Tradition abolition – Emma Gillies and Rebecca Anstey write for STEP Journal
Emma Gillies and Rebecca Anstey on why the proposed abolition of the UK’s non-dom regime will have little impact on many UK resident Americans.
What is the issue?
The UK government has proposed changes to the taxation of non-UK domiciled, UK residents from 6
April 2025.
What does it mean for me?
Individuals will be looking to their advisors for help navigating these changes and those advising US
citizens will need to understand how the new rules affect their clients.
What can I take away?
The interaction between US and UK tax laws means that US citizens residing in or moving to the UK may not be as concerned as others by the changes, but there are still challenges and potential planning opportunities to be aware of.
It will be old news to many that the UK government plans to introduce changes to the tax treatment of non-UK domiciled, UK-resident individuals (so-called ‘non-doms’) with effect from 6 April 2025. Although many non-doms will have concerns about the impact of the new regime, US non-doms should be sheltered from the fallout more than most.
Proposed changes to UK income tax and capital gains tax
Abolition of the remittance basis
Non-doms can currently claim the remittance basis of taxation. Those who do are subject to tax on their UK-source income and capital gains as they arise, but only on non-UK income and gains if and to the extent that they are ‘remitted’ to (broadly, brought to or used in) the UK.
It is proposed that the remittance basis will be abolished and replaced by a new ‘foreign income and gains’ (FIG) regime. Under the FIG regime, those who have not been UK resident in any of the previous ten years will be exempt from tax on their non-UK income and gains during their first four years of residence (regardless of any remittances). Thereafter, they will become subject to tax on their worldwide income and gains as they arise.
In many cases, the loss of access to the remittance basis will not be a major concern to US non-doms.
Unlike most non-doms, US citizens are already exposed to tax (in the US) on their worldwide income and gains as they arise. Fortunately, there is a treaty in place between the UK and the US that is designed to provide relief from double taxation where a liability arises in both countries at the same time. A UK-resident US citizen (with exposure to tax in both countries under domestic rules) may be able to show that they should be treated as tax resident in the US for the purposes of the treaty, at least for the early years of residence when their ties to the US remain strong. In these cases, their exposure to UK tax will be limited to certain types of UK income, with no need to claim the remittance basis on their foreign income and gains.
Where the taxpayer is resident in the UK for the purposes of the treaty, they will generally be exposed to tax at the higher of the two countries’ effective rates on a given item of income or gain. In that scenario, the utility of the remittance basis is generally limited to avoiding the risk of double taxation. This can be helpful where an item of income or gain is treated differently in the UK and the US, and treaty relief is not available. It can also assist in avoiding a higher rate of tax in the UK than is payable in the US; for example, on investment returns from US mutual funds that do not have ‘reporting’ status in the UK, which are taxed at capital gains rates (20 per cent) in the US but income tax rates (45 per cent) in the UK.
For these reasons, it is uncommon for US non-doms to claim the remittance basis beyond the point at which it comes at the cost of an annual charge (i.e., from the beginning of the eighth consecutive tax year of residence). Before that, it can be convenient to claim the remittance basis from a reporting perspective. However, using the remittance basis to defer UK tax is generally not wise for US citizens, because a mismatch in the timing of the UK and US liabilities can often cause a loss of treaty relief, resulting (ironically) in double taxation. It should only really be used where the taxpayer is confident that their foreign income and gains will never be remitted to the UK.
Removal of ‘protected settlement’ status for ‘settlor-interested’ trusts
Under current rules, where a non-dom settles assets into a non-UK-resident trust, the trust’s non-UK source income and capital gains are generally sheltered from tax unless and until a UK-resident individual receives a benefit from the trust, at which point a liability may be triggered. It looks as though the protected’ status of these trusts will no longer be available under the new regime. Instead, where the UK-resident settlor retains an interest in the trust (within the relevant statutory definitions) it is proposed that the trust’s worldwide income and gains will be treated as arising to the settlor, and will be taxed accordingly.
Again, this change will be of less concern to many US settlors, who will have deliberately put their trusts outside the ‘protected settlement’ regime, having been advised to do so on the basis of double taxation risks. These arise because most lifetime trusts settled by US citizens will be grantor trusts for US income tax purposes, meaning the income and gains of the trust are taxed on the settlor as they arise. The resulting mismatch in the timing of the tax liability (immediate in the US versus deferred in the UK) and, potentially, the identity of the taxpayer (settlor in the US versus beneficiary in the UK) will often cause a loss of treaty relief. By contrast, maximum relief should be available if the income and gains are taxed on the settlor in both the UK and the US as they arise.
Changes to UK IHT
Under current rules, non-doms who are not deemed domiciled in the UK (because they have not been resident in 15 or more of the past 20 tax years) are only subject to UK inheritance tax (IHT) on UK assets. Under the new regime, domicile will no longer be relevant when assessing IHT. Instead, a person will become exposed to IHT on worldwide assets after ten years’ tax residence in the UK.
The deemed domicile ‘tail’
Currently, where a non-dom becomes deemed domiciled, they
will continue to be deemed domiciled for IHT purposes for a
further four tax years after ceasing UK residence. Under the new
regime, it is proposed that this IHT ‘tail’ will be extended to ten
years.
Thanks to the US-UK Estate and Gift Tax Convention (the Treaty), US citizens who leave the UK to return to the US will lose this ‘tail’ much sooner than other non-doms, provided they can show they are US resident for the purposes of the Treaty (and they are not UK citizens). In that scenario, the US will have exclusive taxing rights over the estate, save for UK immovable property or business property of a permanent establishment (BPPE).
Excluded property trusts
Until now, assets transferred into trust by non-doms (including US citizens) who are not yet deemed domiciled are excluded from IHT indefinitely (hence the term, ‘excluded property trusts’).
The government has announced that trust assets will no longer be excluded from IHT. However, some US citizens may be able to rely on the Treaty to achieve the same result. The Treaty provides that no IHT is due on trust assets (other than UK real estate and BPPE) settled by someone who was domiciled in the US and not a UK citizen. If the treaty continues to apply in the same way under the new regime (with UK domicile interpreted to mean ten years’ UK tax residence), assets settled into trust by US citizens who are not UK citizens and have not yet spent ten years in the UK may be protected from IHT beyond the ten-year threshold.
Impact on advice
- US non-doms who currently make use of the remittance basis should review their financial affair with their advisors, with the Treaty in mind.
- US citizens moving to the UK for the first time will have four tax years to tailor their investments to account for UK tax considerations. Pre-arrival advice will still be required to avoid tripping up on UK rules affecting existing trusts, business interests and reporting obligations.
- UK-resident US citizens approaching the new ten-year threshold for worldwide IHT exposure may still consider trust planning to protect their non-UK assets from tax. Alternatives to cover include lifetime giving, structuring wills to defer IHT until the second death of a married couple, investing in relievable assets and/or taking out life insurance to cover the bill.
Tradition abolition, Emma Gillies and Rebecca Anstey, STEP Journal (Vol32, Iss5)