Foreign domiciles and non-residents

Key points

• Challenging a charge to tax under the transfer of assets abroad legislation in ITA 2007, Pt 13 ch 2.
• The protection of settlements from ‘tainting’.
• An adjuster clause may provide some protection from inadvertent tainting of trust assets.
• Increasingly, HMRC seems to be challenging claims to non-domicile status.
• Rules to counter the enveloping of interests within overseas structures include provisions on relevant loans.
• A new capital gains tax charge on non-UK residents disposing of UK property interests that derive at least 75% of their value from UK land.

Transfer of assets abroad ‘attack’

An ‘attack’ by HMRC in the form of a charge to tax under the transfer of assets abroad legislation (ITA 2007, Pt 13 ch 2) may be overcome by examining the circumstances carefully. For example, suppose that Mr X (a UK resident, non-UK domiciled individual) owns shares in a foreign incorporated company, which is in receipt of UK rents. Income tax at 20% has previously been paid by the company on the rental profits under ITTOIA 2005, s 268 (‘Charge to tax on profits of a property business’).

HMRC may assess Mr X at, in effect, a further 25% under ITA 2007, s 720, which imposes a charge on income within s 721 (‘Individuals with power to enjoy income as a result of relevant transactions’). However, that charge may be defeated if the company is found to be resident in the UK, even though it is incorporated outside the UK (ITA 2007, s 718). Further, it might be argued that the company has overpaid its tax liabilities (in other words, 20% as opposed to the corporation tax rate of 19%).

‘Tainting’ of protected trusts

Following the changes to the taxation of non-UK domiciled individuals (in F(No 2)A 2017), ‘tainting’ has become a critical issue for trustees of non-UK resident trusts and their advisers. Potentially, protections are available if non-UK domiciled individuals set up non-UK resident trusts before becoming deemed domiciled in the UK under the ‘15 out of 20-year rule’ (these are known as ‘protected settlements’). However, these protections do not apply to non-UK domiciled individuals who were born in the UK and previously had a UK domicile of origin. Protection can apply to capital gains tax charges (TCGA 1992, s 86), the settlements legislation (ITTOIA 2005, s 624, s 629 and s 633), and the transfer of assets abroad rules (ITA 2007, s 720 and s 727).

The tainting rules are found in TCGA 1992, Sch 5 paras 5A and 5B for capital gains tax purposes; ITTOIA 2005, s 628A and s 628B for settlements; and ITA 2007, s 721A, s 721B and s 729A for transfer of assets abroad. The basic proposition is that no property or income can be directly or indirectly provided to the settlement by the settlor (or by the trustees of another settlement of which the settlor is the settlor or the beneficiary) when the settlor is domiciled or deemed domiciled in the UK.

A trust could be tainted inadvertently; for example, by the provision of services to the trust or improvements to trust property. If this occurs, a possible (although expensive) remedy may lie in the doctrine of mistake. Incorrect professional advice does not of itself preclude relief. Another option might be the inclusion of an ‘adjuster clause’ to allow any addition that may cause a protected settlement to be tainted to be reversed (this is similar to the approach endorsed by HMRC in statement of practice 5/92 – see tinyurl.com/HMRC-79563). This might be particularly sensible in the case of loans to underlying companies. The best option would be to proceed with extreme caution and vigilance, and to monitor (but not necessarily rely solely on) HMRC’s guidance.

Domicile status challenges

Challenges by HMRC to foreign domicile status are likely to increase after recent changes in legislation. A potential area of focus by HMRC is individuals with a UK domicile of origin who return to the UK (for example, to work, for health reasons, or to die) particularly if they were not born here and are thus not deemed domiciled under ‘formerly domiciled resident’ provisions; see Gulliver (TC5712). Another possible area of HMRC focus is second or possibly third generation children who have never lived outside the UK (F Henderson and others (TC6010). Further, long-term UK residents with few connections in their purported country of domicile may have acquired a domicile of choice in the UK (Proles v Kohli [2018] EWHC 767 (Ch)).

HMRC may also challenge cases if there is doubt about whether an immigrant parent who had claimed foreign domicile lost it upon arrival in the UK. If the individual did not intend to leave the UK, their child may have acquired a domicile of dependency in the UK which became a domicile of choice; this would not be lost until the individual physically left the UK. HMRC invariably requires a list of questions to be answered in domicile enquiries. However, answers should not be given without all the facts, supported by evidence for any assertions made.

Inheritance tax and UK residential property

The inheritance tax rules on UK residential property interests, which are aimed at countering the ‘enveloping’ of such interests within overseas structures to constitute excluded property, include provisions concerning relevant loans (IHTA 1984, Sch A1 paras 3 and 4). Broadly, a ‘relevant loan’ is one used to finance (directly or indirectly) the acquisition, enhancement or maintenance by an individual, partnership or trustee of:

• a UK residential property interest;
• a company that owns or acquires such residential property interest; or
• a company which owns or acquires relevant loans.

The lender could be a company, partnership, individual or trust. The borrower must be an individual, partnership or trust for a loan to be a relevant loan. Borrowings by a company are within IHTA 1984, Sch A1, para 2 (loan participators).

A loan to buy property is not disallowed as a deduction for inheritance tax purposes, but it is not excluded property if the loan is to a trust, partnership or individual and is used to buy a property acquired by that trust, individual or partnership. Further, a loan to a trust, individual or partnership is not excluded property if it is used to buy a company or partnership that holds or buys UK residential property. This includes loans to maintain or enhance a property. The residence of the borrower or lender is irrelevant, as is whether the borrower or lender are connected. A loan ceases to be a relevant loan on disposal of the residential property, even if it is not repaid.

Capital gains tax and non-UK residents

A new TCGA 1992, s 1A(3)(b), (c) included in Finance (No 3) Bill 2018-19 imposes a capital gains tax charge on non-UK residents who dispose of interests in UK land, or assets which derive at least 75% of their value from UK land if the person has a ‘substantial indirect interest’ in the land. The 75% condition is a ‘snapshot’ test.

This provision ensures that disposals by non-UK residents of rights or interests in companies (which can include UK companies) that derive at least 75% of their value from UK land are liable to capital gains tax on their gains. If the company does not hold the UK land directly but through other assets (such as shares in another company or trust interests), it is necessary to ascertain the value in the qualifying assets that derives directly or indirectly from UK land. The chargeable gain is determined by reference to the assets disposed of, rather than the value of the land.

There is an important exception in relation to interests in UK land used for trading purposes. A disposal of a right or interest in a company is not to be regarded as a disposal of an asset deriving at least 75% of its value from UK land which is used or acquired for the purposes of a qualifying trade. This would cover, for example, the sale of a retail company that has valuable shops or a restaurant chain.

There are rebasing provisions for non-UK residents on the first direct or indirect disposal of UK land held on 5 April 2019. The rebasing rules cover a number of permutations. The provisions include the facility for a taxpayer to elect out of rebasing if, say, the person’s base cost is higher.