident non domiciles ( RNDs ) trying to break deemed domicile may leave to civil law countries where the planning which the consultation document contemplates (sheltering assets in an excluded property trust) will not work or be unacceptable. 32.2 One part of the same tax code will be encouraging trust planning (and actively taxing benefits) whilst another will be proceeding on a basis which ignores the fact it is impossible to work. 32.3 More practically, an RND moving to establish a new domicile of choice elsewhere on leaving the UK will have to plan his estate and gifting to comply with both the local and the hangover UK rules, finding what limited overlap there may be. That is the inevitable consequence now for a short period, that being consistent with policing the deemed domicile rule itself. 32.4 Furthermore, the increased overlap will significantly increase the likelihood of double taxation, particularly for those who become resident in civil law jurisdictions. That is further exacerbated by the lack of an extensive network of capital tax treaties. 32.5 However, it is inconceivable that, after a much longer period, many such who have left the UK will recollect the hangover UK liability or be reminded of it by their local advisers (who it would be reasonable to assume are likely to be ignorant of it). 32.6 Unlike the temporary non-residence rules where HMRC can tax a returning taxpayer, in this scenario the taxpayer would be out of the jurisdiction permanently; it is likely that the same will be true of executors (if any - they are not common in civil law systems). 32.7 There are likely to be IHT charges (such as lifetime chargeable transfers, failed PETs, trust exit charges) inadvertently overlooked arising out of sensible local planning, as well as reliefs not claimed. The position will be worse still concerning the estates of deceased leavers still within an extended tail period. 32.8 This can only bring the law into disrepute: it is simply impractical to assume that, the longer the period chosen, compliance will remain consistent. In the Society s view it is rather the reverse, since it is unlikely that UK advisers will be consulted by such leavers, and it is counter-productive and not consistent with the rule of law to legislate something which may be disregarded. 33. The Society believes that the natural wish for consistency can be achieved by retaining the current IHT tail periods. However, if a 6-year tail is introduced, it

should be expressly provided that those who have left the UK (or who do by 5 April 2017) and who have met (or do then meet) the requirements under current law are not caught by the 6 year rule if that would otherwise be met on 6 April 2017. Question 6 In what circumstances would having a short grace period for inheritance tax help to produce a fair outcome? 34. A number of examples of such temporary return to the UK were put forward in consultation meetings to date. Those examples include coming to the UK to look after sick relatives and posted to the UK on secondment. 35. The Society supports such a grace period. We understand HMT/ HMRC have proposed one (for IHT only) of one tax year before UK domicile for IHT is reacquired. 36. The draft legislation in the consultation document seems drafted accordingly: (iv) he was resident in the United Kingdom for at least one of the two tax years immediately preceding the tax years in which the relevant time falls. Question 7 What difficulties do stakeholders envisage there could be for trustees tasked with calculating the 10 year charge in these circumstances? 37. These will not apply to all trusts established by a returning UK domiciliary. For example, it does not apply to those with a qualifying interest in possession for IHT purposes. 38. Recent changes to the rules for calculating this charge for relevant property trusts (including provisions in Finance Bill 2015 when they come into effect on Royal Assent being given) have to an extent mitigated these potential difficulties. For example: 38.1 related property i.e. property not subject to IHT is no longer relevant to the calculation of the IHT rate, and 38.2 If the net value of assets at the date of the charge are less than the then nil rate band no IHT is due. 39. Some other provisions have made the calculation more complex: 39.1 Same day additions to other trusts are counted as part of the same settlement for IHT, and 39.2 Unaccumulated income over 5 years old is treated as an addition to the trust capital since the preceding 10 year charge, and 39.3 Any assets which were relevant property at any time since the preceding 10 year charge are included in the assets then taxed. 39.4 Some rules in calculating the 10 year charge have not changed such as capital added and distributed since the preceding 10 year charge being taken into account in calculating the amount taxed. 40. Where trustees have kept adequate records, the Society does not anticipate this should cause insurmountable problems in calculating these and indeed exit charges based upon the previous 10 year charge.

