One of the longest running government sagas of the last 10 years has been the threat / promise to do something about the domicile issue and its impact on the tax system. A great deal has been said and written, but precious little has been done. So why is this important, what might it mean to you, and why have government words not been matched by actions?
It is a peculiarity of the British tax system that vital concepts such as residence and domicile are very loosely defined, leaving room for argument and uncertainty. Residence is important for tax purposes because UK residents are taxed on their worldwide income (subject to the domicile issue) whilst non-UK residents are taxed only on UK income.
Very broadly, residence requires physical presence in the UK, for an average of 90+ days over a period of years, or for 183+ days in a particular year. It is therefore possible in many cases to plan life so as to avoid becoming UK resident, although a recent tax case has cast some doubt on how effectively this might be achieved in particular cases.
Domicile is an even more difficult matter to pin down. It is akin to nationality, but is a specific legal concept that can in many cases give surprising results for a particular taxpayer. It is important because a non-UK domiciled UK resident can avoid UK tax on non-UK income and capital gains by keeping them outside the UK.
It is important to understand various aspects of domicile to appreciate its significance for tax purposes. When you are born, you are born with a ‘domicile of origin’, which is your father’s domicile at the time of your birth. Until you become 18 your domicile follows your father’s (‘domicile of dependency’). At age 18 you become capable of establishing your own independent domicile.
In order to change a domicile of origin, it is necessary to do two things. Firstly you need to cut your ties with the relevant country; financial, property, family and social ties are all significant here. Secondly, you need to create such ties with one other specific country, and only one. Thus it can be very difficult to change a domicile of origin. If that domicile is non-UK, that could be very good news indeed.
All of this is best illustrated by an actual example, which, whilst probably an extreme one, shows how hard it can be to lose a domicile of origin.
Mr X’s parents were born in Poland, and owned property and a business there. In the late 1930s they fled the threat of Nazi persecution and settled in the UK, where Mr X was born after the war. The family’s property interests were unenforceable both under the Nazi regime and the Communist one that followed. Mr X’s father died, and those interests passed to Mr X.
When the Polish Communist regime fell, the possibility of enforcing land claims in Poland arose, and Mr X chose to do so. By the late 1990s he had successfully established his rights to the family’s Polish property. Also, although he remained resident in the UK, he had acquired a holiday property in Israel, where he spent a few weeks each year. In 1999 he sold the Polish property.
So where is Mr X domiciled? Seems like an open and shut case doesn’t it? Born and bred in the UK and spent his whole life here, so he must be domiciled in England, mustn’t he?
No he isn’t, and he has a Revenue ruling to prove it. His father’s domicile of origin was clearly Poland, and the family left Poland not through a wish to abandon their ties with the country, but as a result of dire necessity. The family’s property interests may have subsisted, but they existed. Only the ultimate sale of those interests cut Mr X’s ties with Poland. However, by that time he had property ties with both the UK and Israel. So which of those was his domicile of choice? This was unclear, and thus the Polish domicile of origin continues to apply, despite the complete absence of ties with that country. And unless Mr X is careless enough to sell his Israeli property, that situation will not change.
So Mr X can invest money outside the UK and, provided he does not bring back income or gains to the UK, he will not pay UK tax on them. There are complex rules about this ‘remittance basis’ and about how to obtain a Revenue domicile ruling, of which space does not permit discussion. But the fact remains that if your father, or in many cases even your grandfather, was a national of a country other than the UK, you may well be able to establish non-UK domicile. There are many people in that position who have not the faintest idea of this.
Given the power of this tax planning opportunity, it was no great surprise in 1997 when Gordon Brown said that he intended to review urgently the domicile rules. Indeed, the Treasury has said so repeatedly over the past 10 years, but nothing has happened. Why not?
Such is the generosity of the UK’s tax legislation in this respect that many extremely rich individuals have based themselves here, ensuring that their investments are largely based offshore, and that they therefore pay a relatively modest amount of UK tax on their UK income or UK income that they need to remit here to support themselves. Nonetheless, they have a significant beneficial impact on the UK economy even by spending and investing a modest proportion of their wealth here, and the Treasury appears reluctant to frighten them off by radically changing the domicile legislation to their detriment; hence the lack of action in this area.
So the opportunity still remains for many people to take advantage of the position, and you don’t have to be Roman Abramovich to do so.
Mark Simpson
3 July 2007
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