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UK Budget 2008 Non-Domiciled Changes: Revolutionary Or A Damp Squib?

By Eesh Aggarwal - Email Editor

Date : April 08, 2008

Domicile
Domicile is an international legal concept and is not tax related. Domicile is, in short, your permanent home – usually inherited from your father at birth. So what is a non-UK domiciled person? As a rule of thumb this is a person who arrived in the UK, e.g. from Greece, to live there on a temporary basis, but who has always had the intention to return to his or her home country. Thus, most UK immigrants can be classified as non-domiciled. In practice, this temporary basis can extend into decades and can even be passed to the person’s children.

The 2008 UK budget presented by Alistair Darling, Chancellor of the Exchequer for the UK on 12 March 2008, was billed as a revolutionary budget enabling non-UK domiciled residents to be taxed “fairly”. The aim was for non-UK domiciled residents to be taxed in the same manner as UK domiciled residents. Did it achieve its aim?

The Problem
The UK has always been a tax haven for non-UK domiciled residents, as these persons only pay tax on UK source income and gains, and on overseas income and gains remitted into the UK.

In other words, any non-UK income is tax-free unless remitted as income into the UK. In contrast, a domiciled UK resident pays tax on his/her worldwide income and gains, whether or not monies are remitted to the UK. For example, a Greek billionaire can move to the UK (and hence stop paying Greek taxes). He can arrange to remit just enough funds to the UK to live and pay UK taxes just on those remittances. Loopholes allow income and gains to be treated as capital in certain circumstances, in which case even these UK remittances would be tax-free. In addition, most UK investments can be arranged using offshore companies and trusts resulting in minimal UK taxes on income and virtually no taxes on gains! Thus a resident ‘non dom’ could in theory, be a billionaire and live in the UK, free of UK taxes, and at the same time take full advantage of all UK government services e.g. free health care and schooling. On the other hand, a domiciled resident billionaire would pay millions of pounds in taxes. Seems unfair?

It is this advantage that has irritated successive UK governments. There are many reasons why successive governments have tried, but failed, in their attempt to tax resident non-doms including, inter-alia, the billions invested by resident non-doms in the UK real estate market, for tax-free gains, using London as an operating base for many world-class shipping companies, and the ability of the City of London to attract top global financial professionals with the ability to pay minimal taxes. As a result, any increase in taxation would risk a flight of capital out of the UK economy in terms of real estate investment and job losses and risk it becoming a weaker global shipping and finance centre.

However, the generous tax treatment of resident non-doms still blinkers government thinking, as it is perceived as unfair to resident domiciled persons.

Pre-Budget Proposals
In the UK, it was proposed that Gordon Brown, the current UK Prime Minister, wanted to tax resident non-doms when he was Chancellor but was blocked by the then Prime Minister, Tony Blair. Since Gordon Brown became Prime Minister, it was always assumed that Alistair Darling would be free to act. And act he did! Darling proposed sweeping changes on 12 March 2008 in the wake of surprise pressure from virtually all sectors of the UK economy, including finance, shipping, US taxpayers and even the UK Minister of Trade and Investment, Lord Digby-Jones.

Budget 2008
The heavily watered down current proposal tax changes are as follows to be implemented and effective from 6 April 2008.

1. GBP30,000 annual tax charge
Resident non-doms who wish to retain their tax-professional status will need to opt for this status each year by paying a flat GBP30,000 tax. Exemptions proposed are:

• Children will be exempt from this tax and hence can still benefit from tax-free, unremitted, non-UK income and gains,
• To ensure regular immigrant workers with small amounts of overseas savings income and gains not affected (e.g. Polish workers), persons with total non-UK unremitted income and gains not exceeding GBP 2000 per annum will be exempt,
• To ensure global talent is attracted to the UK, especially the City of London, resident non-doms who have been resident for less than 7 years in the UK will also be exempt. It is assumed that such professionals remain in the UK for less than 7 years on average.

If resident non-doms do not elect to pay the GBP30,000 tax, they will need to pay taxes on worldwide income and gains whether or not monies are remitted to the UK.