41. Where such records do not exist (or they do in part) a completely accurate 10 year charge return and calculation may not be possible. Such situations are not uncommon with offshore trusts, especially smaller ones, those administered in jurisdictions where there is less familiarity with the UK tax system and trusts where there have not historically been UK resident settlors and beneficiaries. 42. For such cases, there appears to us to be a number of possible solutions: 42.1 A pragmatic approach by HMRC on the basis that the return and calculation is done on a best endeavours basis with the trustee confirming the information available to it, or 42.2 The trustee could elect in respect of the first 10 year charge: (1) For a re-basing as of a date fixed by law (we suggest 8 th July 2015 as this was the first date when trustees would have been aware of the proposed changes), or (2) For this to be calculated on a simplified statutory basis. 42.3 To encourage filing of a 10 year charge returns computed on the full statutory basis, the circumstances in which the election could be made could be limited to a single occasion with a relatively high tax charge. 42.4 The Society welcomes the proposal to mitigate the 10 year charge if one occurs in a tax year when the returning UK domiciliary settlor is UK resident but has not been for some (or all) of the previous tax years in the preceding 10 years by way of an apportionment. Question 8 Do stakeholders agree this is the most reasonable way to deliver these reforms? Are there any circumstances when applying these rules would produce unfair outcomes 43. We assume this relates to part 4.3 of the consultation document which proposes: 43.1 Returning UK domiciles retaining foreign domicile under the general law lose UK IHT domicile status on becoming non-uk resident. 43.2 They will reacquire UK IHT domicile if they become UK resident again, subject to any period of grace rules. 43.3 Those who meet the 15/ 20 year UK residence rule must be non-resident for 6 years to lose that IHT domicile. 44. The government has proposed some measures to alleviate this including: (1) IHT charges not applying in the first tax year of residence of the settlor ( year of grace ), and (2) 10 year charges pro-rated according to actual UK residence by the settlor in the preceding 10 years. 45. Given the potentially huge IHT exposure if an IHT event occurs when a returning UK domiciliary is UK resident, it is likely some of them will seek to minimise tax years during which they are UK resident. Any year of grace provisions will need to take this into account to be workable.

46. We feel those with a UK domicile of origin who cut their ties with the UK sufficiently to lose that and to acquire a non-uk domicile of choice should have a lead-in period before being treated as UK domiciles for all UK tax purposes longer than one tax year of residence. 47. The operation in practice of a period of grace to be limited to one UK tax year at a time could be somewhat complex; especially as returning UK domiciliaries would have a strong incentive to minimise years of UK residence given the potentially catastrophic implications (especially IHT) of events occurring in them. 48. There are precedents in UK tax law (past and present) for those only temporarily UK resident UK to be outside the full UK tax regime for substantially longer than one tax year. Examples include ordinary residence (past) and overseas workday relief (present). 49. We propose a returning UK domiciliary should be treated in the same way as any other non-domiciliary, that is for income tax and CGT as well as for IHT and in respect of both personal assets and those held within offshore trusts established before return to the UK in the following circumstances: 49.1 If he/ she left the UK before the age of 16, and 49.2 If he/ she left the UK after that age treated as such for the first 5 tax years following a return to the UK. 50. The Society believes that such an approach would be much simpler to operate in practice for both taxpayers and HMRC and in the case of those who left the UK as children also fair given the decision to leave was outside of their control. 51. The time apportionment provisions proposed at 4.2 in the Consultation document only applies to 10 year charges. These have a maximum rate of 6% whereas IHT on death on both the free estate and on the assets of any trust over which there is a gift with reservation of benefit could be up to 40%. 52. Settlors have limited control on some IHT events (such as decisions by trustees) and others by their nature are unpredictable (such as death). 53. It can be somewhat of a lottery whether IHT events occur in a tax year when a returning UK domiciliary is UK resident with very substantial consequences indeed, especially in the event of death. 54. There should be a tapering provision for all IHT events occurring when a returning UK domiciliary is UK resident, not just for 10 year charges. This principle already exists in the IHT legislation in relation to inter vivos gifts (Section 7(4) IHTA). 55. Our proposal is the tax rate on the IHT event falls by 10% for each tax year of non- UK residence prior to the one in which IHT event occurs. This would produce a fairer outcome overall with any reduced yield per IHT event counter-balanced by their being more likely to remain UK resident when IHT events occur as well as increased tax receipts on worldwide income and gains.

Question 9 how? Would the rules as described leave any significant uncertainty? If so, 56. Please see our comments at 8 above concerning the proposed changes to the existing system of taxation of offshore structures. The Society is concerned that radical changes to these would result in significant uncertainty. 57. A discussion draft paper on this particular topic has been submitted to HMRC and HMT following the joint meeting between their representatives and those of CIOT, ICAEW and STEP as well as of the Law Society on the 9 th October 2015. 58. As stated in the foreword to that paper, it does not constitute the formal policy of any of the professional bodies (including the Law Society), has not been through their full review procedures and as such is not attributable as their official views. Rather, it is intended to promote and inform further discussion and engagement between the professional bodies and HMRC and HMT on this subject. 59. Transitional rules should expressly confirm the effectiveness of any steps validly taken under the law applying before 6 th April 2017. Please contact Renee Turner (Renee.Turner@lawsociety.org.uk) if you have any questions about this response.