The UK government recently announced that the current non-domiciled tax status is being abolished from April 2025 in a move that will significantly impact inheritance tax rules.
For over 200 years, inheritance tax liability has been based on a person’s domicile – their permanent home. This allowed non-domiciled residents in the UK to limit their inheritance tax exposure.
However, new rules proposed in the March 2024 budget will switch inheritance tax to being based on residence rather than domicile.
“The proposed changes to inheritance tax would significantly affect clients domiciled in the Middle East who have links with the UK or own property in the UK,” said Jane Shaw, Private Capital Practice Consultant at law firm Addleshaw Goddard.
What does this mean?
Under the current system, overseas residents who prove their permanent home (domicile) is outside the UK can claim non-domicile status. This allows them to limit their inheritance tax liability even if they spend much of their time in the UK.
From April 2025, any UK resident for at least four out of the last seven tax years will pay income and capital gains tax on worldwide assets. After 10 years of residence, their worldwide assets will also likely be subject to up to 40 percent inheritance tax.
This contrasts with the current rules where non-doms only pay UK tax on funds brought into the country.
“For UK tax residents, the starting point is that they are subject to UK tax on their worldwide income and gains. However, if they are neither UK domiciled nor deemed domiciled (often referred to in the media as “resident non-domiciles” (RNDs), they can claim the “remittance basis,” which allows them to use a beneficial UK tax regime,” said Ashley Crossley, Partner at Baker McKenzie.
“Income and capital gains tax is then only payable on UK source income and gains and on non-UK income and gains only to the extent that they are “remitted” to (broadly, brought into or used in) the UK.”
Major implications for Middle Eastern investors
The changes will significantly impact individuals from the Middle East who have links to the UK but claim non-dom status to minimise taxes, experts told Arabian Business.
“It will be more important than ever to be able to show that they are not resident and/or domiciled in the UK,” Shaw explained.
To avoid becoming UK tax resident under the new rules, Middle Eastern investors will need to be meticulous in monitoring the days they spend in the country.
Some tax treaties like those with India and Pakistan can currently override the 15-year inheritance tax exemption period for non-doms. But it is uncertain whether these treaties will provide protection under the residence-based regime.
Long-term expats should review status
Surprisingly, many long-term expats incorrectly believe they have lost their UK domicile status when they may still be considered domiciled under the complex rules.
Severing all ties with the UK and providing strong evidence of a permanent new overseas home is required to lose domicile status. Even one remaining connection like UK property can maintain UK domicile.
“The greatest impact will be on those individuals who are currently UK tax resident and non-UK domiciled (RNDs)… and claiming the remittance basis of taxation under the current RND regime,” said Phyllis Townsend, Partner at Baker McKenzie.
Beginning April 6 next year (subject to transitional provisions), the remittance basis is to be abolished and replaced with a new tax regime focused purely on residence.
“Such previous RND individuals who have been in the UK for some time will likely have to start paying income and capital gains tax on a full worldwide basis as would a normal UK tax resident from 6 April 2025,” added Townsend.
“This is a massive tax change for them. There is a small window of opportunity for those individuals to minimise the effect of these dramatic changes using the window until 5 April 2025 and the proposed transitional rules. However, these planning steps will need to be taken in the coming tax year 6 April 2024 to 5 April 2025. Otherwise, it will be too late, so clients need to act now.”
Overseas property owners
For most overseas investors with UK property, the changes will have limited impact. Their UK assets will remain liable to inheritance tax as they are currently.
The new four-year tax exemption could even attract more foreigners to temporarily reside in the UK for investment purposes.
According to Baker McKenzie Associate Oliver Stephens, the proposed reforms to UK inheritance tax will transition it from a domicile-based system to one based on residence. Under the new rules, an individual’s non-UK assets will become subject to inheritance tax once they have been a UK tax resident for 10 years. Their worldwide assets are likely to remain subject to inheritance tax for 10 years even after they cease to be UK resident.
Stephens believes further changes are expected for trusts and structures owned by non-UK domiciled individuals.
“There is an urgent need to review existing structures before these changes come into effect. In particular, the availability of defences to UK tax anti-avoidance rules that can attribute foreign income and gains of offshore entities to UK residents in certain circumstances is likely to become more important,” he added.
Existing offshore trusts and companies holding UK property will need to be reviewed before the 2025 rules kick in. Any strategies to mitigate the impact of the new inheritance tax regime will need to be implemented in the 2024/25 tax year.
“It will be important for all Middle Eastern clients with family and property ties in the UK to take advice as to how to ensure that they do not inadvertently become UK resident as it seems likely that in the future this may also result in them losing their non-domiciled status for Inheritance Tax purposes,” Shaw advised.
The proposed shakeup of centuries-old inheritance tax rules is set to have major repercussions across the UK. For some wealthy foreign investors who have benefitted from ‘non-dom’ status, urgent tax planning will be needed to minimize the impact.
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