24 June 2024

Winners and losers under the new non-dom reforms

Emma Chamberlain‘s recent article for Tax Journal investigates the detail of the new non-dom regime:

Speed read: Wholesale reforms to the non-dom rules have been proposed by both the Conservative and Labour parties with effect from April 2025. There is a good case for reforming the current non-dom regime: not only is it complex, with inconsistencies between the income tax and CGT rules, but it can be difficult to establish domicile and it discourages investment into the UK. While there are some winners under the proposals – such as new arrivers benefitting from the new regime for foreign income and gains, at least for the first four tax years, and those already domiciled here with unremitted foreign income and gains who can take advantage of the temporary repatriation facility – there are of course many losers too, most obviously including remittance basis users who have been UK resident for longer than four tax years, settlors who are UK resident from 2025/26 and are not new arrivers and those adversely affected by IHT changes. Much will depend on the final shape of the legislation, but there are some clear points for clients to consider now.

Several helpful articles have been published in Tax Journal since the announcements on 6 March 2024 affecting non-doms. The changes are due to come into effect on 6 April 2025. This article assumes that readers are familiar with the main thrust of the Budget proposals and focuses on winners and losers under the regime. Labour announced in April that ‘although they supported most aspects of the proposed replacement to the non-dom rules including the four year window’, they would ‘include all foreign assets held in a trust within UK IHT, whenever they were settled, so that nobody living here permanently can avoid paying UK IHT on their worldwide estates.’ This ambiguous statement has raised further IHT issues. The IHT implications of the new rules will be discussed in a separate article.

The term ‘new arrivers’ in this article means those who have not been UK resident in the ten tax years prior to arriving in the UK and, as at April 2025, have been UK resident for less than four tax years. ‘Leavers’ refers to those who were UK resident for more than ten tax years and are either still UK resident or have left the UK within the previous ten tax years.

I first look at the wider rationale behind the changes to give some context as to the likely overall direction of future legislation. I then examine the winners and losers under the new regime.

Why the changes?

The Conservative government took many by surprise when announcing the changes. Some saw it as just an attempt to steal Labour’s clothes, neutralise the politics of the non-dom regime and perhaps raise some money along the way. However, academics and practitioners were in general agreement that the current system was not fit for purpose, even if they could not agree what to replace it with.

Some of the many problems with the present regime include the following:

Discouraging investment

Tax breaks are geared to discouraging non-doms to invest in the UK and further requires them to access such tax breaks only on the basis that they continue to maintain they will leave the UK. Business investment relief and various other remittance reliefs are partial solutions, but the structural issues raised by the remittance basis remain difficult. Why invest in the UK at all if you know that you may be taxed at up to 45% if you bring your foreign income and gains (FIGs) here? And why risk tripping over the highly technical conditions for business investment relief, often with no ability to put the position right?

The March 2024 proposals address this by providing for an outright four year exemption for new arrivers in respect of all FIGS arising after April 2025 whether or not remitted. The exemption is given to all trust distributions. Labour has said that they will extend the exemption to UK investment income to further encourage investment here.

In addition, in order to encourage remittance of historic pre-2025 FIGs, until April 2027 there is a facility to pay 12% on these (even if the taxpayer is now UK domiciled). Labour has indicated that they support this and may even extend the facility. Like any new relief, the devil will be in the detail but at least the problem of encouraging investment here has been recognised. The CIOT has produced a detailed paper on how the Temporary Repatriation Facility (TRF) could work sensibly and profitably for the UK without the sort of complexity that was introduced in 2017 round the mixed fund rules (Temporary repatriation facility and mixed funds, see tax.org.uk/ref1337).

The question is whether politicians, HMRC and Treasury will learn from the mistakes of the past and make TRF workable.

Difficulty in determining domicile

It is often difficult to determine domicile, particularly after lengthy periods of residence in the UK or where a person has lived in one country most of their life but has a domicile of origin elsewhere. In some cases, it is not possible to determine the domicile of origin, for example, children of same sex marriages where the parents have different domiciles. Wealthy people are increasingly international, moving from country to country. Determining their ‘permanent residence’ is not always straightforward.

