Domicile Decisions

Domicile Decisions

NEIL EDWARDS re-examines some of the basic concepts and planning opportunities of domicile.

DOMICILE IS A very British concept. While many tax jurisdictions rely solely on residency and ordinary residency (or their equivalent) to determine the extent to which an individual is liable to tax, the United Kingdom has the additional status of domicile. For non-United Kingdom domiciled individuals, the United Kingdom can offer generous tax breaks, which may help explain why high-profile wealthy individuals often set up their base within these shores — it is said that the Greek shipping industry is run by Greek domiciles residing in London.

Domicile should not be confused with nationality or indeed residency, although both can indicate where an individual is domiciled. Broadly speaking, domicile is where an individual's permanent home is or where he feels he belongs. Crucially, with one notable exception (see 'deemed domicile' below), there is no statutory definition of domicile. Instead it is a general law concept and is based upon the facts of each individual's case.

All individuals must have a domicile, but may only be domiciled in one country at any one time. It is not possible for an individual to have 'dual domicile' status as he can for nationality or residency. Moreover, once a domicile has been established, it is assumed that it continues until such time as a new permanent domicile has been acquired — or until action is taken to abandon it.

Domicile of origin

All individuals will have a domicile of origin acquired at birth. This is not where a person was born, but is the domicile of his or her parents, or more accurately the father, assuming that the child is the offspring of a legitimate marriage. When confronted with an individual claiming to be domiciled abroad, practitioners will need to confirm that the father was not, for instance, an expatriate, as the individual may already have a United Kingdom domicile of origin even though he has never set foot on these shores.

Even if an individual's father did not have a United Kingdom domicile, then it is possible that the individual may have acquired a United Kingdom domicile either through a domicile of dependency or a domicile of choice.

Domicile of dependency

A domicile of dependency can be acquired by an individual if, before his or her sixteenth birthday, his father changes his domicile (or mother, if the father is unknown or the child is born out of wedlock) or if the child is orphaned. Again, a practitioner who is advising an individual who claims non-United Kingdom domicile status will need to verify his history. Women who married prior to 1974 acquired a domicile of dependency as they automatically adopted the domicile of their spouse.

Domicile of choice

An individual can also seek to change his domicile after his sixteenth birthday by adopting a domicile of choice. In practice it is a lot more difficult than merely turning up at the border with a neatly completed application form and passing a citizenship test.

For a start, an individual must sever all ties with his previous domicile and settle in the country he wishes to adopt with a clear intention to remain there permanently — i.e. not for a limited period or particular purpose. Anything that indicates that the individual intends to one day return to his former home or that he does not intend to remain permanently in his new domicile can be sufficient to deny the individual's domicile of choice. The example that is often cited is the burial plot — i.e. where the individual intends to be interred, ironically, after he has ceased living, although other factors such as where the children of the individual are educated, land and property owned in the previous country of domicile, or indeed the stated intentions of the individual can all impact on any decision.

Another requirement is that the individual must firmly establish him or herself in a single legal jurisdiction. This can be an issue for multi-state countries such as the United States or the United Kingdom, consisting as it does of the legal jurisdictions of England and Wales, Scotland and Northern Ireland. If the individual is moving around, he may never be anywhere long enough to establish a new permanent home. Indeed, it is possible for an individual's domicile of origin to revive, despite him having a clear intention never to return, simply because he or she has failed to establish a clear domicile of choice.

Of course, this may all count in an individual's favour if his or her domicile of origin is outside of the United Kingdom and he or she has retained sufficient ties to prevent the acquisition of a United Kingdom domicile of choice. Under these circumstances, the individual may be able to take advantage of those generous tax breaks already alluded to.

Tax advantages

A non-United Kingdom domiciled individual resident in this country will generally only be liable to tax on his United Kingdom income and capital gains on United Kingdom assets. However, for offshore income and capital gains, the United Kingdom tax system can be very favourable.

First and foremost, any offshore income and gains that arose before the individual arrived in the United Kingdom are effectively exempt from United Kingdom income and capital gains tax even if they are brought into the country, i.e. remitted, after arrival. A general tax planning point for individuals coming to the United Kingdom is to identify such income and gains as funds that can be remitted without a further United Kingdom tax liability.

Once resident in the country, a non-United Kingdom domiciled individual is normally only liable to tax on subsequent offshore income and gains to the extent that they are remitted into this country. There are some exceptions where the remittance basis does not apply — e.g. chargeable event gains on offshore life insurance investment or capital redemption bonds are subject to United Kingdom income tax on an arising basis — so care must be taken where advice is provided.

