How residence and domicile impacts tax planning is a key part of the AF1 syllabus and can also be tested within the multi-choice R03 Personal Taxation exam.
In this article, The Brand Financial Training team look at what domicile is and how it can affect someone’s personal tax position, as well as looking at the type of questions that have been asked in a previous AF1 exam.
The first thing to say is that there’s no strict definition of domicile, but it’s taken to be the place you consider to be your permanent home.
Let’s consider first the Income Tax and Capital Gains Tax (CGT) position.
A non-UK-domicile is someone who lives in the UK and is classed as UK resident for tax purposes, but who does not have their permanent home in the UK. Rather than being taxed in the UK on their worldwide income and gains, they can choose to pay tax on the ‘remittance basis.’ This means that they do not have to pay UK tax on their overseas income and gains, unless they are brought (or remitted) into the UK.
If someone chooses the remittance basis they will not normally benefit from the personal allowance for Income Tax or the CGT annual exempt amount – the exception being where unremitted income and gains are less than £2,000. In this case, the remittance basis automatically applies, they keep both the personal allowance and the CGT annual exempt amount and no remittance basis charge is payable.
Remember, if the person has no overseas income or gains then their domicile status has no impact at all on their UK Income Tax or CGT position (but could be relevant for Inheritance Tax (IHT) purposes).
After a length of time of living in the UK, those classed as non-UK-domiciles must pay an annual tax charge to continue to avoid paying UK tax on their overseas income.
If the remittance basis is chosen and the individual is a long term UK resident then an annual tax charge will apply if they are over 18 and where they have more than £2,000 unremitted income or gains.
The definition of long term residence is more than 7 out of the previous 9 tax years and the levels of charge are:
- £30,000 for those UK resident in at least 7 of the previous 9 tax years
- £60,000 for those UK resident in at least 12 out of the previous 14 tax years
This is essentially a tax charge on the overseas income and gains that are left outside of the UK (i.e. not remitted to the UK) and must be paid on top of any UK tax due on UK income and gains as well as on any overseas income and gains that are remitted to the UK.
Once someone has been resident in the UK in 15 of the previous 20 tax years, they will be deemed UK domiciled for all tax purposes (applying from the 16th year) and the remittance basis is no longer available to them.
Those that qualify for the remittance basis do not actually have to use it; they can decide to pay tax in the UK at any point on their worldwide income and gains.
Also those who have a UK domicile at birth and then become domiciled overseas will revert back to being classed as UK domiciled for tax purposes if they become UK resident at any point.
UK domiciles who have been UK resident in at least 15 tax years and then emigrate and establish a domicile of choice overseas will be deemed to be UK domiciled for Income Tax and CGT for six years after departure.
As well as being unable to use the remittance basis of tax, once someone is deemed UK domicile, all their overseas assets along with their UK assets will be subject to IHT. So let’s now consider in more detail the IHT position.
So firstly let’s confirm that IHT is based on someone’s domicile status. If you are a UK domicile then you’ll pay IHT on your worldwide assets and, if you’re not, then just your UK assets will be caught in the IHT net.
If both spouses/civil partners are UK domiciles then any transfer between them during lifetime and on death is free of IHT with no limit. However, where the recipient spouse/civil partner is not a UK domicile then there is a limit on the spouse/civil partner exemption of £325,000 (in addition to the nil rate band of £325,000 – see example below).
A non-UK domicile married to a UK domicile can elect to be treated as UK domicile for IHT purposes. This would mean that would benefit from an unlimited spouse/civil partner exemption and so avoid the £325,000 cap, but their worldwide assets would be caught in the IHT net rather than just their UK assets.
An election can take place during lifetime – in which case it takes effect from the date the election is made or an election can be made within two years of the death of the UK domiciled spouse – in which case it takes effect from the date they died.
Once the election is made, any assets that are inherited from the UK-domiciled spouse are then free from IHT.
Let’s look at an example:
Sally and Fed are married. Sally is UK-domiciled and Fed was born in Spain and retains
his Spanish domicile. On Sally’s death her estate was valued at £900,000 and was left to Fed.
The legal personal representatives of Sally’s estate can use her nil rate band of £325,000 but the spouse exemption is limited to £325,000. This means that £650,000 of Sally’s estate is free from IHT, but the remaining £250,000 is liable.
If Fed elects to be treated as UK-domiciled for IHT, this would mean the full spouse exemption is available and no IHT would be payable.
In the February 2021 AF1 exam this very subject was tested. Question 1 was regarding Jonah, a UK-domicile and his fiancée, Sophia, who had Italian domicile.
There were two questions testing the IHT position, the second question asked candidates to explain how Sophia could elect to be treated as domiciled in the UK for IHT purposes and the financial impact of this. This was for 10 marks.
The model answer was:
- She would need to make the election to HM Revenue & Customs.
- It would take effect from the date of making it.
- but can be backdated by up to seven years or the date of their marriage, if later.
- She could also make the election after Jonah’s death, provided it is within 2 years.
- Once an election is made the exemption is unlimited and the estate passes free of IHT.
- She can also benefit from the transferrable nil rate band.
- Her worldwide assets would become liable to IHT.
- In her case, this may increase their overall liability to IHT.
- Once made, the election cannot be revoked.
The senior examiner report for this sitting stated that ‘many candidates gained some marks but few provided enough detail to their answers’.
With residence and domicile a key part of the AF1 syllabus, future candidates should ensure they study this learning outcome in full before sitting their exam.
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