Whilst domicile will continue to be relevant in other legal contexts, such as succession or jurisdiction, it is an uncertain test to apply in relation to tax where the taxpayer must self-assess his position each year and can be held careless and subject to penalties for getting it wrong. A taxpayer cannot claim the remittance basis or obtain the trust protections if he is not foreign domiciled as a matter of law. Small variances in facts can lead to radically different outcomes in determining someone’s domicile. The case law on domicile is not dissimilar to that of residence prior to the introduction of the statutory residence test in 2013.

There are at present four different types of deemed domicile for IHT purposes and two for CGT and income tax purposes – only in the world of UK tax could this be thought a sensible system! However, it is likely that the conditions of SRT will be monitored with increased vigilance given the importance of non-residence. Clients should keep careful records of their day counts, work and other ties.

Gaps in trust protections

There are already gaps in the trust protections for deemed domiciled settlors: for example, HMRC do not accept that the trust protections apply in relation to offshore income gains and accrued income. These gaps can lead to considerable resentment as deemed doms find that they do not have the complete tax-free roll up of trust gains and income originally promised in 2015. Abolition of the trust protections from April 2025 will at least bring clarity and save further argument.

Risk of tainting protected trusts

Protected trusts where the settlor is deemed domiciled remain exposed to a risk of tainting. The rules are complex and not well understood by taxpayers. The smallest addition of value can result in a client losing all the trust protections. From 6 April 2025, settlors who are deemed domiciled will no longer need to worry about these rules (and of course tainting problems do not apply to those not yet deemed domiciled anyway). From April 2025, it will not matter if a deemed domiciled settlor taints their trust as the trust income and gains will be chargeable on them anyway. (There may be certain IHT implications but only in respect of the added funds not the whole trust.)

Difficulty of maintaining domicile of origin

Crucially, the trust protections for income tax and CGT purposes depend on the foreign domiciled taxpayer continuing to be able to demonstrate credibly that he has not acquired a UK domicile of choice. The same is true of the 2017 rebasing option and the 2008 trust rebasing options. That in turn assumes the foreign domiciliary still intends to leave the UK and that it is not his permanent home. More and more deemed domiciled persons would no doubt have found themselves embroiled in long disputes about whether they had in fact acquired a UK domicile of choice anyway and therefore whether their trusts were protected at all. The abolition of the income tax and CGT trust protections for all trusts from April 2025 will avoid the need for such arguments.

Complexity of the regime

The present regime is very complex. There are inconsistencies between the CGT and income tax trust codes. There are four different types of CGT regimes for overseas trusts:

Each of these has different rules and treats losses differently. There should be an attempt as part of the reforms to simplify some of this, particularly as many more people will become subject to the s 86 CGT and transfer of assets regimes.

The winners

New arrivers

New arrivers are winners under the new regime, although their income tax and CGT exemption is short-lived and their difficulties are great once the four year period is over.

Example 1: Joan arrives in the UK for full time work in January 2024 (2023/24) having always been German resident and domiciled. She currently claims the remittance basis. From April 2025 until 5 April 2027, as a new arriver Joan is exempt from income tax and CGT on FIGs. Her two years’ UK residence prior to 25 April are counted towards the four years. Joan will need to be certain that she was not UK resident for any of the ten years prior to arrival here otherwise she will not qualify as a new arriver. Fortunately, this only entails looking at her position under the SRT which at least is more certain than the pre-2013 common law position where recent cases further highlight the difficulties for a taxpayer in making the necessary ‘distinct break’ (see Batten v HMRC [2022] UKFTT 199 (TC), McCabe v HMRC [2022] UKFTT 356 and Peck v HMRC [2017] UKFTT 770).

