If you are a Non-UK Domiciled individual (hereinafter: "ND") who is tax resident in the UK, there are two different systems of taxation that could apply to you. While it is the number of days you spend in the UK in a UK tax year (6 April to the following 5 April), and the number of ties you have to the UK, that will determine whether you are UK tax resident in any tax year, your domicile will typically be determined by your father's country of birth (your "domicile of origin") unless you have moved to another country and intend to stay there permanently or indefinitely (in which case, that country becomes your "domicile of choice").
The two systems of taxation that can apply to a UK resident ND individual are called: the arising basis and the remittance basis of taxation.
- When the arising basis of taxation applies you are taxed on your worldwide income and gains when it arises.
- The remittance basis of taxation applies if you are not domiciled in the UK and elect (in your UK tax return) to be taxed only on your UK income and gains and any foreign income and gains you bring into the UK. A remittance basis charge applies if you wish to elect for the remittance basis of taxation and have been tax resident in the UK for 7 out of the last 9 tax years. The initial rate of the charge is £30,000, rising to £60,000 depending on the number of tax years you have been UK tax resident. After you have been resident for 15 of out the last 20 tax years, following changes shortly due to be introduced, it is no longer possible to claim the remittance basis of taxation.
UK Tax Changes:
The UK Government announced in its 2015 Budget that significant changes would be made to the ND regime and the taxation of NDs from 6 April 2017. However, when the Government called the 'snap' general election earlier this year these changes were withdrawn and did not take effect under the Finance Act 2017 as planned. Following the general election, the UK Government announced that they will introduce a second Finance Bill for 2017 and also confirmed that the previously announced ND changes will be brought into effect from 6 April 2017, as originally anticipated. Draft legislation for the new Finance Bill has now been published but has not yet finalised. Please bear in mind, therefore, that some of the details of the new rules (as summarised below) may yet change.
As currently set out in the draft Bill, the new ND regime will affect:
- ND individuals who have been UK tax resident in at least 15 of the last 20 UK tax years ("long-term UK residents"). From 6 April 2017, they will be deemed UK domiciled for all UK tax purposes; they will, therefore, cease to be eligible to elect the remittance basis of taxation and will be subject to the arising basis of taxation (i.e., they will have to pay UK tax on their worldwide income and gains in the same way as an individual who is domiciled in the UK).
An individual who becomes UK deemed domiciled under the new long-term UK residents rule above, only ceases to be UK deemed domiciled for UK income tax and capital gains tax purposes if they are non-UK resident for 6 complete tax years.
- Individuals who were born in the UK and who have a UK domicile of origin ("formerly domiciled residents"). From 6 April 2017, if they return to the UK, they will no longer be able to claim the ND status for tax purposes, and will be deemed domiciled for all UK tax purposes; they will be subject to the arising basis of taxation while they are UK tax resident, even if they had previously left the UK and acquired a domicile of choice in another country.
These are referred to as the "deeming provisions" of the reforms. (https://www.gov.uk/government/consultations/reforms-to-the-taxation-of-n...)
In addition to the fact that the arising basis of taxation (for income tax and capital gains tax purposes) will apply to those who become UK deemed domiciled under the new deeming rules, there are several other (related) changes that arise for ND individuals affected by these reforms.
We mention below only those that are relevant for this article:
- Capital Gains Tax (CGT): In particular, in relation to capital gains that have accrued on foreign assets held while the individual was ND individual. Under the proposed changes, long-term UK residents (but not formerly domiciled residents) will be able to rebase overseas assets to the market value of the asset on 5 April 2017, with the result that any gain which accrued before 6 April 2017, will not be charged CGT in the UK. However, any further increase in the value of an asset between 6 April 2017 and the date of disposal will be charged CGT. If preferred, an individual can elect for this "CGT re-basing" not to apply (https://www.gov.uk/government/consultations/reforms-to-the-taxation-of-n...).
There is also the opportunity for any ND individual, whether currently UK resident or not (but not those within the category of formerly domiciled residents) to de-segregate certain mixed funds (referred to as "cleansing of mixed funds"). This can be an asset or a bank account which contains a mixture of any of the following: income, capital gain or capital. Currently, there is no way to segregate the different components of a mixed fund with a view to making tax efficient remittances to the UK. However, under new transitional rules which apply to 5 April 2019, it will be possible to transfer each known component of a mixed fund held in cash or in a bank account (which can include liquidated mixed fund assets) to its own income, capital gain or capital account, as appropriate.
