Non-domicile changes – The impact for Americans in the UK

In the Spring Budget 2024 Jeremy Hunt announced the abolition of the non-dom tax regime and a new modernised ‘tax holiday’ for individuals moving to the UK.

It is one of the most significant reforms to the non-dom tax regime in our generation. Many affected individuals will now face a dilemma due to the proposed rules, in terms of both their existing structures and ongoing exposure to UK Tax.

If you are such an individual, the Chancellor’s Budget announcements will clearly be of interest. However, an American in the UK needs to view those changes through a different lens. Unlike your situation, most non-dom individuals are not involved in a lifetime relationship with the US Internal Revenue Service (IRS).

As a result of this relationship with the IRS:

• You are already subject to US Federal Income Tax on your world-wide income.
• The Chancellor’s Budget announcements will eventually make you liable to UK tax on world-wide income – perhaps sooner than originally envisaged.
• Your interest should be on the interaction of two different national taxing regimes targeting your world-wide income.
• That is a completely different perspective from that of a non-US individual, who will be considering the future effect of the UK taxing income/gains which to date may have suffered little or no tax anywhere.

Although there are some broad guidelines on how the US and UK tax systems interact (see below), you should review your situation with an advisor who understands both systems. It is possible that such a review might result in a ‘surprise’ for you. Nobody likes that sort of ‘surprise’, but it is better to be aware early when there is time to plan either a coping or avoidance strategy.

Broad guidelines on the interaction of US and UK taxes

1. The UK allows a credit for US tax charged on certain income/gain arising from a US source.

In some circumstances (e.g. a dividend received from a US source) not all US tax paid will be eligible for credit. When that occurs, the US/UK Tax Treaty contains a mechanism for the avoidance of double taxation.

2. The US allows a credit for non-US tax against US tax charged on income/gain arising from a source outside the US.

• Credit is given after sorting income/gain (and the associated foreign taxes) by type into different ‘baskets’.
• Cross-crediting between baskets is not permitted. This aims to prevent the US tax on foreign income suffering low or zero foreign tax being reduced by a credit derived from a high foreign tax suffered on another income source.

3. Where credit of taxes is available, the economic cost of taxation will be whichever of the US or the UK applies the higher rate on the income/gain in question.

How does this affect a US person moving to the UK?

Qualifying individuals will not pay UK tax on any of their foreign income and gains (FIG) in the first four tax years after becoming UK tax resident. As such FIG can be remitted to, and enjoyed in, the UK with no UK tax.

There should be a reduced need for pre-entry planning given this four-year ‘grace period’. There are, however, some nuances to be careful of, particularly with respect to Trusts, LLCs and S Corporations, so taking proactive pre-entry advice is still important.

Following the fourth tax year of residence in the UK, such individuals’ worldwide income and gains will then become subject to UK tax regardless. The four-year rule brings forward the decision for individuals as to whether they wish to remain in the UK, compared to a current seven-year period where the Remittance Basis can be claimed without having to pay the annual charge to do so.

Taking pro-active advice in the fourth year of UK residence will be key, as careful planning will need to be considered to ensure sufficient tax is paid in the UK to maximise the ability to claim foreign tax credits in the US and mitigate potential double tax.

How does this affect a US person currently living in the UK?

Certain individuals may benefit from the transitional rules. In all cases, there are still several questions that need to be answered in respect of how this will work in practice.

Individuals considering the merits of the ‘Temporary Repatriation Facility’ will be keen to understand what double taxation relief may be available (if any) where US tax has been suffered on FIG which has been protected from UK tax by a remittance basis claim. Nonetheless, the preferential 12% flat tax rate could be attractive for those needing to ‘unlock’ funds currently held outside the UK.

US persons will need to carefully consider the impact of rebasing rules, as although UK Capital Gains Tax exposure may be reduced, US tax arising on the same gain will be unaffected. A detailed asset review may be needed, in addition to exploring whether pre-6 April 2025 sales may be beneficial.

The ‘one year only’ 50% reduction in taxable income will also need careful thought to ensure full Foreign Tax Credit Relief can be obtained to offset US tax arising on the same income.

Pro-active Foreign Tax Credit planning is going to be more important than ever.

What about UK Inheritance Tax?

The feeling at present seems to be that the changes are overly strict and potentially unworkable. It is expected that there will be changes following the consultation.

That said, the US/UK Estate & Gift tax treaty is unlikely to provide relief for US persons who have been living in the UK for more than 10 years. However, if such a person ‘returned home’, the US/UK Estate & Gift tax treaty could remove the UK Inheritance Tax (IHT) tail much quicker than the intended 10 years. The devil will be in the detail of the consultation and subsequent legislative change, especially given the US/UK Estate & Gift tax treaty references the concept of domicile.

Importantly, for US persons who are not yet deemed domiciled in the UK, it has been confirmed that the use of trust structures can still be effective to provide UK IHT protection if such a trust is settled before 6 April 2025. Labour have however indicated that they would look to remove such UK IHT protection should they prevail at the next General Election. A watching brief is required more than ever here.

What about trust protections?

Trust protections remain in play for a US person moving to the UK who is the settlor of a US trust. For the first four years of UK residence, FIG arising within the US trust will be outside the scope of UK tax.

Following the fourth year of residency, if the US trust is ‘settlor interested’ the trust protections will be lost.

Grantor trusts: It is very common for a US person living in the UK to have settled an ‘Excluded Property Trust’ to provide UK IHT protection. Such a trust is commonly a grantor trust for US Income Tax purposes. Where the UK resident settlor has been UK resident for more than four years, the trust protections will likely be lost. In such a scenario we broadly expect that the 2001 US/UK Tax Treaty should provide relief from double tax. The economic cost of the loss of trust protections being any additional UK tax due where the UK has the primary taxing right on certain income/gains.

Other US trusts: We expect the impact of these rules changes on other US trust structures to be limited. Naturally, one requirement is that the economic settlor of the US trust be UK tax resident.

It will be more important than ever to ensure that all US trusts, where there is a UK connection, be reviewed on a case-by-case basis to identify whether any UK tax concerns are present.

How we can help

If you would like to discuss how the above may affect you and your tax affairs, please get in touch with your usual Blick Rothenberg contact, or one of the team using the form below.