Estate planning for Isle of Man resident and domiciled individuals
Monday 03 August 2015
By Phillip Dearden, Director - Tax, Equiom Solutions
The Isle of Man possesses an extremely benign, local tax environment. There are no local wealth, gift or estate taxes and no taxes on disposals of capital assets. Income tax is levied at a maximum rate of 20% and there is an upper limit for the amount of tax payable.
Unfortunately, life is never as simple as it first seems! Isle of Man residents like to spend time in other jurisdictions often due to family connections. This can extend to acquiring assets there, such as property, potentially giving rise to tax considerations in those jurisdictions.
Due to its proximity, the United Kingdom is the place that Island residents visit most often and also the favoured location in which to acquire assets. Bearing this in mind, recent changes to UK tax rules will have significant implications for Isle of Man residents.
Residence is the attaching concept used in most countries to determine who is subject to local tax. Each country has its own rules on residence, however. Isle of Man residents should be aware of the residence rules in other jurisdictions that they regularly or habitually visit, to ensure they do not fall foul of those rules and, as a result, become unwittingly tax liable residents in another jurisdiction. If a foreign tax authority contends that an individual is resident in their country, it is no defence for a taxpayer to claim that they are Isle of Man resident. Each country will apply its residence rules independently of other jurisdictions and it is quite possible for a taxpayer to be resident in two jurisdictions at the same time.
This is all the more problematic now that the UK has introduced a Statutory Residence Test (SRT) which is quite unlike the rules applied in the Isle of Man. There may be some confusion, as there are now very different rules for determining residence in the two jurisdictions. Viewed in isolation, the new UK legislation regarding residence will have two advantages for Island residents. The first being that replacing the existing rules, in most cases, will make it more straightforward to determine whether one is resident or not. This was not the case previously. The second advantage is that, in most cases, under the new rules, an Island resident will now be able to spend more time in the UK before becoming a UK resident, than was possible under the old legislation.
Since 6 April 2013, the SRT has applied to determine an individual’s residence status for UK tax purposes, including income tax, capital gains tax (CGT) and inheritance tax (IHT).
The SRT includes:
- Automatic tests for non-residence
- Automatic tests for residence
- The determination of the residence status of individuals who are not automatically non-resident or resident by counting their life ties and the number of days spent in the UK
The tests are applied on an annual basis and, if an automatic test is satisfied, no further ones need to be considered.
There are up to five potential ties to consider for the day-counting test; the family tie, the accommodation tie, the work tie, the 90 days tie and, in some cases, the country tie. The number of ties in point determines the number of days an individual can spend in the UK without becoming UK resident.
Until recently, the tax position of Isle of Man residents who wished to invest in UK property, was relatively straightforward. If an individual acquired the UK property, any rental income earned would be taxed at UK income tax rates up to 45%. There would be no CGT on sale, but if the owner passed away whilst owning the property, there would be an IHT exposure in respect of the property.
A popular alternative was to own UK investment properties via a non-UK resident company. This meant that tax on rent was capped at 20% and there was no exposure to estate taxes or tax on disposal.
Recent changes regarding UK property
The above remains the case for investments in commercial property, but there have been a number of changes with respect to UK residential property.
From April 2015, all disposals of UK residential property by non-residents have been subject to CGT. This is in addition to earlier changes which resulted in a tax charge where a non-UK resident company disposed of an expensive residential property and also an annual charge for a company holding such properties.
In order that HMRC can collect tax with respect to these new charges, a new reporting regime has been introduced. A non-resident who sells UK residential property is required to file a return regarding the disposal within 30 days of conveyance. This reporting requirement applies whether or not there is any tax to pay or not.
A further change recently announced, but not effective until 2017, is that where UK residential property is owned by an Isle of Man company, it will fall within the scope of UK IHT. This does mean that Island residents who own UK residential property, either as an income-earning investment or as a place to live in themselves, now face a potential exposure to IHT, CGT and, in some cases, an annual tax charge, levied on companies owning expensive properties.
The tax on capital gains will not bite to any great extent for some time, as property values will be re-based to their value when the new regime took effect. . In many cases this was April 2015, in others slightly earlier. The only element exposed to CGT will be any additional value over the re-based cost. This may also be more palatable since it will be a charge on a profit achieved on disposal, after cash proceeds have been received.
The IHT charge may cause more concern. After taking account of any nil-rate band, IHT will be charged at 40% upon death, although there may be mitigation in respect of debt attaching to the property and, in some cases, it will be possible to take out life-insurance to cover this exposure.
The use of trusts in estate planning for Isle of Man residents
Subject to some important exceptions referred to above, individuals who are resident in the Isle of Man are, in general, outside the scope of UK income tax and CGT and, if they are not domiciled in the UK, they can organise their affairs so that they are also outside the scope of UK IHT.
However, in many cases, the death of these individuals can result in the transfer of assets back into the UK for income tax, capital gains tax and inheritance tax purposes. With careful planning, this can be avoided, even if the benefitting family members live in the UK.
Trusts can play an important part in estate planning of this nature and consideration will often be given to the establishment of a Trust for the intended beneficiaries, either under the terms of a Will, or during lifetime. In this way, wealth can be passed to Trusts for the benefit of UK individuals, such as family members but, because ownership remains with the Trustees in the Isle of Man, any immediate exposure to UK tax can be deferred or avoided.
The Isle of Man remains a very tax efficient place to live but, unless a very insular lifestyle is adopted, tax in other jurisdictions is an issue that needs to be considered. The UK rules regarding residence should be borne in mind, with recent changes meaning these new laws will now be clearer and more generous.
Unfortunately, investment in UK property, especially residential property, will now involve complex tax issues and, in many cases, an increased exposure to UK taxes. Trusts can play an important part in maintaining the family wealth of Island residents outside of the scope of tax in other jurisdictions. Nevertheless, this is a very complex area and requires serious thought.