This article was written for and first published in Private Client Adviser.
Whatever you may or may not think of George Osborne, he cannot be accused of not having introduced major reforms to the UK tax system. Whether these reforms are desirable or appropriate remains to be seen, however. As we embark on a new tax year, now sees like a very good time to consider whether a change in strategy is required when it comes to some aspects of traditional tax planning.
A close inspection of non-UK domiciled individuals (non-doms) is a good place to start. This group has always had a favoured place in the UK tax system, but this has been chipped away somewhat for inheritance tax purposes since the introduction of capital transfer tax in 1975 and now the introduction of the concept of deemed domicile after 17 years of UK residence.
From 6 April 2017, a person becomes deemed domiciled – and thus liable to IHT – if he has been resident in the UK for all (or part of) 15 out of the 20 tax years prior to his death or the making of a taxable gift. However, the indications are that excluded property trusts created before a person becomes deemed domiciled will be unaffected by this change. An excluded property trust is one where the settlor was non-dom (and non deemed domiciled) at the time he created the settlement and which holds non-UK assets.
As a result, a non-dom who has been resident in the UK for less than 17 years but will complete 15 years (or part years) of residence in 2017/18 should consider putting his overseas assets into an excluded property settlement before 6 April 2017. He could also consider putting some of his UK assets into an offshore company as doing so would transform them into a non-UK asset. It should, however, be noted that this will not work for UK residential property, and a transfer to a company can trigger both CGT and IHT so this option is unlikely to be attractive if there is a large inbuilt unrealised gain. Remember, too, that if a person was born in the UK with a UK domicile of birth, the 15-year rule will not apply in any event; from 6 April 2017, such a person will be treated as UK domiciled for any tax year in which he is resident here.
George’s other big change has been to extend deemed tax domicile to income tax and CGT. This means that an individual will become taxable in the UK on worldwide income and gains arising after 6 April 2017; he will no longer be eligible to use the remittance basis (although this will probably remain effective for income and gains arising before that date). It might, therefore, be worth considering gifts now to divert the income away from the individual to someone with a lower tax rate. In particular, if the individual is likely to end up leaving a large part of his assets to charity on his death, why not give them to a charitable trust now? The assets would continue to grow tax-free after 6 April 2017, the individual can continue to determine the investment policy and he might even get an income tax deduction for the gift.
Finally on this topic, if a client spends significant time overseas, he could consider emigrating. George’s statutory residence test takes most of the uncertainty out of emigrating and, in most cases, will allow a person to spend 3 or 4 months a year in the UK as a non-resident. If he has a peripatetic lifestyle, this may prove to be less inconvenient than the taxable alternative.
The IHT additional residence nil rate band
Last year, George announced his additional residence nil rate band which, he claimed, enables a married couple to leave a house worth £1million to their children free of IHT. Unfortunately, he did not have time to mention that to achieve this, one of the parents has to live beyond 5 April 2020. The new relief does not apply at all if both parents die before 6 April 2017 and after that it will only cover a £850,000 house until 5 April 2018, gradually rising after that to the £1million figure. He also neglected to mention that the relief will not apply at all if, when the individual dies, his total assets – not simply the house – exceed £2.35million (£2.2million for the year to 5 April 2018). Nor did he make wholly clear that the relief applies only to the extent that a person gifts an interest in his main residence to his children (or other descendants), and only applies to the extent of the value of each parent’s share in the house, less his share of the mortgage.
Loan interest relief on buy to let investments
Tax relief for loan interest on a loan to buy residential property to let out is being reduced to an effective rate of 35% from 6 April 2017, 30% from 6 April 2018, 25% from 6 April 2019 and 20% from 6 April 2020. This is causing some people to consider putting their rental business into a company, as a company pays corporation tax at 19%, so can obtain full relief. Is that a good idea? It may be, but in many cases it is not. This is partly because the extra tax when taking money out of a company makes it unattractive if the landlord needs the rental income to live on, and partly because if he intends to pass the business onto his children, his death will eliminate CGT on the increase in value if he owns the property personally but it will not eliminate the tax on unrealised gains within the company. Furthermore, the individual will crystallise CGT to put his properties into a company unless he can show that his activities go beyond investment and amount to a business. It is difficult to know whether in any particular case the person meets his test. But it’s fair to say that he is unlikely to do so if his property activities are not a full-time occupation for him.
The new dividend tax
The system of taxing dividends changes from 6 April 2016. Tax credits (and the effective tax exemption for basic rate taxpayers) will be scrapped. Instead the first £5,000 of dividends will be taxed at nil%, so will be effectively exempt from tax. Where dividends exceed this figure, the excess will be taxed at 7.5% for a basic rate taxpayer rising to 38.1% for a 45% taxpayer. This is an extra 7.5% tax at all levels of income. Of course, for many people the change will be beneficial as most do not receive in excess of £5,000 worth of dividends. The main category that does is owners of family businesses, who find it cheaper to take dividends from their company rather than salary. This won’t change after 5 April, but the differential will be much narrower.