Kevin Loundes, senior tax manager at Abacus, explains the differences between residency and domicile for U.K. citizens.
Many people confuse tax residence and domicile. In particular, it is common for individuals to assume that because they have ceased to be tax resident in the U.K., it must follow that they have also ceased to be U.K. domiciled. But is this necessarily the case? In short, the answer is definitely no.
What is domicile?
Domicile is a common law concept rather than a matter of tax law. In simple terms, a person is normally domiciled in the country that he/she regards as his/her “home.” This is not necessarily the country where they are currently living temporarily. It is perfectly possible, therefore, for a person to emigrate to the Cayman Islands, live there for many years, but still retain a U.K. domicile. The key point to note is that domicile and residence are not interchangeable concepts.
At any one point in time, an individual has one country of domicile. While it is possible to be tax resident in more than one country, you can only be domiciled in one country at a time. When determining an individual’s domicile position, there are three concepts that need to be considered:
Domicile of origin
Domicile of dependence
Domicile of choice.
I do not propose covering each of these concepts in detail, as the analysis would be too lengthy for the purposes of this article. Nevertheless, a brief summary of each follows:
Domicile of origin
Everyone is born with a domicile, your domicile of origin. This is normally your father’s domicile at the time you were born (note, this is not necessarily the country you were born in). A domicile of origin can be displaced. However, it never goes away.
Domicile of dependence
The domicile position of a “dependent person” (e.g., a minor/child or mentally disabled person) will normally follow that of the person on whom they are dependent. Typically, this will be the father of the child. If a father changes his domicile position, any minor children will adopt his new domicile.
Domicile of choice
Once an individual has reached the age of 16, he/she is entitled to obtain a domicile of choice. In order to displace an existing domicile (e.g., a domicile of origin) with a new domicile of choice, an individual is required to move to another jurisdiction with an intention to remain there permanently or indefinitely. On the face of it, obtaining a new domicile sounds relatively simple. However, it is notoriously difficult to acquire, and two key factors are required:
The intention to reside in the new country (e.g., the Cayman Islands)
Living in the new country as an inhabitant.
The key point is the individual’s intention. Have they formed an intention to remain in the new country permanently or indefinitely? If the answer to this is no, they have not adopted a new domicile of choice.
So how does this apply to the person who has relocated to the Cayman Islands?
Let us consider a typical scenario. An individual is born with a U.K. domicile of origin and later in life decides to relocate to the Cayman Islands, perhaps for work purposes. If the individual in question remains in the Cayman Islands for many years, at what point, if at all, do they cease to be U.K. domiciled? As noted above, the key is their intention. If the individual is only in the Cayman Islands for work purposes and they plan to return to the U.K. upon retirement, their U.K. domicile of origin will remain (even if they spent their entire working career in the Cayman Islands!) If, however, at some point they decided they wanted to stay in the Cayman Islands permanently and never return to live in the U.K., they will displace their U.K. domicile of origin with a new domicile of choice in the Cayman Islands.
It is important to note that significant evidence is required. Proving an intention to reside in the Cayman Islands (or any other country, for that matter) permanently or indefinitely is notoriously difficult. Simply buying a burial plot and drafting a will under Cayman Islands law will not be sufficient. Also, an individual simply stating his/her intention to remain in the Cayman Islands permanently will not be sufficient if it is not supported by significant evidence.
What is the significance of domicile?
The reason domicile is a key U.K. tax concept is that it determines an individual’s liability to U.K. inheritance tax. If an individual is U.K. domiciled, all of his/her worldwide assets are within the scope of U.K. inheritance tax upon death (and since the rate of tax payable is 40 percent, this can be a significant cost). Also, if an individual is U.K. domiciled, there can be inheritance tax costs as a result of undertaking estate planning measures, such as establishing an offshore trust to benefit future generations.
It is crucial, therefore, for an individual to consider their domicile position carefully and obtain appropriate tax advice. Tax advice on an individual’s domicile position should be obtained as a matter of course when considering how assets will be passed on to future generations or if establishing an offshore trust is being considered.
What is the benefit of ceasing to be U.K. domiciled?
If an individual is able to displace a U.K. domicile with a domicile of choice in the Cayman Islands, then this can result in significant inheritance tax savings. Any non-U.K. situated assets would be outside the scope of U.K. inheritance tax (i.e. U.K. inheritance tax at a rate of 40 percent would not be payable in relation to these assets). Furthermore, an individual who is not domiciled in the U.K. can establish an offshore trust if they wish without there being any U.K. inheritance tax consequences, provided they settle non-U.K. assets (tax advice should be sought to ensure there is no U.K. tax leakage). This should mean that assets can be passed down to future generations without the U.K. government taking a 40 percent cut first.
Other points to note
There are a couple of other key points which should be borne in mind. First of all, the U.K.. has rules which deem an individual to be U.K. domiciled. For example, if an individual were to displace their U.K. domicile with a new domicile in the Cayman Islands, they would continue to be deemed U.K. domiciled for a further three years. If the individual were to die within this three-year period, their entire estate would continue to be subject to U.K. inheritance tax.
The second common misunderstanding to note is that the burden of proof falls on the taxpayer or the executor of their estate. If Her Majesty’s Revenue and Customs challenges an individual’s claim to be non-U.K. domiciled, it is up to the individual (or the executor of their estate) to prove they are non-U.K. domiciled. HMRC is not required to prove the individual’s domicile of origin remains in place.
It is, therefore, crucial that significant evidence to support the individual’s non-U.K. domicile status is collated. Having a pre-prepared package of evidence to support a claim to be non-U.K. domiciled is especially important from the perspective of the executors of an estate. After all, proving the intention of the deceased is extremely difficult if they are no longer alive to speak to!
Hopefully what is clear is that an individual’s domicile position is crucial to establishing liability to U.K. inheritance tax. Furthermore, should an individual want to evidence that they have adopted a new domicile of choice (displacing their U.K. domicile of origin), perhaps in the Cayman Islands, significant evidence will be required. That said, adopting a domicile of choice in the Cayman Islands is possible and in the right circumstances can result in significant U.K. tax savings.