Long-term Cayman residents who started their lives in the U.K. may think that they long since waved goodbye to the U.K. taxman, HM Revenue and Customs (HMRC). Unfortunately, in many cases they will be wrong. 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 U.K. inheritance tax. This crucial point is overlooked by a large number of people each year, with significant financial consequences.
As at Sept. 30, 2016, there were 24,077 foreign workers residing and working in the Cayman Islands. Of this group of work permit holders, some 8.1 percent are identified as British, which amounts to 1,957 British work-permit holders.
The above figure does not include permanent residents. Figures are not available on the number of British citizens with permanent residence rights in Cayman but the figure is likely to be as high as 10 percent of the Cayman population, or around 5,800 people. This is a significant group. Coupled with the facts that Cayman wages are relatively high and that there are no direct taxes in the Cayman Islands, 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. The asset-protection benefits of trusts are even more compelling given that many of the professional services firms in Cayman continue to operate as traditional general partnerships, without the benefit of limited liability protection for their partners.
So, how does this relate to U.K. 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 U.K. 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 percent 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 U.K. 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 U.K. 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 U.K.
Inheritance tax also applies to all transfers of assets, regardless of where they are legally situated, where the person making that transfer is U.K. 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 Cayman Islands for the last 20 years takes £2 million from their Cayman Islands bank account and puts it into a Cayman Islands law governed trust, that transfer triggers an immediate charge to inheritance tax (of, in most cases, £670,000) if that person retains their U.K. “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 U.K.?
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).
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 are 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 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 U.K. 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 U.K. but of positively and actively forming an intention to permanently remain in the new place.
English law requires that the person asserting that their domicile has changed is responsible for proving it. In this context, this usually means that the person who moved from the U.K. to Cayman needs to prove that they have changed their domicile. 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 Cayman example, a young professional couple moves from London, England to the Cayman Islands, to take up positions in the financial services industry. Initially they plan to spend two or three years in Cayman. Their plans change and they decide that their future lies in Cayman and they want to start putting down roots. They buy a house and start a family. Their children are raised and educated in Cayman.
During the initial period, the couple lacks the necessary intention to abandon the U.K. and to acquire Cayman as their domicile of choice. They will remain U.K. domiciled during this period. After the initial period, and depending how they conduct themselves and the connections that they have with each of Cayman and the U.K., it is possible that they will be able to acquire a domicile of choice in Cayman, to displace their domicile of origin.
If the couple later changes their mind and moves to another country, say the U.S. (although this applies wherever they move, provided it is not back to the U.K.) then at that point it is likely that they will lose their domicile of choice in Cayman and either their U.K. domicile of origin revives or they acquire a domicile of choice in the U.S. state to which they have moved. This requires a further examination of the intentions of each of the couple and how this is supported by what they actually do.
Where does this leave a long-term non-resident?
HMRC do 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 they believe that the person making the transfer was U.K. 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 Cayman Islands, 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 U.K. 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 U.K. 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.
Governments throughout the world are looking for ways to increase the tax that they collect. Collecting inheritance tax from non-residents, especially wealthy ones, is often a fairly easy way to achieve that goal (especially if those non-residents no longer vote in U.K. elections). By placing the burden of proving a change of domicile onto the tax payer, the tax man merely has to identify an individual and ask them to prove that they have changed their domicile. If that question is raised after the individual has set up one or more lifetime trusts, there is an immediate question of Inheritance Tax hanging on the outcome.
As with much in life, proper planning is essential to put the client in a position of being able to defend against such a challenge and to successfully assert a change of domicile.