Tax Doctor: Bond is best for non-dom facing tax trial on property

With new UK domicile rules coming into force in April 2017, Luca should consider an offshore bond to protect his assets from income tax and CGT, writes Gordon Andrews of Old Mutual Wealth.

THE CASE

Luca is 52. He is Italian, but he has been living in the UK for the past 14 years with his British wife and their two children in their £750,000 house. He also has a property in Italy. He has some savings in the UK but most of his savings are held in overseas bank accounts and investments.

In this year’s Summer Budget, the chancellor announced the government would abolish permanent non-domicile status for those who have lived in the UK for 15 of the past 20 years.

From 6 April 2017, non-UK domiciles will be deemed UK domiciled once they have been in the UK for 15 out of 20 years (a reduction from the current 17 out of 20 years).

There are a number of financial planning opportunities open to non-domiciles that Luca will lose once he becomes UK domiciled. As he has been living in the UK for 14 years, he needs to consider his position now and take effective action, before it is too late.

THE PRESCRIPTION

Non-domiciles have two options when it comes to paying tax on overseas income and gains. They can pay UK tax as and when the liability arises, or they can defer the tax on what is known as a remittance basis. If they choose the remittance basis they have to pay an annual remittance basis charge.

Luca has chosen to pay income tax on a remittance basis, which means he pays £60,000 each year to HM Revenue & Customs.

Once he has lived in the UK for 15 out of 20 years, he will be deemed UK domiciled and his income tax position will change. He will no longer be able to pay income tax on his overseas assets on a remittance basis.

Offshore bond option

Luca could move his overseas investments into an offshore bond. His investment would benefit from gross roll-up and would be free from income tax and capital gains tax (CGT), although there may be an element of withholding tax on certain underlying assets. He could withdraw up to 5% of the capital each year without triggering a chargeable event and would only pay income tax in a year in which he triggered a chargeable event.

Life and redemption bonds are not subject to CGT and therefore an encashment from the bond would be free from CGT.

Inheritance tax (IHT) planning should also be considered. Currently, if Luca were to die, his estate would be liable to UK IHT on any assets held in the UK. Overseas assets would not be liable to UK IHT.

However, once Luca is deemed UK domicile his worldwide assets will become liable to UK IHT on his death. Even if he subsequently leaves the UK, he will still be liable to UK IHT on his worldwide assets for a period of six years (as proposed in the Treasury’s consultation paper).

Excluded property trust

Luca should also consider making the offshore bond an excluded property trust.

By assigning the bond into a settlor-included discretionary trust while non-UK domiciled, he would create an excluded property trust on his offshore bond.

Once he becomes UK domiciled the bond would not be included in his estate for IHT even though he would still benefit from the trust. This is because he would have created the trust before he became UK domiciled and the trust fund is held outside the UK.

If Luca was concerned about protecting his family financially in the event of his death, he might consider life assurance. This too can be set up in an effective way, but it makes no difference if it is set up while he is a non-domicile.

He could consider taking out a whole-of-life policy. If this was subject to a settlor-excluded protection trust and he made his wife joint trustee, on his death the sum assured would be paid out to his wife as the surviving trustee (and possible beneficiary along with the children) but would remain outside his estate for IHT.

Premiums paid would be chargeable lifetime transfers if not otherwise exempt through the annual exempt amount of £3,000 or normal expenditure out of income exemption.

Gordon Andrews is a financial planning expert at Old Mutual Wealth.