“The only difference between death and taxes is that death doesn’t get worse every time [Parliament] meets” Will Rogers
Long-term Barbados residents who started their lives in the UK may think that they long-since waved goodbye to the UK taxman, HM Revenue and Customs (HMRC). Unfortunately, in many cases they will be wrong. Shedding one’s tax residence is a simple matter of packing up and leaving but changing one’s domicile is a much trickier affair. And it is domicile that is the relevant “connecting factor” for UK Inheritance Tax. This crucial point is overlooked by a large number of people each year, with significant financial consequences.
With an average daytime temperature of 27°C year round and a flight time of just over 8 hours from the UK, Barbados has proved a popular choice for expats looking to retire, or to relocate during their working years to secure a better quality of life. A 2010 report by the Institute for Public Policy Research estimated that there were 29,000 Brits living on the island, representing over 10% of the entire population.
Although Barbados does not offer its residents a tax-free system, some tax benefits do arise from residence. These benefits include:
- an increased personal allowance for pensioners;
- the fact that the non-Barbados investment income (such as dividends, interest, and rental income) of someone who is resident but not domiciled in Barbados – and which income is not “remitted” to Barbados – is outside the scope of Barbados income tax; and
- capital gains are not subject to tax in Barbados.
Moreover, the new Special Entry Permit regime has enabled certain qualifying high net worth individuals, with assets of not less than US$5 million, to enter and reside in Barbados with their dependants with few restrictions. As a result, a large proportion of the British expat community in Barbados is likely to have amassed wealth of a sufficient level to attract the attention of estate planners.
Popular within the tool-kit of estate planners is the trust; a tried and tested method to protect wealth from dissipation by divorce, dispute, mismanagement or overindulgence. The asset-protection benefits of trusts are even more compelling as children and grand-children get married and parents and grand-parents turn their attention to protecting their wealth in the event of future divorces.
So, how does this relate to UK tax? It all comes down to Inheritance Tax and to the concept of domicile. Inheritance Tax is not, as the name suggests a tax on inheritances. It is a tax that applies mainly to estates when someone dies but which also applies to certain lifetime transfers, including gifts. This article focuses on the way in which Inheritance Tax applies to lifetime gifts into trusts.
For the past decade, the UK tax rules have treated gifts into most lifetime trusts as “chargeable transfers” for Inheritance Tax purposes. This is significant because Inheritance Tax is charged immediately at the rate of 20% on the value of a lifetime chargeable transfer, after the transferor’s “nil rate band” (currently £325,000) is exhausted. For a person setting up a trust (and we call that person the “Settlor”) containing £10m in assets, such a transfer would trigger an immediate charge to Inheritance Tax of £1,935,000. If the Settlor dies within seven years of making that transfer, charges of up to an additional £1,935,000 can also apply.
The Inheritance Tax rules do not apply to all transfers taking place throughout the world; that’s where connecting factors come in. There must be some UK connection with either the property being transferred or the person making the transfer (or both) for Inheritance Tax to apply.
Inheritance Tax applies to all transfers of UK situated property. For example, any transfer of a London apartment (even one owned by a foreign company, following recent changes), or shares in an English company, falls within the scope of Inheritance Tax on the basis that the property is legally situated in the UK.
Inheritance Tax also applies to all transfers of assets, regardless of where they are legally situated, where the person making that transfer is UK domiciled at the time of the transfer. This is the trap that often catches out long-term non-residents. For example, if someone who has been in Barbados for the last 20 years takes £2m from their Barbados bank account and puts it into a Cayman Islands law governed trust, that transfer triggers an immediate charge to Inheritance Tax (of, in most cases, £670,000) if that person retains their UK “domicile of origin”. The questions “what is domicile?” and “how do I change my domicile?” therefore assume a significant degree of importance.
When and how can a long-term expat lose their domicile of origin in the UK?
To understand how a person might lose their domicile of origin, we first need to understand what this term means. Every person has a domicile of origin as a matter of English law. It is acquired at birth by reference to that person’s parentage. A child usually takes his father’s domicile, at the child’s date of birth, as his own domicile of origin (with different rules applying where the parents are unmarried or where the father dies before the birth).
A person cannot lose their domicile of origin. It remains with them throughout their life. However, a domicile of origin can be displaced by the acquisition of a domicile of choice in some other place. If the domicile of choice is later abandoned then either (i) the domicile of origin revives; or (ii) a new domicile of choice is immediately acquired, which means that the displacement of the domicile of origin continues.
Domicile, and particularly domicile of origin, is an incredibly adhesive concept. Acquiring a domicile of choice in some other place requires a lot more than simply moving there, even for a long time. Legally speaking it requires both a physical presence in the other place and an intention to remain in that new place “permanently or indefinitely”.
Of the two concepts, “physical presence” is often the most straightforward. A person must fix his or her sole or main residence in that place. In most cases this is the place where that person’s family are based.
The concept of “permanently or indefinitely” is often a little trickier. The notion of “indefinitely” remaining in a place, taken literally, appears to suggest that a person who resides in a place with no fixed idea of when they might leave could claim to be there “indefinitely”. For domicile purposes, that is not sufficient and “indefinite” means that the person has decided to end his days in that place.
The English case-law on domicile is littered with examples of long-term non-residents who are held to retain their English domicile many years (and often decades) after they ceased to reside in the UK. In almost all of those cases, the person (or their estate, after they had died) claimed that they had acquired a domicile of choice in some other place. Every one of these cases should act as a warning to others in a similar position: acquiring a domicile of choice in another place is not a simple matter. It is not a case of abandoning the UK but of positively and actively forming an intention to permanently remain in the new place.
