What Americans need to know - the UK's non-dom regime

30 April 2024 | Applicable law: England and Wales, US | 22 minute read

The United States is unique among industrialised nations in subjecting its citizens to worldwide income and gains tax wherever they happen to live.  Accordingly, Americans living in the UK have historically faced fewer incentives than nationals of other countries to elect to use the 'remittance basis' of UK taxation simply because they face a citizen-based tax 'floor' with which virtually no other country's citizens are burdened.

The Conservative Government's Spring Budget purports to eliminate the UK's non-dom regime from 6 April 2025.  From an income and gains perspective, this change will likely worry US citizens less than the typical UK remittance basis user.  Nonetheless, UK-resident US citizens who have been relying on the remittance basis thus far will face a distinctive set of challenges when the non-dom regime comes to an end.  The end of the domicile-based UK inheritance tax ('IHT') regime may pose more immediate concerns for Americans living in the country due to the significant gap between the UK IHT 'nil rate band' and the lifetime exemption amount that applies in the US federal estate tax context.  Recent announcements from the Labour Party to close perceived loopholes in the Spring Budget should it form the next government has thrown a further spanner in the works.

A US citizen living in another jurisdiction generally must file income tax returns and pay income and gains tax annually in both countries on all worldwide income and gains.  To keep any double taxation to a minimum, such an individual must generally use 'foreign tax credits' in one or both countries to offset tax paid in one country against tentative tax owed in the other.  For US citizens living in the UK, Article 24(6) of the US-UK Income Tax Treaty (the 'Income Tax Treaty') sets out when and under what circumstances such an individual must pay UK tax to HMRC, claiming such tax as a US foreign tax credit, or, in other instances, must pay US federal income tax to the Internal Revenue Service (the 'Service'), claiming such tax as a UK foreign tax credit.  

The Article 24(6) system functions relatively well in simple cases.  Yet the system tends to break down in instances where, for instance, the two countries take inconsistent views as to the proper characterization of assets or holding structures or have differing perspectives as to the timing of certain tax events.  Another disadvantage of the foreign tax credit method is that a US citizen living in another country will effectively always be taxed at the higher of each jurisdiction's rate of tax on a particular income or gain item.  For these and other reasons, many Americans living in the UK do frequently elect to be taxed on the UK remittance basis, in spite of their citizenship-based tax floor, to reduce the bite of these inconsistencies and drawbacks.

A US citizen is also subject to US federal estate tax on all assets he owns or is treated as owning at death but only to the extent the value of his or her estate exceeds his remaining inflation-adjusted lifetime exemption amount (currently $13.61 million and slated to be reduced to around $7 million at the end of 2025).

On 6 March 2024, the Conservative Government announced the abolition of the existing UK tax regime for non-UK domiciliaries from 6 April 2025.  The current rules will continue to apply until that date. From 6 April 2025, the concept of 'domicile' will no longer be a factor in relation to UK tax liability and it is proposed that there will be two new residence-based regimes: (i) one for income tax and capital gains ('CGT') purposes and (ii) one for IHT purposes.  

The technical detail of the changes is not yet known; further details and draft legislation are due to be issued later in the year. As a result, there will be a period during which it will not be entirely clear what rules will apply from 6 April 2025. This is compounded by the fact that there will be a General Election before the next UK tax year.  If the Labour Party win that election, further changes may be introduced.

The Labour Party has refrained from issuing detailed commentary as to what they would propose as an alternative to the Spring Budget. However, over the past week or so, Labour has begun to pass comment and carve out a direction of their own.   At the time of writing, we understand that Labour supports most aspects of the Conservative's residence-based replacement regime, including the four-year time period and the ten-year UK residency period before worldwide assets are subject to IHT, but with restrictions to transitional provisions that would otherwise have softened the blow of these changes.

We continue to monitor the situation. In the meantime, we have set out below a whistle-stop tour of the key changes proposed by the Conservative Government, their relevance for US citizens living in the UK and Labour's counter-proposals (to the extent these are known).

