Evolution of the UK's Non-Domiciled Regime: A Shift Towards Residence-Based Taxation
1. Introduction:
For over two centuries, the UK’s non-domiciled regime has been a fundamental aspect of its tax framework, offering benefits to residents whose primary domicile is outside the country. However, recent reforms signify a significant departure from the current reality, as the nation moves towards a residence-based taxation model. In this exploration, we delve into the evolution of the non-domiciled regime and its gradual shift towards a new method of taxation based on residence.
The term “non-dom” refers to individuals residing in the UK whose permanent domicile, for taxation purposes, lies outside its borders. This status is independent of nationality, citizenship, or residency, though these factors may influence it.
Non-domiciled status is granted to individuals who live in the UK but maintain their permanent residence abroad. They must provide evidence to HMRC confirming their foreign domicile for tax purposes, typically aligning with the country they considered their primary home at birth, with intentions of eventual return, often upon retirement.
Individuals classified as non-domiciled by HM Revenue and Customs (HMRC) are considered tax residents in the UK but enjoy exemptions on foreign income and capital gains, provided such funds are kept offshore or not deposited into UK bank accounts. However, they remain liable for UK taxation on domestically sourced income.
2. The reality of the “Non-dom Regime” until 2025
For generations, the non-domiciled regime has been a fundamental aspect of the UK’s tax system, providing eligible individuals with the advantageous ‘remittance basis’. This taxation system governs how foreign income and capital gains are taxed for residents not domiciled in the country. Essentially, it exempted foreign income and gains from UK taxation unless brought into the country, also offering protection against Inheritance Tax on non-UK assets. Over time, this regime has undergone various adjustments and refinements to adapt to evolving economic landscapes and tax policies.
If you are a non-domiciled individual residing in the United Kingdom, it’s crucial to understand the taxation rules regarding foreign income and gains. In brief, currently, foreign income or gains under £2,000 are exempt from UK taxation if not remitted to the UK. However, amounts exceeding £2,000 or any funds remitted to the UK must be
declared within a Self-Assessment tax return.
Upon declaration, individuals have two options: either subject their foreign income or gains to UK taxation, with the possibility of reimbursement, or opt for the ‘remittance basis’. Moreover, individuals may face an annual charge based on their residency duration in the UK.
Opting for the remittance basis streamlines your UK tax obligations by only taxing the income or gains you bring into the UK. However, this choice comes with its trade-offs: you forfeit tax-free allowances for Income Tax and Capital Gains Tax (though some ‘dual residents’ may retain them), and may incur an annual charge based on your length of residency in the UK.
Alternatively, if you’re taxed on your foreign income both by the UK and the country where you earned it, you can usually claim tax relief. The process varies depending on whether your foreign income has already been taxed. If you have not been taxed yet, you must apply for relief in the country where your income is from. You need to prove your eligibility by completing a form or sending a UK certificate of residence. However, If you have already paid tax on your foreign income, you can claim Foreign Tax Credit Relief when reporting it in your tax return. The amount of relief depends on the UK’s double-taxation agreement with the country of your income. For Capital Gains Tax, you generally pay tax in the country where you reside and are exempt in the country where you made the capital gain with some exemptions.
individuals who have been in the UK for at least 7 of the previous 9 tax years face an annual charge of £30,000. For those residing in the UK for at least 12 of the previous 14 tax years, the charge increases to £60,000 Foreign nationals residing in the UK can opt to pay British taxes on their worldwide income and capital gains, irrespective of holding a UK passport.
3. Transition to a Residence-Based Test:
The latest evolution in the non-domiciled regime heralds a shift towards a residence-based test. Beginning April 2025, individuals relocating to the UK will enjoy a tax-free status on overseas earnings for the first four years. Subsequently, if they continue residency in the UK, they will be subject to standard tax rates. This departure from the previous taxation regime in moving forward, individuals will be subject to UK income tax on worldwide income and capital gains tax on global asset disposals, irrespective of their location.
To qualify for the four-year Foreign Income and Gains (FIG) regime, individuals must
be in their initial four tax years of UK residency after a continuous absence of ten years outside the UK. Existing tax residents, who have been tax resident for fewer than 4 tax years and are eligible for the scheme, will also benefit from the relief until the end of their 4th year of tax residence. During this period, any foreign income or gains will be exempt from UK taxation if remitted to the UK. Furthermore, choosing the new four-year residency system means relinquishing personal allowances and the Capital Gains Tax (CGT) annual exempt allowance.
Taxpayers will need to submit a claim each year they wish to utilize the new Foreign Income and Gains (FIG) regime. However, unlike the current remittance basis regime, it’s expected that there won’t be any charge associated with making this claim. If a taxpayer ceases to be a UK resident within the four-year period, they can still claim any remaining qualifying years upon their return to the UK
To ease this transition, current non-domiciled individuals will receive a two-year grace period to integrate their foreign assets into the UK tax system.
The Four-Year FIG Regime:
Effective from April 6, 2025, new UK residents will benefit from a four-year tax exemption on foreign income and gains (FIG) or distributions from non-resident trusts. However, they will forfeit personal allowances and annual exempt amounts for Capital Gains Tax (CGT) during this period.
Customized Transitional Arrangements:
The announcement also outlines several accommodating measures tailored for current non-UK domiciled individuals who are ineligible for the new FIG regime:
- For tax year 2025-26, non-domiciled individuals losing access to the remittance basis on April 6, 2025, and not qualifying for the new FIG regime, will benefit from a temporary 50% reduction in the taxation of their personal foreign income.