The precise scope of the four year exemption remains unclear until we see legislation but presumably there will be no matching of trust gains or income to capital advancements made in the exempt four year period. All such benefits and advancements from the trust will be tax free to Joan as a new arriver. Equally, advancements in the exempt period should not reduce the pool of stockpiled gains. In effect, Joan as a new arriver will be in the same position as if she were non-UK resident (except in relation to UK income and gains) and therefore capital distributions are effectively ignored. Nor should distributions made in the four year period be matched to trust gains realised after the four years has expired. The same disregards should apply as in TCGA 1992 s 87D.

What happens if Joan as the new arriver receives a capital distribution from a trust in the first four years and gives it onto a person who is subject to UK tax on a worldwide basis? Presumably, there will need to be an extension of the onward gifts rules in TCGA 1992 s 87I in these circumstances to provide that the trust distribution is taxed if the funds are given by Joan within three years to a recipient who is subject to UK tax. Some considerable redrafting of the onward gifts rules will be required and it is hoped that there will be simplification here. Much of the complexity could be removed for distributions made after 5 April 2025 as the remittance basis will no longer apply. (Inevitably, some of the existing provisions will remain to deal with distributions to a remittance basis user or non-resident before April 2025 where the same has been gifted on within three years.)

The four year exemption gives those who have not sought advice before arriving here, or who become inadvertently UK resident, time to sort their affairs out. Thus, in the above example, Joan could rebase her foreign property in that four year period to obtain a high base cost. Trusts where the new arriver is the settlor could follow a similar course. The new rules are at least a simplification: it will be a lot easier to explain residence compared with domicile and the remittance basis to Joan and there will be less need for professional advice in this area. Equally, the need for professional advice is likely to increase significantly in relation to areas such as the transfer of assets code (see below).

Temporary repatriates

Those who are now domiciled here under general law or are deemed domiciled are winners to the extent that they have historic unremitted FIGs which they can bring to the UK, hopefully taking advantage of the TRF and paying 12%. For those who are or were non-doms and decide to stay in the UK, the TRF could be a very useful way of bringing funds to the UK and paying only 12% tax. However, it is presumably unlikely that any credit would be given for foreign taxes suffered on the funds so the rate may be less favourable than originally thought. Identifying the clean and untaxed parts of any mixed fund is also problematic, so this facility needs to solve those problems. The CIOT paper suggests some ways of how to do this.

Uncertain domicile status

The new rules benefit those who have been out of the UK for a long time and are uncertain about their domicile status, perhaps because they left the UK many years ago, have a domicile of origin but are not settled in any particular state, a common occurrence for those who go to work in federal states such as Canada, USA or Australia. This is particularly relevant to IHT where the radical step is taken of removing domicile as a connecting factor altogether. (The technical March paper refers to consultation to discuss ‘additional connecting factors’ for IHT purposes, which it is hoped will be abandoned.) Instead, someone who has been non-UK resident for ten tax years will fall outside the IHT net. Moreover, for the first ten years of UK residence, the technical paper suggests that all new arrivers, whatever their domicile, will be free of IHT. This is a win for those with a UK domicile who have been non-UK resident for many years. They can live here again for ten years, settle foreign property into trusts without an entry charge, make gifts of foreign assets without the need to survive seven years and die before the ten years has expired without having to worry about IHT on foreign assets. Those clients who have not yet been UK resident for ten years and are uncertain about their domicile status now or were born here with a UK domicile of origin but a foreign domicile of choice (see IHTA 1984 s 267(2)(aa)) may want to wait until April 2025 before effecting any IHT planning. It is hoped that HMRC will not introduce any special rules to catch formerly domiciled residents.

Having noted the above, it remains unclear how the ten years UK residence will be counted. Presumably it will not be ten years consecutive UK residence; otherwise someone could leave in the ninth year and come back, say, three years later and not be within the scope of IHT. While it could be a requirement that the taxpayer must have ten years consecutive non-UK residence to lose the IHT tail, it could equally be provided that someone comes within the scope of IHT if they have been UK resident for more than ten out of the last 15 years. This gives people some flexibility, but it may entail looking at non-residence periods prior to 2013 which introduces some uncertainty. For example, under this model, you could leave the UK in your ninth year, stay out for six years and never come within the UK IHT net at all. However, once the individual has been here for ten years, it is assumed that HMRC will stick to the proposal in the policy document that leavers will be subject to IHT on their worldwide assets until they have been non-UK resident for ten consecutive years. This is a long tail and there have been strong objections to it from various professional bodies.

