|The Bahamas Investor Magazine
February 16, 2019
February 16, 2019
Long-term Bahamas 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, that isn’t always the case. 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 a warm climate and a flight time of just over nine hours from the UK, The Bahamas 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 6,000 Brits living on the islands. Coupled with the fact that wages in The Bahamas are relatively high and that there is no income tax, capital gains tax or inheritance tax, a large proportion of that group 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. 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 per cent 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 £10 million 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 The Bahamas for the last 20 years takes £2 million from their Bahamian bank account and puts it into a Bahamian law governed trust, that transfer triggers an immediate charge of 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).
Strictly, 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 is 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 or her 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.
Burden of proof
English law provides that the person asserting that their domicile has changed is responsible for proving it. In this context, this means that the person who moved from the UK to The Bahamas needs to prove that they have acquired a domicile of choice in The Bahamas. 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 example, a young entrepreneur moves from London to The Bahamas to start a new company. Initially he plans to spend four or five years in The Bahamas, developing and then selling the new company. After the successful sale of the company, his plans change and he decides that his future lies in The Bahamas and he wants to start putting down roots. He buys a house, gets married, and starts a family. Their children are raised and educated in The Bahamas.
During the initial period, the man lacks the necessary intention to abandon the UK and to acquire The Bahamas as his domicile of choice. He will remain UK domiciled during this period. After the initial period, and depending how he conducts himself and the connections he has with both The Bahamas and the UK, it is possible that he will be able to acquire a domicile of choice in The Bahamas, to displace his domicile of origin.
Taking another example, a retired former professional couple moves to The Bahamas from the UK to allow them to take advantage of a slower pace of life and a high standard of living in their retirement. They have been visiting The Bahamas for the last 30 years and always planned to move there full-time when they retired. They sell their house in the UK and buy a larger house in The Bahamas, also selling the small apartment in The Bahamas 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 the UK, and visits The Bahamas for holidays–even extended holidays–the couple lacks the necessary intention to abandon the UK and to acquire The Bahamas as their domicile of choice. They will therefore remain UK domiciled during this period. However, once they retire and, again, depending on how they conduct themselves, they will be able to acquire a domicile of choice in The Bahamas.
In both of the above cases, if the people involved later change their minds and move 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 The Bahamas 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 individuals and how this is supported by what they actually do.
Where does this leave a long-term non-resident? HMRC does 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 it believes 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 The Bahamas), 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) is generally the key to acquiring a domicile of choice in the new place.
Once the domicile statement is finalized and signed, it is helpful to obtain a domicile report from a suitably qualified professional, specializing 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.