- Those who have previously claimed the remittance basis will have the option, upon disposal of assets held personally on April 5, 2019, to rebase those assets to their value as of that date. Essentially, it allows taxpayers to use the value of the assets from April 5, 2019, as the new baseline for calculating any potential capital gains or losses when they sell or dispose of those assets after April 6, 2025. This option provides a potential tax benefit, as it may reduce the capital gains tax liability associated with the assets’ appreciation in value between April 5, 2019, and the date of disposal.
- A new temporary repatriation facility (TRF) will allow non-domiciled individuals
- to bring foreign income and gains generated before April 6, 2025, to the UK at a 12% rate during tax years 2025-26 and 2026-27.
- However, it’s important to understand the implications of the transitional measures regarding non-resident trusts and the temporary repatriation facility (TRF). While the TRF offers the opportunity to bring foreign income and gains to the UK at a reduced tax rate during specified tax years, it’s crucial to note that this facility excludes income and gains from trusts established before April 6, 2025. Moreover, to aid individuals in utilizing the TRF more effectively, there will be some relaxation of the mixed fund ordering rules. This adjustment aims to assist taxpayers who have foreign income and gains within mixed funds or encounter challenges in accurately determining the extent of their foreign income and gains. Therefore, while the TRF presents a beneficial opportunity, it’s essential to consider the limitations regarding income and gains from pre-2025 trusts and take advantage of the relaxed rules to navigate complex tax scenarios effectively.
3.1 Overseas Workday Relief:
Overseas Workday Relief is a current tax exemption exclusive to Non-Domiciled employed in the UK. This relief operates by treating a portion of earnings from UK employment, wholly or partly conducted abroad, as if it were foreign income. If earnings from work performed abroad are not brought into the UK, they are not subject to UK tax.
The UK Government has announced the introduction of a new Overseas Workday Relief, continuing to provide relief to individuals employed in the UK but performing their employment duties overseas (subject to eligibility criteria). This relief will apply to income tax on earnings, regardless of whether those earnings are brought into the UK. However, no relief will be granted for National Insurance contributions.
Eligible employees can claim this relief for the first three tax years of their UK residence. However, employees leaving the UK and returning after 2025-26 will be unable to claim relief if they do not qualify for the new four-year foreign income and gains regime.
3.2 Protected Trusts:
Starting from April 6, 2025, non-UK domiciled and UK deemed domiciled individuals who do not qualify for the new four-year foreign income and gains regime will no longer benefit from protections against taxation on income and gains derived from settlor-interested trust structures.
Settlor-interested trust structures are trusts where the individual (or their spouse or civil partner) who decides how the assets in the trust should be utilized also benefits from the trust.
This change implies that income and gains arising from such trusts will be taxed on the settlor, aligning with the principles currently applied to UK domiciled settlors. This taxation applies irrespective of when the trust was established, unless the settlor qualifies for the new four-year foreign income and gains regime.
Non-domiciled individuals will also lose entitlement to the remittance basis for worldwide trust distributions, while pre-6 April 2025 rules regarding trust distributions will remain unchanged.
Beneficiaries and settlors within the four-year foreign income and gains regime will enjoy tax-free benefits from April 6, 2025, regardless of whether these benefits are received within the UK. However, these benefits do not extend to trust income and gains and will be subject to a modified onwards gift rule.
This represents a substantial change for long-term residents who have found Protected Trusts advantageous from a UK tax perspective, as well as for asset protection and succession purposes. Therefore, careful consideration is necessary regarding the taxation of these structures in the future.
4. Inheritance Tax:
Inheritance tax (IHT) is a complex area of taxation, and recent and upcoming changes are set to further complicate matters for individuals, especially those with assets both in and outside the UK
Under the current rules, IHT is primarily based on an individual’s domicile status, with assets located in the UK falling under the scope of the IHT regime, regardless of domicile or residence status. This means that even non-UK residents with assets in the UK are subject to IHT.
Additionally, assets settled into an excluded property trust (EPT) by a non-UK domiciled settlor are exempt from IHT, even if the settlor becomes UK domiciled. However, assets settled into an EPT after April 6, 2025, will be subject to the settlor’s residence status at the time of transfer, potentially leading to IHT charges.
4.1 Impending Changes from April 6, 2025
From April 6, 2025, significant changes are set to reshape the IHT landscape. The shift from a domicile-based system to a residence-based system will have far-reaching implications for individuals and their estates. Under the new rules, IHT will apply to worldwide assets owned outright if the individual has been a UK resident for 10 years, with liability extending for 10 years post-UK departure.
Moreover, the taxation of trust assets will also be contingent on the settlor’s residence status at the time of settlement and during subsequent charge events. However, UK assets held in trusts will continue to be taxed as currently, irrespective of residence.
5. Navigating the Future for Non-Domiciles
The adjustments to the tax regime for non-domiciles signify significant shifts, and while there’s a notion of simplification, the intricacies of the rules may still present multifaceted scenarios. The transitional provisions afford individuals an opportunity to reevaluate their financial strategies before the new rules come into effect.
6. A Final Note of Caution:
The information provided in this article is derived from government press releases and technical notices released shortly after the Budget announcement. Until the government concludes its consultations on various aspects of the new regime and publishes the draft legislation, definitive commentary on the proposed changes remains pending. Therefore, it’s important to understand that our insights should not be construed as tax advice.
We are committed to closely monitoring developments and will promptly share further tax updates as the government releases additional guidance and draft legislation.
Should you have any questions or require assistance regarding this topic or any other tax-related matters, please don’t hesitate to reach out to our team.
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