Example 2: Robin, UK domiciled by origin, has worked in Australia for 20 years, moving from state to state as his work dictates. He is not settled in any particular state and so has not acquired a foreign domicile of choice. On retirement, he decides to spend more time in the UK to see if he wants to settle here or remain in Australia. He becomes UK resident in 2024/25.

Under current rules, he is subject to IHT on his worldwide estate as he has not acquired a foreign domicile of choice. Even if he had acquired a domicile of choice abroad from the start of his second tax year, Robin will be subject to IHT on his worldwide assets as a formerly domiciled resident (IHTA 1984 s 267(2)(aa)). Under the new rules, if residence is the only connecting factor he will not be subject to IHT from 2025/26. The writer hopes that HMRC will accept the logic of keeping residence as the sole connecting factor (but equally may then apply it as the sole connecting factor for those who have left – see example 4).

The losers

There are of course many losers under the new regime. These have been highlighted in earlier Tax Journal articles and most obviously include the following:

Remittance basis users who have been UK resident for longer than four tax years

They were expecting the current regime to last for much longer and will now need to accelerate receipts of foreign income or rebase assets for CGT purposes before April 2025. After that, they will be taxed on an arising basis unless they decide to leave. Once they leave, they may remain within the IHT net, but they will not be subject to income tax and CGT provided they remain non-UK resident for more than five tax years.

Settlors who are UK resident from 2025/26 and are not new arrivers

They will be taxed on the same basis as UK domiciled settlors. Many of these may be deemed domiciled here and have been actively encouraged by the 2017 trust protections to set up trusts. They will be subject to income tax on an arising basis on all trust and corporate income and offshore income gains within the trust if they or their spouse/civil partner can benefit. It may be possible to exclude the settlor and spouse/civil partner so as to avoid a charge under the transfer of assets and settlement provisions. This should be done before April 2025 to avoid a deemed PET under FA 1986 s 102(4).

Even if they are excluded, gains realised by the trust will be chargeable on the settlor unless all of the settlor, children, grandchildren and their respective spouses or civil partners are excluded from any benefit. It may be common to exclude the settlor and spouse from a trust but excluding the issue of the settlor will be rare and if the settlor is excluded they will have difficulty enforcing their statutory rights of reimbursement.

Example 3: Idris is the settlor of a trust holding a group of companies operating out of India. It is possible that the motive defence applies to the corporate income if it can be demonstrated that none of the transactions were effected for the purposes of any UK tax avoidance or the transactions involve largely trading companies but the burden is on Idris to show this and he cannot obtain any advance clearance on the point. He faces uncertainty on his income tax position for some years. If the motive defence is eventually rejected, then Idris is exposed to income tax on the profits of the foreign companies which profits will no doubt have already suffered Indian corporation tax for which he obtains no credit. There is no right of reimbursement in these circumstances. If Idris receives distributions sufficient to pay the UK tax, that is a further taxable benefit. One legislative improvement that could be made is to impose primary or concurrent liability on the trust or company to pay the income tax (or CGT), although in the case of India there will be other difficulties, not least foreign exchange control restrictions.

Those with interests (either through trusts or in direct ownership) in foreign companies will therefore need to consider carefully before April 2025 whether they will qualify for the motive defence (ITA 2007 s 737). They may prefer to be excluded from the trust before April 2025 or to give away their interests in foreign companies before 2025 (to avoid CGT and IHT on the gift if they are not deemed domiciled).

