Update United Kingdom (UK): Contemplated changes to the ‘non dom’ regime

In the UK’s Spring Budget on 6 March 2024, the Chancellor of the Exchequer of the current Conservative government, Jeremy Hunt, proposed a new tax system  that would include the abolition of tax subject to the remittance basis for individuals resident in the UK.

It comes somewhat unexpected from Hunt, in his last Budget before the next General Election. By reforming the remittance basis, after more than 200 years, the Tories are raising eyebrows. If implemented, it would have a significant impact on taxpayers resident in the UK, and those who wish to move to and from the UK in the future.

Current legal situation in the UK

Claiming the remittance basis,” as HMRC puts it, is currently possible in the UK even if the taxpayer is resident in the UK, i.e. present for more than 183 days in the tax year. However, this is only the case if a taxpayer’s domicile is outside the UK.

To be classed as a non-domiciled resident, one must be a individual with no previous points of contact with the UK. This individualcan indeed be resident in the UK but do not have a UK domicile, while being resident in the UK for less than 15 years in the last 20 years (pure duration of residence). Anyone who has been resident in the UK for less than seven years in the last nine years can apply to be taxed using the remittance base without having to pay a fee. Anyone who has been resident in the UK for more than seven years but less than 15 years can apply to be taxed using the remittance base for a fee, the remittance-base charge.

This way it is possible for foreign income and profits not imported into the UK to not be subject to UK tax. As a result, the taxpayer’s worldwide income is not taken into account, even if he or she is resident in the UK.

UK inheritance tax provides for similar favours for individuals resident in the UK who are classified as having non-UK domicile. As long as the above requirements for being classified as having a non-UK domicile are met in the event of the death of a individual living in the UK, only assets located in the UK are subject to inheritance tax; foreign assets, such as an interest in a foreign corporation or partnership, are not recognised as part of the estate. This has the effect that a individual resident in the UK might not be subject to UK inheritance tax on their entire worldwide assets in the event of their death.

New legal situation in the UK

By abolishing the non-dom regime, the Tory government has said that the only connecting factor for taxation in the UK will be a individuals residency.

In the first four years of tax residency in the UK, 100% tax relief is to be granted for foreign income and profits within the framework of income tax. The tax relief is claimed at no charge in the UK tax return, In addition, the relief is also granted if foreign income and profits are transferred to the UK. In contrast to the system of remittance basis taxation, the new regulation is intended to encourage taxpayers to spend and invest assets in the UK. This tax relief is granted to anyone who has not been resident in the UK for 10 years. For those who already live in the UK, they can benefit from tax relief until the end of their fourth year of residency in the country. Anyone resident in the UK for more than four years will then be taxed on their worldwide income.

As such, the inheritance tax system will also no longer be based on a individuals domicile, but on their residency only.

What does this mean for German taxation?

If the announced new regulation comes into effect in April 2025, the following income tax consequences are to be expected:

The (treaty) residency of individuals in the UK will in future lead to the realisation of profits in accordance with Sec. 4(1) sentences 3 and 4 of the German Income Tax Act (Einkommensteuergesetz – EStG) with regard to shareholdings held via (only) commercially structured GmbH & Co. KGs. Without the remittance basis rule and the treaty benefits under Art. 24 of the double taxation treaty between Germany and the UK (“DTT-UK”), it can no longer be ensured that the German right of taxation in respect of hidden reserves is not excluded or limited by taxation in the UK.

In addition, exit taxation pursuant to Sec. 6(1) sentence 1 no. 3 of the German Foreign Tax Act (Außensteuergesetz – AStG) is triggered in the case of residency in the UK and dual residence cases with regard to shareholdings in corporations within the meaning of Sec. 17(1) sentence 1 EStG. This is because without the remittance basis rule and treaty benefits pursuant to Art. 24 DTT-UK, it can be no longer ensured that the German right to tax the profit from the sale of the shares is not excluded or restricted.

From April 2025 - envisaged transitional arrangements

The Tories’ proposed changes come after years of calls to abolish the non-dom regime by the Labour party, in opposition since May 2010. It is a special feature of the British tax system that income and corporate income tax is decided annually, maintaining the state’s authority to levy it. Other taxes, such as inheritance tax, do not necessarily have to be decided or amended in the annual budget.  The proposal in Hunt’s budget will now be discussed in Parliament; if approved, it will be passed in the usual legislative process.

The new system would then come into effect in April 2025. In the UK, the tax assessment period for individuals runs from 6 April to 5 April of the following year.

The following transitional arrangements for non-UK domiciled individuals have been announced:

1. Taxpayers who are taxed subject to the remittance basis and have been resident in the UK for less than four years will be able to take advantage of 100% tax relief on foreign income and gains from April 2025 until the end of their four-year residency.
2. Taxpayers who currently benefit from being taxed subject to the remittance basis due to being classed as non-UK domiciled and have been resident in the UK for more than four years can benefit from 50% tax relief on foreign income (not capital gains) in the 2025/26 assessment period. Capital gains from capital assets previously subject to being taxed subject to the remittance basis can be taxed in the 2025/26 assessment period as of 5 April 2019 (instead of the actual acquisition date). In the tax years 2025/26 and 2026/27, foreign income and gains arising during the remittance basis taxation can be transferred to the UK at a tax rate of 12% (this does not apply to income from trusts).
3. From the 2027/28 assessment period, individualswill be taxed uniformly according to the new system.

Conclusion and outlook

The UK government’s proposal to abolish tax subject to the remittance basis is to be discussed in Parliament. Changes to income tax still have to be approved. As things currently stand, it can be assumed that proposed changes to the taxation of individualsin the UK will take effect from April 2025. After 100% tax relief is granted on foreign income and profits for the first four years of residency, all income and profits (worldwide income) will subsequently be taxed in the UK. With the abolition of the non-dom regime, the inheritance tax system is also to be reformed.