What tax rules apply to non-doms in the UK?
The Chancellor’s wife is ‘non-domiciled’ we have all learned, and has had tax benefits as a result. This has led to a flurry of controversy, and a great deal of commentary about the non-dom tax system. While some of this has been correct, there has also been a great deal of confusion about exactly what benefits non-doms get, and for how long.
One might be forgiven, for example, for thinking that the tax benefits of non-dom status were available indefinitely, and that the UK was the only country to have such a regime for foreigners. It was even suggested that there is a ‘loophole in the law’ or a ‘tax avoidance scheme’ that non-doms can use, or that foreigners may need to use their non-dom status in order to maintain their citizenship. All of this is misleading.
This post is not about Akshata Murthy specifically, but is rather intended to clarify the actual tax rules that apply in the UK today to non-domiciliaries in general. Without writing a book (or several) on the subject it is impossible to cover the non-dom tax regime comprehensively which could be why so many commentators and even some politicians have been confused on the issue. The intention is, therefore, to focus on the key principles, which would apply in most cases.
So what is a non-dom?
The first question is: what a ‘non-dom’? This is in fact not straightforward, and is further complicated by the fact that there is one concept of ‘domicile’ for general law, which we will refer to as ‘actual domicile’ (being relevant both for tax purposes and other purposes, such as succession law) and another concept of ‘deemed domicile’ which is only relevant for tax purposes.
In terms of actual domicile, everyone is born with a ‘domicile of origin’ which is based on the domicile of their parents at the time of their birth. On reaching the age of 16, if the individual moves to a new place, and intends to remain there permanently, they acquire a ‘domicile of choice’ in the new place. So, broadly speaking, an individual who is resident in the UK but is not domiciled here is usually someone from overseas who does not intend to remain in the UK permanently.
However, an individual who is not actually UK domiciled can become ‘deemed domiciled’ in the UK for tax purposes. This can happen in a number of ways, but probably the most common situation is when the individual has been UK tax resident for 15 of the previous 20 tax years. In practice, due to the way the years are counted, deemed domicile can sometimes arise after not much more than 13 years’ residence. A non-UK domiciled individual has certain tax benefits prior to becoming deemed domiciled, but on becoming deemed domiciled they are taxed under the same rules as a UK domiciliary.
Why do non-doms have tax benefits at all?
The reason for offering a favourable tax regime to non-doms is that ‘UK PLC’ has to compete with the rest of the world to attract investment and talent, and successive governments have recognised that the UK’s tax system has the potential to deter this. Many other countries also offer alternative (usually temporary) tax systems to arriving foreigners including, within Europe, Italy and Portugal.
The aim, which has evolved over the years (gradually becoming much less generous to non-domiciliaries) is to balance fairness in taxation with a commercial approach which will benefit the economy as a whole.
The benefits non-doms actually have – the remittance basis
The standard system of taxation, applying to income and gains, is called the ‘arising basis’. Under the arising basis of taxation, an individual is liable to tax on their worldwide income and gains. This is the only system available to UK resident individuals who are UK domiciled, and also to non-doms who are deemed domiciled in the UK.
The alternative system of taxation, offered as an option to non-doms who are not deemed domiciled, is the ‘remittance basis’ of taxation. If the non-dom chooses this option, they will pay tax on UK source income and gains and on foreign income and gains which are ‘remitted’ to the UK, either by being brought in directly, or by paying for assets which are brought to the UK, or by being used in connection with UK assets (such as paying a mortgage on their home in the UK). Other foreign income and gains are not taxed in the UK.
Not all non-doms opt for the remittance basis. It does have certain disadvantages. Using the remittance basis correctly takes some care, and it can be very complicated if you get it wrong. In many cases the tax benefits of the remittance basis are minimal – many individuals do not have enough income or assets outside the UK for it to be worth the trouble – in fact, generally speaking, up to £2,000 a year of foreign income can be free of income tax without making a claim for the remittance basis. For many, this is enough.
Other non-doms have significant non-UK income or gains but pay tax on it in their country of origin anyway – and this foreign tax paid would be credited (usually under a tax treaty) against any tax due in the UK. So effectively the only benefit the remittance basis would give the non-dom is to save the balance of tax, if there is one.
The remittance basis also has certain financial costs associated with it, and these rise over time. Non-doms who elect to use it lose their personal allowances for income tax and CGT. Then, when they have been resident in the UK for seven of the previous 9 tax years there is a charge of £30,000 for every year the individual wishes to use the remittance basis (this is called the ‘remittance basis charge’ and was introduced in 2008). This rises to £60,000 a year when the individual has been UK tax resident for 12 of the previous 14 tax years.
Finally, as noted above, when the individual has been resident for 15 of the previous 20 tax years, they become deemed domiciled for all tax purposes and lose the right to the remittance basis altogether. This rule was introduced with effect from 6 April 2017 – prior to this the remittance basis was available indefinitely.
Inheritance tax (IHT)
There are also advantages given to non-doms – until they become deemed UK domiciled – with respect to IHT. The worldwide assets of UK domiciled individuals, wherever they are resident, are within the scope of IHT, as are the worldwide assets of the majority of deemed domiciled individuals (though a few tax treaties provide otherwise in certain limited cases).
For non-doms who are not deemed UK domiciled, only their assets in the UK are within the scope of IHT.
Unlike the remittance basis, these IHT benefits are automatic and do not require an election.
Non-UK domiciliaries have certain tax benefits available to them for a limited time. Broadly speaking these benefits start to be eroded after 7 years, when the non-dom needs to pay the remittance basis charge if they wish to continue to be able to use the remittance basis. After (broadly speaking) 15 years the benefits cease, and the non-dom in the majority of cases will be taxed on the same basis as UK domiciliaries.
In addition to this, even before the 15 tax years has elapsed, once a non-dom has been in the UK for a number of years the question might arise as to whether they genuinely intend to leave the UK, or whether they have in fact become UK domiciled. If they have acquired a domicile of choice in the UK, through being resident here and intending to remain, all the tax benefits are lost at that point.
The non-dom tax rules in the UK are not unusual, and like the other countries which have similar regimes, they were introduced in order to benefit the economy as a whole. They have been retained for this reason, though they have been restricted a good deal over the years and made more expensive for those who benefit from them. If further review of the rules is considered, the views of the public are likely to be influential, and these opinions need to be based on accurate facts.