The remittance basis of taxation will be abolished from 6 April 2025 and a new 4-year foreign income and gains ('FIG') regime introduced in its place. This regime scraps the concept of domicile for the purposes of determining liability to UK income tax and CGT.  Instead, taxpayers will be able to elect to limit their exposure to income tax and CGT on their non-UK income and gains for four years after becoming UK tax resident, provided they have been non-UK tax resident for the previous 10 years.  The UK's statutory residence test ('SRT') will be used to determine residence; treaty residence or non-residence under the terms of the Income Tax Treaty and split years will be ignored.

The election will need to be made each UK tax year that the FIG regime is available to a taxpayer and will be capable of being made for some of those four years but not others, if desirable. In practice, we would expect most taxpayers to elect into the FIG regime (although they will lose their entitlement to personal allowances and the CGT annual exempt amount). After the end of the 4-year period, individuals who remain UK tax resident will become taxable on worldwide income and gains.  Arrival in the UK after a period of 10 years non-UK tax residence will start a timer and once four UK tax years have elapsed, an individual will no longer be eligible to elect into the FIG regime. If an individual leaves the UK temporarily during the 4-year period, they will be able to make a claim under the FIG regime for any of the qualifying tax years remaining on their return to the UK. For example, if an individual becomes non-UK resident in year 2 and 3 but is UK resident again for year 4, they will be able to use the FIG regime for year 4.  Individuals who on 6 April 2025 have been tax resident in the UK for less than 4 years (after a period of 10 years non-UK tax residence) will be able to use the FIG regime for any UK tax year of UK residence in the remainder of those 4 years. Thus, an individual who became resident in the UK in 2022/23, after a 10-year period of non-residence, will be able to claim under the FIG regime for 2025/26.

While the FIG regime will have a much shorter period of availability than the remittance basis, it will operate in a much simpler fashion.  In contrast to the current system, the taxpayer's FIGs will not be subject to tax in the UK even if the taxpayer remits them to UK. 

As mentioned above, Americans who claim the UK remittance basis are generally not trying to achieve a zero or de minimis effective rate of cross-border tax on their unremitted non-UK income and gains; that is effectively impossible in view of the fact that they must pay US federal income tax on the bulk of those earnings merely by virtue of their US citizenship.   Instead, a US citizen who claims the UK remittance basis of taxation is typically aiming to: (i) avoid entity characterization mismatches, foreign exchange distortions, and/or timing issues created by the UK's April 6-April 5 taxable year; or (ii) lock in the benefit of preferential US tax treatment on income or gain items where there is no corresponding tax benefit on the UK side of the ledger (for example, so-called 'qualified dividends,' Qualified Small Business Stock, or tax-free municipal bonds) or punitive UK taxation on anodyne US tax items (such as the 45% UK 'Offshore Income Gains' rate which would ordinarily apply to gains realized on US non-reporting fund redemptions for additional rate UK taxpayers – for instance, regular US mutual funds that have not registered for UK reporting fund status).  Consequently, the abolition of the non-dom system, the introduction of the FIG regime, and the various transitional arrangements described below are likely to affect US citizens in more subtle and contingent ways as compared with nationals of other countries.

For those Americans who are ineligible to take advantage of the FIG regime, one possible avenue for avoiding the full brunt of UK residence-based taxation might be to make a residency 'tie-breaker' claim under the Income Tax Treaty to break away from UK tax residence under the SRT.    Article 4 of the Income Tax Treaty generally applies where an individual happens to meet the internal criteria for tax residency in each of the two jurisdictions. A person in these circumstances can sometimes use Article 4 to tie-break his or her tax residency to one country or the other (with the result that the 'losing' country is permitted to tax that individual only on a narrow slice of income or gains which have their 'source' in that country).  The tie-breaker test looks to various personal and economic ties such as the individual's home, family, assets, and business connections.   