- Inheritance tax (IHT): Under the previous regime, and until the new changes become law, ND individuals enjoyed a significant advantage over other UK domiciled individuals for IHT purposes. UK domiciled individuals and ND individuals who, under the old rules, became UK deemed domiciled individuals for IHT purposes only (i.e., those who were UK tax resident for all or part of 17 out of the 20 tax years preceding an occasion of charge) are liable to UK IHT on their worldwide assets. Whereas those who were non-UK domiciled were only liable to UK IHT on their assets situated in the UK. Non-UK assets were not subject to UK IHT. This was the case both for non-UK domiciled individuals who were resident in the UK and those who were resident elsewhere.
Under the proposed changes any ND individual who is deemed UK domiciled as a long-term UK resident, or is a formerly domiciled resident who has been UK resident in at least one of the two previous UK tax years, will be liable for UK IHT on their worldwide assets. Moreover, a longterm resident, will only cease to be UK deemed domiciled for UK IHT purposes after three complete UK tax years of non-UK residence, although a formerly domiciled residence would lose UK deemed domiciled status for UK IHT purposes in the first full year of non-UK residence provided he retained a foreign domicile of choice under general principles.
Another proposed change relates to residential property in the UK owned by a ND individual directly or indirectly, or a loan (or collateral for a loan) made to a structure to acquire or maintain or develop UK residential property. From 6 April 2017, the value of that residential property (or the loan/collateral) will be within the charge of IHT. Consequently, whereas it has been standard practice for such individuals to hold UK residential properties through an overseas company or a similar vehicle so that the asset of the individual consisted of overseas shares which were situated outside the UK and therefore excluded from IHT, the proposed changes mean that any UK residential property owned indirectly through a company with five or fewer participators and certain other offshore structures will also be within scope of UK IHT for ND individuals. The value of the property, or the value of the loan, will also be deemed to remain within scope of UK IHT for two years after the property is sold, or the loan repaid (or the collateral released).
- Offshore Trusts: An individual who is UK resident and UK domiciled who has settled assets into a non-UK resident trust has to pay income tax and capital gains tax on chargeable gains arising in the trust if they retain an interest in the trust. This is the case regardless of whether they receive any benefit from the income or gains.
Under the proposed changes, the UK government wants to apply the same rules in relation to the taxation of settlors of non-UK resident trust to all those who become UK deemed domiciled as long-term UK residents under the new rules. This will ensure that those who are UK deemed domiciled pay tax on income and gains arising in a non-UK resident trust in the same way as an individual who is domiciled in the UK.
However, the legislation will not extend to a non-UK resident trust of a UK deemed domiciled settlor where the trust was set up before the settlor became UK deemed domiciled and no additions have been made to the trust since that date.
This means that trusts established prior to attaining UK deemed domiciled status will offer a degree of protection from UK taxes on foreign income and gains arising to the trustee until there is a distribution. In addition, if there are any assets added to the trust by the settlor after he/she has been UK deemed domicile, any trust protection will be lost resulting in ongoing taxation. This position could be potentially problematic for a ND individual who becomes UK deemed domiciled under the new rules if, as expected, the changes are indeed brought in from 6 April 2017 and no such trust has already been created or an addition has been to a non-UK resident trust on or after that date.
In light of all the upcoming changes mentioned above, in particular to UK residents ND individuals, successful advisers of high net worth individuals are required to now rethink their tax strategies and focus on more sophisticated tax planning alternatives in order to create optimal results for their clients so that they can hold their high value portfolios of investments in a tax-free environment.
Given the loss of the remittance basis of taxation for long-term residents, Private Placement Life Insurance addresses all of these needs in a relatively simple way.
Private Placement Life Insurance (PPLI):
One solution to many of the changes can be to advise the client to invest in a life insurance policy, such as a PPLI. Using PPLI as an investment vehicle has the potential to provide for complete tax deferral on investments held within the policy whilst allowing tax-free access to the funds invested over time.
PPLI originated in the United States, but is also an established planning tool in the UK. It is a variable universal life insurance policy that provides a tax efficient platform, asset protection and generational planning mechanism, all in one simple structure. PPLI possesses all the characteristics of life insurance but combines the benefits of an insurance product with a tax efficient and versatile investment platform. This solution is attractive for individuals and families seeking future growth and strong asset protection.
How it works:
The basic setup is simple. The policyholder pays a premium (either one time or through yearly payments) to the insurance company. The premiums are placed in a segregated and separate account. The insurance company then hires any investment adviser to manage the assets in the insurance policy's account according to general investment strategies that the policyholder discussed with the insurance company.
The premiums can be invested in bankable and non-bankable assets (e.g., securities, bonds, art, diamonds and real estate). There are certain restrictions on the types of investments which can be held and the way that premiums are invested in the case of a UK tax resident policyholder. All investments are made in the name of the insurance policy.
It is important to note that there are also limitations to how much control the policyholder can have over the assets.
