I am a British expat living abroad. What should I be thinking about?
British expats are typically UK domiciled (“UK dom“) but non-UK resident for UK tax purposes. The extent to which they are likely to be affected by the changes to the taxation of non-UK domiciled individuals announced by the Chancellor in his Spring Budget of 6 March 2024 is discussed below.
UK inheritance tax (“IHT”)
UK dom individuals are currently subject to IHT on their worldwide estate. Under the proposed new rules, their UK situated assets and/or indirectly held UK residential property interests (including “relevant loans” in connection with such) will remain subject to IHT regardless of their residence or domicile status; but they may be in a better position with respect to their non-UK assets.
This is because it has been proposed that, with effect from 6 April 2025, exposure to IHT on non-UK assets will be based on the individual’s residence status, rather than on their domicile position (as is currently the case). It is proposed that individuals will be subject to IHT once they have been UK resident for ten years and will remain within the scope of IHT for a further ten years after they cease UK residence (“the ten-year IHT tail“).
The government has said that this proposed change is subject to consultation and it may be that other connecting factors to the UK (e.g. citizenship) may be taken into account in determining whether the ten-year IHT tail should have universal application. The UK tax system currently differentiates “born and bred” Brits from other UK doms under the rules for “formerly domiciled residents” (“FDRs“), so there is precedent for a distinction being drawn in this context.
If, however, the proposed change is implemented universally, it would enable a returning UK dom to avoid creating IHT exposure on their non-UK assets simply by spending ten years outside the UK. This is more favourable than the current IHT regime, under which the only way of individuals taking themselves outside the IHT net is for them to shed their UK domicile of origin and replace it with a domicile of choice elsewhere. A UK domicile of origin is said to be adhesive and difficult to lose, however. To do so requires the formation of an intention to live permanently or indefinitely elsewhere. There is no bright line test to establish whether this has been done and instead an assessment is required of all relevant facts and circumstances. Typically, under the current regime, individuals must divest themselves of UK homes and assets, sever UK business interests and loosen UK social connections; while acquiring a home and property, establishing business interests and creating social connections in their new place of residence. The subjective nature of the test for domicile leads to uncertainty and has frequently been the subject of HM Revenue and Customs enquiries. A new fixed ten-year IHT tail would give some much needed clarity and certainty to UK expats.
Under the existing domicile test, it is relatively easy for spouses (or civil partners, the terms are used interchangeably here) to align their actual domiciles, based on their common intentions for the future, or elect to be treated as UK domiciled to eliminate a domicile mismatch. A potential downside of moving to a residency-based test for IHT is that the periods of non-residence of spouses may not align; for example, where an individual leaves the UK for work, it is not uncommon for their spouse to follow them at a later date after completion of house sales or children’s school terms, etc. A residency-based IHT test may result in one spouse falling outside the scope of IHT before the other and the spouse exemption potentially being inadvertently (temporarily) limited to £325,000. This would be relevant if a spouse who has not yet been non-UK resident for ten years were to pre-decease a spouse who has already lost their ten-year IHT tail. It is currently unclear whether the new IHT rules might make any kind of provision for the IHT treatment of spouses to be aligned, but prima facie a residence-based approach would not naturally lend itself to this.
UK income tax and capital gains tax
As non-UK residents, under current rules, UK dom expats only pay UK tax on their UK source income and UK property-related gains. Their foreign income and non-UK property related gains are outside the scope of UK tax, subject to anti-avoidance rules known as the “temporary non-residence rules”.
The temporary non-residence rules apply to individuals who are (i) UK resident during at least four of the seven tax years prior to their departure from the UK; and (ii) non-UK resident for five years or less (which, because of the technical detail of how the rules work, often means six tax years). UK doms who are only temporarily non-resident will be subject to UK tax on their gains and certain categories of income arising during the period of temporary non-residence in the tax year of their return to the UK.
No changes have been announced to these rules, although it is possible for the period of temporary non-residence to be lengthened to reflect the ten-year IHT tail and period of non-residence that will be required before arrivals to the UK would be able to benefit from the newly-announced four-year residence-based exemption regime (“four-year FIG regime“) for foreign income and gains (“FIGs“).
What should you do if you are planning to return to live in the UK?
Where a British expat has already acquired a domicile of choice overseas, there is scope for them to carry out tax planning on the basis of trusts before 6 April 2025 in order to shelter their non-UK assets from IHT in the event that they return to live in the UK, or if their descendants are living in the UK.
From 6 April 2025, where a British expat who remains UK dom returns to live in the UK:
- if they will have been non-UK resident for fewer than ten UK tax years, on their return there will be no change to the status quo and their worldwide assets will continue to be within the scope of IHT. If, however, they have been non-UK resident for more than ten UK tax years, their worldwide assets will only be within the scope of IHT once they have been UK resident for ten years. It should be noted, however, that there is a question as to how the ten-year UK residence rule will apply and, specifically, whether historical periods of UK residence may count towards that period. This may be an aspect that the government consults about in due course; and
- if they have been non-UK resident for at least ten years, they will be able to benefit from the new four-year FIG regime, meaning that they will not be subject to UK tax on their FIGs for the first four years of UK residence. This is more favourable than the current regime because, even as an FDR, a British expat would be ineligible for the remittance basis during tax years of UK residence and would immediately be subject to UK tax on their worldwide income and gains on the arising basis. It may therefore be advantageous to delay any planned return to the UK until after 5 April 2025.