However,  US citizens are not eligible to tie-break away from US tax residency under Article 4, which explains why Americans who have lived in the UK for decades are still forced to use the imperfect foreign tax credit method to blunt any double income and/or gains taxation rather than simply tie-breaking their tax residence to the UK;  nonetheless, these individuals can potentially tie-break away from UK tax residence towards exclusive United States tax residence provided (i) they maintain any one of a 'substantial presence, permanent home, or habitual abode' in the United States for the relevant taxable period; and (ii) they satisfy the multi-factor tie-breaker test.   While the Article 4 solution will not work for all UK-resident US citizens—those individuals who no longer have deep roots in the United States will have a difficult time demonstrating that they are eligible for Article 4 tie-breaker relief—this strategy may ultimately prove more tax-efficient than the remittance basis system (at least for those who are able to take advantage of it).

Three transitional measures have been announced to soften the impact of these changes:

  1. Existing remittance basis users will have the option to rebase the value of capital assets which they hold personally to their values as at 5 April 2019 for disposals which take place on or after 6 April 2025.  This rebasing will not apply to assets held in trust.

    For a US citizen, this option will be most attractive where he or she owns an asset the tax base cost of which is high from a US perspective but low from a UK point of view.  Conversely, where an asset has a low tax basis in both jurisdictions, the opportunity to artificially re-base a particular asset from a UK-only perspective will be less appealing; to the extent there is no corresponding re-basing relief on the US side, then that individual will not necessarily achieve any overall economic benefit as a result of the re-basing relief because he or she would be subject to US federal income tax on the full amount of the gain on an eventual sale.

  2. Those individuals who have been in the UK for four years, and who will pass from being remittance basis users in the 2024/25 UK tax year to being taxed on an arising basis in 2025/26, will benefit from a 50% exemption for the taxation of their foreign income for the 2025/26 UK tax year (the '50% Income Concession').  This exemption will not apply to chargeable gains. From 2026/27 onwards, tax will be due on all worldwide income in the normal way.  

    While Americans living in the UK will be subject to full US federal tax on all of their worldwide income and gains, irrespective of the 50% Income Concession, this transitional relief provision, whilst short-lived, could still prove attractive in instances where the item of income is ordinarily taxed at a lower rate in the United States as compared to the corresponding UK rate.  For instance, 'qualified dividend' income is subject to US federal income tax at a maximum rate of 23.8%, while the UK tax rate on dividends is much higher at 39.35%.   Accordingly, UK-resident Americans should still be able benefit from the 50% rate reduction on income items of this kind.  But it is important that they approach this provision with caution given that the Labour Party has already indicated that it plans to remove the 50% Income Concession should it be victorious at the next election.  

  3. There will be two-year Temporary Repatriation Facility ('TRF') in the 2025/26 and 2026/27 UK tax years.  This will allow existing remittance basis taxpayers who have accumulated foreign income and gains to remit them to the UK subject to a rate of tax of only 12%.  The UK's additional rate of income tax is 45% and the higher rate of CGT is generally 20% (24% for residential property gains and 28% for carried interest gains), and so this facility may present a very attractive route of repatriating funds (and rendering them capable of being spent in the UK without any further charge to income tax or CGT). There does, however, remain some uncertainty as to the availability of the TRF in certain scenarios.   In particular, it is not yet clear whether the TRF would be available in respect of income/gains attributed to UK resident beneficiaries under the UK's matching regime for offshore trusts. The Government's Technical Note simply provides that the new 12% tax rate will be available where the foreign income and gains arose to an individual 'personally' without further explanation as to what this might mean in practice.

    To avoid 'wasting' the economic benefit of the special 12% remittance rate, a UK-resident US citizen will need to consider how his or her repatriation strategy aligns with his or her existing US foreign tax credit profile.  Very generally, where a US citizen pays or accrues a foreign income tax during a particular year but is unable to actually make use of the credit during that year, he or she is permitted to carry back any unused or 'excess' foreign tax credits up to one year (on an amended US tax return) or else carry that excess credit forward up to 10 years.  These rules will likely come into play for a US citizen repatriating funds under the special regime because the mere act of remitting prior-year income and gains will not give rise to any taxable event from a US perspective (the corresponding US tax event will have occurred years earlier, during the year the income or gain item was first earned); likewise, any new investment earnings by that individual during the remittance year and going forward will generally continue to be subject to UK tax in the regular way.  Accordingly, there may be little available 'credit limitation' against which the 12% repatriation tax can actually be claimed as a foreign tax credit under US rules; in technical terms, the individual risks being in an 'excess credit' position and therefore causing those foreign tax credits to expire if they cannot be used within the ten-year carryforward window.  The key to addressing this concern will be to locate opportunities to trigger income or gain of a kind which would ordinarily be taxed at standard rates in the United States but low or zero rates of UK tax—for instance, gain on the sale of a UK principal residence or gain on the sale of company shares qualifying for UK Business Asset Disposal Relief—before the 10-year carryforward window expires.