PPLI permits the investments owned inside the insurance policy to benefit from complete deferral of income tax and capital gains tax during the insured's lifetime and, if structured appropriately, potentially the policy proceeds will be protected from UK IHT as well.
The PPLI policy is not restricted only to individuals. It can be owned by any legal structure such as a corporation, a partnership, or a trust.
Depending on where the policyholder is based, PPLI can allow flexible investing in:
- Cash and securities
- Hedge funds/alternative asset classes
- Private equity
- Physical assets such as art and yachts
- Real estate/ Intellectual property
- Alternative currency denominations
For UK resident policyholders, more limited investment options apply and funds must be invested either through an investment manager appointed by the insurer or the policyholder can select their investments from a range of funds offered by the insurer which are available to all (or a particular class of) policyholders.
In addition to the wide array of tax benefits inherent to PPLI, it can also serve as a powerful asset protection tool. It enables wealthy individuals to create structures that will prevent a loss of their wealth due to a lawsuit, divorce, disgruntled partners or other unanticipated liability, keeping in mind of course applicable fraudulent conveyance rules.
There are two parts to asset protection:
- Investors want protection from the creditors of the insurance carrier where the segregated or separated account is held. Segregated or separated accounts contain funds that are separate from the assets owned by the insurance company. Consequently, these accounts generally are not reachable by the creditors of the insurance company.
- Investors seek protection from their own creditors. The policy's assets and death benefits are in general afforded protection from the policy holder's creditors. The level of asset protection depends on the local jurisdiction and the identities of the policy's owner, beneficiary, and insured.
As an asset protection vehicle, PPLI offers financial privacy as well. Confidentiality is maintained between the insurer, advisors and the policyholder. The client's information is not publically available. In addition, the policy is now the beneficial owner of the assets rather than the policyholder and as such is recorded for bank and ownership records and KYC purposes.
PPLI in the UK:
In the UK, the unique way in which life assurance contracts are treated for tax purposes creates significant tax planning opportunities.
The benefits of a PPLI from the UK perspective are as follows:
- Income tax and capital gains tax - deferred taxation of accumulation of the investments held within the insurance policy.
- There is the ability to withdraw up to 5% of the value of the premiums per year (without triggering a tax charge). Although only 5% per year can be withdrawn from the PPLI tax free, it is cumulative, so amounts not withdrawn in early years can be withdrawn later on.
- Simple to administer and there is minimal reporting.
- Gifting of the policy is not subject to capital gains tax nor income tax.
- No inheritance tax- depending on structure and jurisdiction.
- Minimum 1% additional death benefit.
- There is access to a broad range of investments. As mentioned above, there are limitations and it should be noted that it is not permissible to include in a PPLI policy, assets needed for personal use such as real estate, private companies and planes.
It is important to plan carefully ahead when any UK resident non-UK domiciled individuals invest in a life insurance policy. There will likely be capital gains tax implications to liquidate assets to fund premiums for the policy. This is where the rebasing opportunity might prove useful. Cleansing mixed funds may also be a valuable exercise to undertake to maximise tax efficiency when investing using insurance, so that only capital which can be remitted to the UK free of tax is used to fund the policy. This would mean that withdrawals of up to 5% per year would then be tax free and could be freely spent in the UK. If the funds placed within the policy amount to a mixed fund, then any withdrawals (including the 5% withdrawal mentioned above) can become liable to tax as a taxable remittance of any foreign income and gains inherent in those funds.
It is important to emphasize that a UK resident policyholder has limited ability to control the investments within the PPLI. Any breach of this will result not only in the income within the PPLI being taxed but also a punitive additional rate of tax.
As we have seen from this article, long term UK residents will be hampered by the loss of the remittance basis in the future and will be limited in the ways they can minimise their UK tax liabilities. Insurance will potentially give them continued valuable tax deferral on their investments. The structure of PPLI is also very flexible and can be adjusted during its life in order to accommodate changes in the client's family situation or lifestyle. This option hugely expands the range of planning possibilities available to tax planners and investors. PPLI's unique structure enables wealth management and inheritance planning for many types of wealthy clients making it a solid solution for the UK deemed domiciled individuals of today.
The content of this article is intended to provide a general guide to the subject matters and is not a substitute for legal consultation. Specific legal advice should be sought in accordance with the particular circumstances.
Dave Wolf is the founding partner of Dave Wolf & Co. Law Firm and a director in Clarity Life Insurance Ltd., a PPLI company. Mirit Reif is a partner at Dave Wolf & Co. Law Firm, and specializes in PPLI and Voluntary Disclosure Programs in the United States and Israel. Mirit can be reached at firstname.lastname@example.org.