Labour’s IHT announcement has thrown another spanner in the works, as settlors like Idris may find themselves subject to IHT on death under the reservation of benefit rules if they can benefit from the trust and are within the IHT tail. Even if they are not a beneficiary, the trust is subject to continuing 6% charges while the settlor is within the scope of IHT. Spouse exemption is difficult to obtain in these circumstances (except through a general testamentary power of appointment). It may be better to exclude at least Idris now to avoid a ROB charge, even if his spouse remains a beneficiary. If done before April 2025, this should avoid a deemed PET under FA 1986 s 102(4). However, the trust cannot be wound up without income tax and CGT charges if Idris is deemed domiciled here and no doubt this will further incentivise long stayers to become non-UK resident before April 2025. The trust can then be wound up shortly after April 2025 with a minimal exit charge and no income tax or CGT if Idris remains non-UK resident for more than five tax years. Italy and Dubai seem favoured jurisdictions at the moment.

Certain trust beneficiaries

Beneficiaries of trusts who are remittance basis users but not settlors will need to check that any capital payments or benefits retained abroad are fully matched to trust gains this tax year. If they are taxed on the arising basis next tax year, those unmatched capital payments could become matched to trust gains realised in a year when the new rules apply. Those who were not foreign domiciled and became non-UK resident but return after April 2025 within six years of leaving will be subject to the temporary non-residence rules. The difficulty is that the exemption regime will not apply to them on return after April 2025 as they are not new arrivers so most types of gains and certain categories of income (for example, dividends from close companies) realised in the period of temporary non-residence will be chargeable on an arising basis in the year of return.

Certain returners

Those non-doms who left in 2017/18 or before and resumed UK residence after six tax years abroad, thinking that they have lost deemed domicile, will not qualify as new arrivers under the new regime. Hence although they may currently be claiming the remittance basis, that will cease from April 2025. They will, from April 2025, be taxed on an arising basis on all worldwide income and gains and, if settlor of any trusts, they will be exposed to all the charges above.

Those adversely affected by IHT changes

The IHT position for those within the ten year tail from April 2025 remains uncertain and affects different categories of people in different ways. This will be discussed in much more detail in a future article but it can best be illustrated at the moment through a series of examples.

Example 4: Gee has never become UK deemed domiciled and left the UK in March 2018 in his 14th year of UK residence. He is not presently subject to IHT on foreign assets. If there is no transitional relief he will become potentially subject to IHT on worldwide assets from April 2025 as he was UK resident for more than ten years and has been non-UK resident for less than ten years. He may have set up trusts which under Labour proposals could be taxed. From 2028/29, it is assumed he will fall outside IHT, but the question is whether any relief will be given to people between 25 to 28 in these circumstances.

Example 5: Berthe was UK resident for 20 years before leaving the UK in 2017/18 to return home to Germany. Under present law she has lost her deemed domicile but from April 2025 if the ten year tail applies to her she will be subject to IHT until 2027/28 (and no doubt her estate is also chargeable in Germany).

Example 6: Arj (deemed domiciled) left the UK as soon as he heard the Budget proposals and is non-UK resident in 2024/25 living in Dubai. He does not intend to return and has given up his UK home but retains his home in India where he is domiciled. Will he be able to claim double tax relief on foreign assets passing under his non-UK will on his death under the 1956 Estate Duty Treaty with India on the basis that he is domiciled there or will HMRC disapply treaty relief where the effective rate of tax is 0% (as they did in respect of the IHTA 1984 Sch A1 legislation)? These and other IHT points will be discussed further in a future article.

For related reading, the following articles are inTax Journal: 

  • Non-dom reform: the proposals (R Sheldon, 15.5.24)
  • Labour’s reaction to the non-dom proposals (T Evennett, N Morgan & H Hare-Scott, 2.5.24)
  • Labour’s tax plans: aiming at the wrong target? (J Quarmby, 18.4.24)
  • The non-doms reforms: a practitioner view (H McGhee, 3.4.24)
  • What the Budget means for non-UK resident trusts (E Hayes, 13.3.24)

Non-subscribers can access the above articles free of charge by registering on the Tax Journal website.

If you would like more information on how one of our members may be able to help you in this complex area, please contact the clerks.

This article was first published on 14th June 2024 in Tax Journal.