The exact scope and limitations of these transitional arrangements, along with opportunities for pre-regime change planning, should become clearer once draft legislation is published.

Under the current rules, trusts settled by non-UK domiciled (and non-deemed domiciled) individuals are capable of benefitting from 'protected' trust status.  The effect of this protection, in short, is that income and chargeable gains can roll up in the trust free from UK income tax and CGT, becoming subject to UK tax only once a distribution is made from the trust to a UK tax resident beneficiary. 

Protected trust status will, however, be swept away under the new regime.  According to the new rules, a UK tax resident settlor of a trust who is no longer capable of electing to be taxed under the new FIG regime will be taxed on the trust's income and gains on an arising basis.  These rules will apply to trusts in which the settlor retains an interest, which includes the ability to benefit themselves, their spouse/civil partner and minor children for UK income tax purposes, and the settlor, settlor's spouse/civil partner, children and grandchildren for UK CGT purposes.

Historic FIG which arose in the trust or its underlying structure before 6 April 2025 will be taxed in line with the current rules, i.e. only when UK tax resident beneficiaries receive a distribution (albeit that UK resident non-domiciled individuals will no longer be able to shelter distributions using the remittance basis).

For those taxpayers who elect to be taxed under the FIG regime, distributions from offshore trusts will not be subject to UK tax, regardless of where the taxpayer receives them. A modified 'onward gift rule' will, however, apply to prevent individuals who are not subject to UK taxation receiving a distribution from offshore trusts and then passing the benefit on to others who would have been subject to UK tax on the distribution had they received it directly.

Most US citizens will be relatively sanguine about the changes to the protected trust regime.  In the typical case, a trust that has UK protected trust status will be treated as a so-called 'grantor trust' for US tax purposes to the extent the trust has a living US citizen settlor.  The settlor of a grantor trust is required to include all of the trust's income and gain items on his own personal US tax return, as if the trust did not exist.    As a result of this dynamic, US citizen trust settlors will typically take steps to ensure that any trust they establish while resident in the UK does not qualify for UK protected trust status, thereby causing the trust's income to be taxed to them from a UK perspective on a flow-through basis as it arises at trust level.  This approach blunts the potential for cross-border mismatches or other source of leakage and makes it easier to harmonize the settlor's cross-border foreign tax credit position.

Unfortunately, the proposals in relation to UK IHT are not particularly detailed as there is due to be a consultation later this year to consider how the new regime might operate in practice.  Very broadly, from 6 April 2025, an individual who has been resident in the UK for more than 10 years will be subject to UK IHT on worldwide assets if a charge arises whilst that individual is UK resident or during 10 years after that individual ceases to be UK tax resident.  As a result, there will be a grace period of 10 years for incoming residents.  For those leaving (after 10 years of residence), there would be a 10-year UK IHT 'tail'.  

The Conservative Government has said that the current UK IHT treatment of non-UK assets held in a settlement created and funded by a non-UK domiciled individual prior to 6 April 2025 will continue to apply so that those assets will remain outside the charge to UK IHT (subject to certain anti-avoidance rules).  If so, for individuals who intend to come to the UK or are UK resident but not UK domiciled or deemed domiciled, it may still be advantageous for UK IHT purposes to create and fund an 'excluded property trust' to hold non-UK assets prior to 6 April 2025. However, it is not completely clear how new settlements created after 5 April 2025 will be treated.  Any excluded property trust planning prior to 6 April 2025 would need to be completed in the knowledge that the Labour Party has announced that it plans to prevent non-domiciled individuals from sheltering their offshore assets from UK IHT in this manner.  Details of what Labour actually propose remain unclear, but the limited comments carried by the press do point towards the potential for excluded property trusts (whenever settled) to come under attack, which will be a point of great sensitivity for many UK long-stayers, regardless of citizenship.  We could see the inclusion of trust assets in the estate of the settlor and/or the usual IHT charges which apply to trusts established by UK domiciliaries, including ten yearly and exit charges.

