Tax truths behind the Dragons’ Den domicile row

Tuesday, May 18, 2010 | Posted by: Sue Knight
Categories: Protecting your wealth | Tags: tax, entrepreneurs, tax planning, investment, offshore, Sue Knight, IHT, James Caan, domicile, non-dom, Cayman Islands, non-domicile, Inheritance Tax, Duncan Bannatyne, Pakistan, earnings, Dragons’ Den

The reported rift between the Dragons’ Den entrepreneurs James Caan and Duncan Bannatyne centres around Caan’s domicile status for UK tax purposes. Here we review non UK domicile (non-dom) tax planning and explain why Bannatyne thinks this gives Caan an unfair advantage…

In March the BBC reported that Duncan Bannatyne said he thought it was ‘unfair’ that, as a non-dom, Caan did not pay tax in the UK on money he earned overseas.

He believes that this provides a competitive advantage to non-dom investors over UK-domiciled investors like himself.

So, what is domicile and why is it advantageous to be a non-dom for tax purposes?

Most countries tax individuals on the basis of residency but the UK also brings into account a concept known as domicile.

Domicile is distinct from residency and is essentially concerned with where an individual feels they belong and where they have their roots. 

If an individual was born in, or their father was born in, another country, then they may well be non-UK domiciled for UK tax purposes, providing they do not intend to stay permanently or indefinitely in the UK.

If a non-dom has been resident in the UK for seven out of the past 10 years, then they can pay a £30,000 levy in order to avoid UK tax on their overseas income and gains until such time as they bring the funds into the UK. This is known as opting for the remittance basis and as long as the funds are left outside of the UK no further UK income/capital gain tax charges will arise.

In all likelihood, there is probably no reason to bring overseas income/gains into the UK as normally, day-to-day living costs in the UK are usually paid for out of taxed UK earnings. If they want to bring funds to the UK to invest, then this can be structured through an appropriate offshore vehicle to avoid remitting any overseas income or gains to the UK.

This is what arguably provides a competitive advantage to non-doms as they can structure their affairs to effectively invest 100% of their overseas income/gains into the UK, whereas UK doms can only invest whatever is left after paying UK taxes on worldwide income.

Similarly if companies are involved, UK companies can only invest around 72% of their profits, having suffered up to 28% UK corporation tax. Companies managed and controlled overseas may not pay any UK taxes, depending on their activities, so they can invest 100% of their profits. Usually, overseas companies pay tax in the country in which management and control is undertaken, but many non-doms operate through tax havens such as the Cayman Islands which impose little, or no, corporation tax. 

There is also the possibility of passing on funds that are free of inheritance tax (IHT).

The rules differ for UK IHT in that there is an additional concept of ‘deemed domicile’, which broadly applies if an individual has been resident in the UK for at least 17 of the past 20 tax years.

Therefore, even if the individual is non-UK domiciled under general rules – which provide income tax and capital gains tax advantages – they will be deemed domiciled in the UK for the purposes of IHT and this brings their worldwide assets into the UK IHT net in the event of their death.

That said, non-doms from India, Pakistan, France and Italy might be able to structure their affairs to rely on an Estate Agreement as this ‘deemed domicile’ rule does not apply to these particular tax treaties.

With careful planning, non-doms from these four countries could avoid UK IHT on their overseas assets and possibly look to convert UK assets into overseas assets, thereby avoiding UK IHT on the majority of their wealth.

This amounts to sensible planning for non-dom individuals, who are able to take advantage of the current tax rules to structure their affairs to significantly reduce their overall UK tax bill.

That said, the Liberal Democrats want to limit such tax advantages where non-doms have resided in the UK for more than seven years. After seven years, they will be fully taxed as UK domiciled individuals.  It remains to be seen whether they will be able to influence the new coalition government on this particular issue.

Image: James Caan © Andy Fitzsimons; Duncan Bannatyne © The Rambling Man/FelixstoweTV.co.uk

Read more stories on recent domicile issues and UK residency status changes.

Read more posts by Sue Knight.