Remittance

The definition of remittance can have a wide basis. Not only does it cover the obvious, e.g. transferring cash to a United Kingdom bank account, but it can also include implied remittances such as bringing into the country goods and services acquired with offshore funds and/or settling United Kingdom liabilities using offshore assets. Incidentally, merely changing the form of offshore funds or assets will not enable an individual to circumvent the remittance rules. In effect, the income or capital gains follow the money into whatever shape or form it takes.

If the funds that are remitted into the United Kingdom include an element of capital gain, then the amount of gain remitted is proportionate to the amount of proceeds brought into the country. In other words, if half the proceeds are remitted then so is half of any gain. For tax planning purposes, this can be a very useful method of exploiting the annual exemption. An individual who incurs a substantial offshore gain can remit just sufficient into the country each tax year to use up his or her annual exemption. This staggering of the remittance can realise the gain(s) with minimal, or possibly no, capital gains tax liability.

Capital gains on an offshore deemed disposal, e.g. a gift to a connected person, cannot be remitted and there is no relief for offshore capital losses, even if the proceeds are remitted into the United Kingdom.

Unlike capital gains, where a remittance comes from funds consisting of a mixture of initial capital and income then it is generally the income element that is remitted first. One standard tax planning solution is to ensure that income earned on offshore assets is kept separate from its original capital — e.g. interest earned on an offshore account is credited to a separate account, thereby enabling the individual to remit funds from the original capital account as and when required. The potentially taxable income is kept offshore. There are other tax planning measures that exploit the remittance basis and, needless to say, individuals will be well served to seek professional advice.

For inheritance tax purposes, a non-United Kingdom domiciled individual is generally only liable on United Kingdom situs assets. Offshore assets (and certain United Kingdom investments) are excluded property, so again keeping funds offshore can protect them from the Inland Revenue. There is, however, a sting in the tail for long term residents in the form of deemed domicile.

Deemed domicile

An individual will acquire a United Kingdom deemed domicile if he has been a tax resident in the United Kingdom for seventeen out of the past twenty tax years (section 267(1) (b) , Inheritance Tax Act 1984). An individual with a deemed domicile in the United Kingdom is liable to inheritance tax on his worldwide assets, although he is still treated as a non domicile for income and capital gains tax purposes. To counteract the deemed domicile rule, individuals will often place excluded assets into a discretionary trust, usually referred to as an excluded property trust, before they acquire a United Kingdom deemed domicile status.

Individuals who have already acquired a United Kingdom deemed domicile for inheritance tax purposes may still be able to use an excluded property trust if they are able to take up residency elsewhere. However, it takes at least three years for the loss of a United Kingdom domicile to be effective for inheritance tax purposes (section 267(1) (a) , Inheritance Tax Act 1984), so individuals should be prepared for an extended stay abroad.

Incidentally, in 2001 the Inland Revenue amended its internal manuals to have all cases where the excluded property trust inheritance tax exemption was claimed referred 'upwards' for further investigation — the implication being that Capital Taxes is looking for a possible test case to challenge the excluded property trust rule.

Intra-spouse transfers

One thing that any married non-United Kingdom domiciled individual has to consider is the effect that domicile has on intra-spouse transfers. Transfers to a United Kingdom domiciled spouse, including a deemed domiciled spouse, will be covered by the normal inheritance tax exemption. However, transfers to a non-United Kingdom domiciled spouse have a restricted exemption of only £55,000 on the cumulative transfers throughout the entire marriage. Any transfers in excess of this exemption will, to the extent that they are not covered by another exemption, be potentially exempt transfers.

Matters can become more complicated if a non-United Kingdom domiciled spouse subsequently acquires United Kingdom deemed domicile status. Under these circumstances it is possible that there will be transfers prior to the change, which will be potentially exempt transfers, and transfers after the change that will be exempt. Moreover, once an individual has acquired deemed domicile status he and his spouse may have to reconsider all their inheritance tax planning, particularly with regards to using the nil rate band.

Treasury review

Needless to say, domicile is a complex area and this article is a broad overview of some of the issues. In his 2002 Budget, the Chancellor of the Exchequer, Gordon Brown announced a review of the residency and domicile rules, implying that non domiciles have enjoyed too many tax breaks. However, despite a reiteration of intentions in the 2003 Budget, there has been little or no movement. In fact the review got no mention at all in the 2004 Budget speech and, as with so many areas of tax planning, it's a case of 'watch this space'.

Neil Edwards is senior tax and financial planning adviser at HBOS Financial Services.

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