If implemented, these proposals would have far-reaching consequences for UK resident Americans who have set up trust structures, even if they were created decades ago and even if they are unable to benefit from them.  One solution might lie in Article 5(4) of the US-UK Estate Tax Treaty (the 'Estate Tax Treaty').  According to that provision, the UK cannot impose UK IHT liability in respect of property that was settled in trust 'if at the time when the [trust] was made the settlor was domiciled in the United States and was not a national of the United Kingdom' (subject to a limited exception for certain UK situs assets).  Read literally, Article 5(4) would seem to offer protection against even the most far-reaching of Labour's proposed changes to the excluded property trust regime—in particular, by continuing to shield assets held in trust which were settled at a time when the settlor was domiciled exclusively in the United States (and also not a UK citizen at the time).   Until now, few Americans would have had any need to make an Article 5(4) claim for Estate Tax Treaty Relief, which means that the reach and scope of that provision is largely untested.

In contrast to the nuanced considerations that come into play when deciding whether to elect UK remittance basis treatment on the income and gains side, US citizens living in the UK are typically highly motivated to stay outside the scope of the worldwide UK IHT regime whenever they can.  At bottom, this is because the US lifetime exemption amount is much more generous than the corresponding 'nil rate band' that applies in the UK IHT context; a US citizen who becomes subject to worldwide UK IHT will suffer significant tax leakage on each dollar of value in his or her estate between the UK nil rate band amount and the amount of his or her remaining US exemption amount at death.

Under the existing UK IHT regime, many US citizens living in the UK will have assumed that they can reside in the country for at least fifteen years before becoming deemed domiciled and thus caught within the worldwide UK IHT net.  These individuals will need to consider their position carefully under the new rules—in particular the draconian ten-year UK IHT tail that could potentially follow these individuals even after they have left the UK.  One strategy in response might be to lean more heavily on the Estate Tax Treaty than has been customary in the past.  The Estate Tax Treaty generally provides that to the extent a US citizen is also subject to UK IHT on a worldwide basis under internal UK rules, then that individual may in certain circumstances use the Estate Tax Treaty to tie-break away from the UK IHT system, effectively taking the position that the United States should have exclusive estate taxing rights over his or her worldwide estate (aside from a narrow class of UK-situs assets, including UK real estate and UK business assets).   

Importantly, an individual who is a US citizen and also a UK citizen cannot claim relief in this way under the Estate Tax Treaty, which may raise the stakes for a US citizen who is presented with the opportunity to gain dual US-UK citizenship.   It is also worth noting that the Estate Tax Treaty rests on the fundamental premise that UK IHT liability hinges largely on the basis of the decedent's 'domicile'; to the extent the new legislation dispenses entirely with the domicile concept, that may call into question whether the UK government will give full effect to these aspects of the Estate Tax Treaty going forward.

Action required

It seems that the only constant here is change. Although uncertainty surrounding the outcome of the upcoming election in the UK and lack of draft legislation would tend to favour delaying taking tax planning steps, taxpayers will face very little time to modify or implement new structures in advance of the new rules taking effect. US persons with UK connections should review their wealth holding structures and consider what planning opportunities should be seized prior to 6 April 2025. The months leading up to the end of the UK tax year will undoubtedly be a very busy period, so it is important that conversations are started now and as much preparatory work completed as possible.

Withers LLP has a large team of US-qualified tax lawyers based in London and across our offices in the United States, Europe, and Asia.  The US team works closely with the firm's UK solicitors to provide seamless cross-border advice as well as innovative US/UK tax structuring solutions to individuals, their businesses, and their families.  We are therefore uniquely well placed to help address any queries you may have in this area.

This document (and any information accessed through links in this document) is provided for information purposes only and does not constitute legal advice. Professional legal advice should be obtained before taking or refraining from any action as a result of the contents of this document.


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