English law requires that the person asserting that their domicile has changed is responsible for proving it. In this context, this usually means that the person who moved from the UK to Barbados needs to prove that they have changed their domicile. The legal threshold for proving a change of domicile is “on the balance of probabilities” but where an individual is seeking to displace their domicile of origin (rather than an earlier domicile of choice) some of the cases suggest that a slightly higher burden of proof applies.
Taking a typical Barbados example, a retired former professional couple moves from London, England to Barbados, to allow them to take advantage of a slower pace of life and a high standard of living. They have been visiting Barbados for the last 30 years and always planned to move there full-time when they retired. They sell their house in London and buy a larger house in Barbados, also selling the small Barbados apartment that they bought 25 years ago, and in which they have stayed on their various visits over the years. They become active in local clubs and charities and quickly establish a good network of friends.
During the period in which the couple lives and works in London, and visits Barbados for holidays – even extended holidays – the couple lacks the necessary intention to abandon the UK and to acquire Barbados as their domicile of choice. They will remain UK domiciled during this period. Once they retire, and depending how they conduct themselves and the connections that they have with each of Barbados and the UK, it is possible that they will be able to acquire a domicile of choice in Barbados, to displace their domicile of origin.
If the couple later changes their mind and moves to another country, say the US (although this applies wherever they move, provided it is not back to the UK) then at that point it is likely that they will lose their domicile of choice in Barbados and either their UK domicile of origin revives or they acquire a domicile of choice in the US state to which they have moved. This requires a further examination of the intentions of each of the couple and how this is supported by what they actually do.
Where does this leave a long-term non-resident?
HMRC do not give pre-clearance rulings on the question of where someone is domiciled. This makes it tricky to have certainty over the question, despite its obvious importance. Furthermore, HMRC will often take action many years after a transfer has taken place, if they believe that the person making the transfer was UK domiciled at the time of the transfer. In many cases, this challenge happens after the Settlor has died. The timing of such enquiries deprives the Settlor of the ability to back up his assertion of a change of domicile.
A well-advised client, who believes that he has acquired a domicile of choice in another country (such as Barbados) will typically take formal steps to document that intention and will ensure that this process is completed before any lifetime trusts are established. This documentation process usually takes the form of a formal domicile statement. Whilst such a statement is not conclusive of the domicile of an individual, these stated intentions are influential. This is because a domicile determination involves a very close examination of the life of the person and statements of intention by that person have evidential value.
The production of a domicile statement is not a “check box” exercise – the case-law makes that very clear – but the process often starts with the completion of a detailed questionnaire. At that stage, someone with expertise dealing with the English law concept of domicile needs to consider the responses and to prompt the client for more information. This process results in the production of a draft statement which records the client’s current intentions. In many cases this exercise is repeated periodically, especially if there are any material changes to the client’s circumstances.
Amongst other things, a domicile statement looks to the subjective intention of the maker, as supported by the objectively verifiable actions taken by that person: cutting most ties to the UK and acquiring multiple and complex connections to the new home (both personally and professionally – unless the person is retired) is generally the key to acquiring a domicile of choice in the new place.
Once the domicile statement is finalised and signed it is helpful to obtain a domicile report from a suitably qualified professional, specialising in UK tax. As with the domicile statement, such a report is not conclusive but it is also very helpful for giving the client the comfort that a qualified professional considers that he has (or has not) acquired a domicile of choice in some other place. Such reports often set out what else a client needs to do to make it more likely that their change of domicile assertion will be successful. Ultimately, only the courts can make a binding determination of a person’s domicile but absent a pre-clearance procedure long-term non-residents looking to put in place their estate planning are likely to need to take comfort from a domicile report and to plan their affairs accordingly.
A unique trap created by the Barbados income tax system
We mentioned, earlier, that Barbados does not charge income tax on non-Barbados investment income of someone is resident but not domiciled in Barbados. This generous approach to income tax can create problems when these rules are considered against the UK Inheritance Tax rules. This is because avoiding UK Inheritance Tax requires a person to have (in this case) a Barbados domicile of choice, and the acquisition of a Barbados domicile of choice removes the ability for that person to use this beneficial income tax treatment to avoid taxation of their non-Barbados investment income. This creates a trap for the unwary. If, relying on this rule, you fail to pay Barbados tax on your non-Barbados investment income you are effectively declaring that you are not domiciled in Barbados. Conversely, if you are to avoid UK Inheritance Tax on death – or on certain lifetime transfers – you need to be considered domiciled in Barbados at the relevant time. This means that, as part of a UK Inheritance Tax planning exercise, there will come a point at which the right advice will be to start paying Barbados income tax on your non-Barbados investment income, accepting that you are domiciled in Barbados for that purpose. HMRC would look at your declarations in your Barbados tax return, that you were not domiciled there, if you later made a claim that you were domiciled there.
Governments throughout the world are looking for ways to increase the tax that they collect. Collecting Inheritance Tax from non-residents, especially wealthy ones, is often a fairly easy way to achieve that goal (especially if those non-residents no longer vote in UK elections). By placing the burden of proving a change of domicile onto the tax payer, the tax man merely has to identify an individual and ask them to prove that they have changed their domicile. If that question is raised after the individual has set up one or more lifetime trusts, there is an immediate question of Inheritance Tax hanging on the outcome.
As with much in life, proper planning is essential to put the client in a position of being able to defend against such a challenge and to successfully assert a change of domicile.
Written by David Cooney, Partner, Charles Russell Speechlys AG, Zurich office and And Jack Carter, Trainee, Charles Russell Speechlys AG, Zurich office (April 2018)