Understanding domicile and its impact on UK tax exposures

Domicile & UK Taxation

Domicile is a vitally important concept in determining an individual’s exposures to UK taxation, if there is some form of connection to the UK, be it their tax residence or assets that they own, for example. Non-UK domiciled tax status confers special UK tax advantages.

The Concept of Domicile

In English law, domicile should be distinguished from tax residence, albeit the two are interconnected. During an individual’s minority:  

• First, the child is born with a domicile of origin, which is the domicile of their father (or their mother’s domicile in certain circumstances), and
• Up to the age of 16, their domicile of origin will be displaced by a domicile of dependency if the parent’s domicile changes. 

Beyond age 16, the individual now has free will to establish their own domicile of choice, which will be determined by two key factors:

• Where the individual resides on an habitual basis, and 
• Their future intentions

Based upon case law, if after the age of minority the individual decides to take up residence in a new territory with an intent of remaining there permanently or indefinitely, then they would establish a domicile of choice in that new territory.

The law relating to the domicile is based in English common law and is inevitably complex and nuanced. The purpose of this article is not to examine that complexity, but rather to focus on the UK tax advantages for non-UK domiciled persons.  

UK Tax Advantages

UK tax resident individuals who are domiciled outside the UK are afforded income and capital gains tax (CGT) advantages under the remittance basis of taxation, namely:

• Certain forms of foreign income, known as relevant foreign income, are only taxable when remitted to the UK, and
• Capital gains realised on foreign assets are only subject to CGT when proceeds of sale are remitted

For foreign domiciliaries who take up tax residence in the UK and who remain there year on year without establishing the intent to remain there permanently or indefinitely, the remittance basis of taxation is available without charge for the first seven years of tax residence. From the eighth year of tax residence there is an annual remittance basis charge which increases over time, up to and including the 15th year of UK tax residence. Thereafter the remittance basis not available due to the application of the deemed domicile rule, of which more later.

What constitutes a taxable remittance is slightly more complex than one might initially imagine. It envisages simple cash transfers that comprise the relevant foreign income and proceeds of capital gains transactions, but there are less obvious cases which we might describe more broadly as constructive remittances. Great care should be taken and UK tax advice should be sought if the remittance basis of taxation is to be utilised.

Perhaps the most significant UK tax advantage for the non-UK domiciliary is protection from exposures to inheritance tax (IHT). Foreign assets are outside the scope of IHT for as long as an individual remains domiciled outside the UK.  

But here we must introduce a further concept of domicile which is enshrined in statute law, the deemed domicile referred to earlier, which is relevant to the individual’s IHT position and, indeed, their UK income tax and CGT exposures.

Deemed Domicile

Deemed domicile has, until recently, only had application for IHT purposes. The existing rules were amended and expanded with effect from 6th April 2017, and the key points to be borne in mind are:

• Long-Stayers – an individual who has been UK tax resident for at least 15 out of the 20 previous tax years, they will be considered to be deemed domiciled (in other words, for somebody who moves to the UK and continues to be UK tax resident thereafter, deemed domicile attaches at the start of the 16th tax year of tax residence)
• UK Returner – if an individual was born in the UK with a UK domicile of origin, but had managed to shed their UK domicile of origin in favour of a domicile of choice elsewhere, before later returning to the UK to take up residence, they will be deemed domiciled on their return, even if the move is temporary and they continue to retain their domicile of choice overseas; and 
• UK Leaver – the three-year rule dictates that UK domiciled individuals who leave the UK to take up residence elsewhere will continue to be deemed domiciled for three years after shedding their UK domicile in favour of a domicile of choice

For a returner, there is one tax year of grace for IHT purposes, but relevant foreign income and capital gains are taxable as they arise from the first tax year of resuming UK residence. 

Once a foreign domiciliary becomes deemed domiciled, he or she joins the rank-and-file of UK taxpayers; there are no special tax advantages to their status, even if they continue to be treated as domiciled abroad under common law principles.

Trust Arrangements

For the wealthy and well-advised individual who is approaching the point of becoming deemed domiciled, there are measures that can continue to afford protection against UK tax exposures.  
Whilst there might be ideas that can insulate against the imposition of UK tax in the shorter term, such as non-qualifying life policies or IHT insurance, offshore trust arrangements provide a more permanent solution to these issues.

Trust arrangements made by foreign domiciled individuals before they become deemed domiciled, via the transfer of foreign assets onto a settlement, confer these longer-term advantages, viz.:

• The trust is colloquially termed an excluded property settlement, meaning that the assets held on trust are permanently outside the scope of IHT for the lifetime of the trust, providing:
     •  the trustees do not hold UK situated assets directly and, 
     •  with minor exceptions, no further funds are added to the trust by the settlor after he or she has become domiciled in the UK under common law or deemed domiciled under the special statutory rules;
• Foreign income and all capital gains (other than those arising on disposals of UK real estate) arising to the trustees or underlying companies are not taxed immediately in the UK, which allows for a gross accumulation of funds

UK income tax and CGT cannot be avoided altogether, these amounts would be taxable in future if UK resident beneficiaries receive distributions or any form of benefit from the settlement, such as an interest-free loan.

These trust arrangements are referred to as protected settlements and their UK tax advantages can live on long after the remittance basis has become unavailable under the deemed domicile rule.

This article was first published in the ThoughtLeaders4 Private Client Magazine Tax Edition 2024.

This article has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. This article cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained within this article without obtaining specific professional advice. Please contact Equiom Group to discuss these matters in the context of your particular circumstance. Equiom Group, its partners, employees, and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this article or for any decision based on it.