2. UK remittances
Having charged GBP30,000, things still looked rosy for resident non-doms. Prior to this Budget, they could remit income and gains to the UK using various methods tax-free e.g. offshore mortgages, source ceasing, and alienation of income. The Budget aims to stop this and wants to tax monies brought into the UK. Thus, most of these methods of converting income and gains into tax-free capital will be blocked. In short, resident non-doms will pay UK tax on most UK remittances.

Interestingly, art works brought into the UK, or art purchased in the UK, was at risk of being treated as a UK remittance and hence taxable. Apparently, museums faced requests from resident non-doms to have their loaned art works exported from the UK prior to 6 April 2008, leading to a scarcity of art in the UK. Oops, an unintended consequence of the new legislation. The museum curators lobbied the Chancellor and it was hastily announced that such art works would not be treated as taxable remittances to the UK.

There is an interesting tax planning option available. The GBP30,000 tax can be paid from remitted funds and this payment of tax will not be treated as a UK remittance. In addition, the GBP30,000 tax paid can be offset against specific overseas taxable income or gains. E.g. for a 40% taxpayer, this equates to unremitted income of GBP75,000. Thus the GBP75,000 can be transferred to a separate bank account and later remitted to the UK tax-free, as tax has already been paid. If this separation of funds is not done, due to a quirk in the law, the resident non-dom may be liable to pay tax when the GBP75,000 is remitted.

3. Offshore structures
Most resident non-doms live in the UK and own offshore assets via trusts and offshore companies. These trusts and companies can simply invest back into the UK virtually tax-free. The Chancellor originally proposed that these structures would be taxed annually on any UK assets held, whether remitted to the resident non-dom in the UK or not. In addition, it was proposed that full disclosure of transactions within these offshore structures would be required by the UK government. Seems fair?

There was a massive unexpected protest by resident non-doms, the City of London and the banking sector. As a result the Chancellor withdrew these proposals and hastily confirmed that (a) no information would be sought from such offshore structures and (b) resident non-doms would only be taxed when monies were paid out by trusts and/or companies to them.

Interestingly, the taxation of trusts has changed dramatically. The Chancellor now seeks to tax the capital gains element of distributions made by offshore trusts to resident non-doms. Thus, it is important for existing trusts to elect to adjust the cost base of assets pregnant with gains as of 6 April 2008. To avoid this, the trustees can elect to have the building treated as if it were sold and repurchased for GBP5 million as of 6 April 2008. This will result in the GBP3 million gain to date being treated as tax-free and only gains above the new adjusted ‘purchase’ price of GBPm will, in the future, be taxable. The rules are complex and actual treatment will vary from the general principle outlined above.

4. Foreign dividend income
Resident non-doms currently pay 32.5% tax on dividend income remitted to the UK. This will be taxed at 40% from 6 April 2008.

So has the Budget achieved its aim of taxing resident non-doms on par with resident domiciled persons? It is clear the UK government has caved in and lost the opportunity to create a ‘fair’ system to tax resident non-doms. The extra tax revenue raised is likely to be less that GBP600 million, representing 0.1% of the total GBP575 billion budget expenditure – an insignificant amount. To save face and keep the headline GBP30,000 charge, it has merely tinkered with the system and, in an exercise of damage limitation, provided an element of uncertainly in a system that has worked well for decades. Indeed, the government was so worried about the instability it was causing that it was forced to announce in the Budget that no changes to resident non-doms taxation would be considered for the rest of this parliament and the next!

Eesh Aggarwal

Disclaimer: this article reflects the views of the writer and is of a general nature. Thus, no specific tax planning action should be taken based on this article without professional tax advice that examines your individual circumstances.

Key Budget changes for UK resident non-doms

• GBP30,000 annual flat rate charge to retain non-dom tax advantages
• Only payable if UK resident for over 7 years
• Exemptions for children, those with unremitted income up to GBP2000
• UK remittance loopholes closed
• Offshore structures – no changes to disclosure and remittance basis
• Offshore trust remittances to be taxed on capital gains element
• Foreign dividends to be taxed at 40%
• No future changes expected to this parliament and the next

 
Eesh Aggarwal is a practicing UK chartered accountant and registered auditor specializing in international taxation. For more information, click here.

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