Transatlantic shockwaves herald sea change in UK tax treatment of US-connected individuals

Since the previous (Conservative) UK government made its shock Budget announcements on 6 March 2024, much has been made about how this would affect the circa 37,000 people living in the UK who are taxed on the remittance basis. 

Now, the new (Labour) UK Government has announced, at its first Budget on 30 October 2024, what changes it will be bringing in, and has published detailed guidance and draft legislation. 

In this note, we focus on the impact of the changes for our US-connected clients and outline a few risk areas to keep under review. 

To summarise the changes, to take effect from 6 April 2025:

• A new four-year special tax regime will be introduced, under which qualifying individuals will be exempt from tax on their foreign income and gains for their first four years of UK residence, regardless of whether such income and gains are remitted to the UK.  After this four-year period is over, all income and gains (including those realised within non-UK trusts and other entities) will be taxable in the UK.
• Domicile will no longer be a connecting factor for inheritance tax (IHT). Instead, the degree of an individual’s exposure to IHT will be determined by whether the individual qualifies as a “long-term resident” (or LTR). Under the new regime, LTRs will be exposed to IHT with respect to all assets, whereas non-LTRs will generally be exposed to IHT with respect to UK situated assets only. By default, an individual will qualify as an LTR under the new regime if they have been UK resident for at least ten of the previous twenty UK tax years.
• There will be a significant “tail” of IHT exposure when an LTR ceases to be UK resident – it may take many years for the individual to shake off LTR status, after leaving the UK. In many cases the “tail” will be ten tax years. However, the tail will be shorter for those who, prior to leaving the UK, have been resident for fewer than twenty tax years. Those UK resident for between 10 and 13 years will have LTR status for 3 tax years from the date of departure from the UK. This will then increase by one tax year for each additional year of residence. So, if a person was resident for 15 out of 20 tax years on leaving, they would remain subject to full IHT exposure for 5 years.

Long-term residence: the new connecting factor for IHT 

Turning first to how these proposed new rules will affect clients originally from the UK, who have moved to the US: one of the issues that many of these people have commonly faced is understanding their ongoing relationship with IHT. As IHT is currently connected to domicile, an individual will first need to be certain that they have lost their domicile in some part of the UK before they can be sure that their worldwide estate does not continue to be exposed to IHT. Over the years, this has become trickier as HMRC has been increasingly willing to challenge individuals over their domicile.  

IHT applies both on death and when assets are moved into trust. This latter point is particularly relevant to those in the US, where it is common to plan with trusts. For expats, the tax risks of creating any of these common US-focused trusts can be intolerable under the current regime. With the new IHT “tail” rule noted above, it will be easier for those leaving the UK to plan with certainty. 

In fact, some people moving to the US may have an additional advantage over most. One of the key criticisms of the new IHT “tail” rule is that the length, at a maximum of 10 years, is too long. For those who can take advantage specifically of the US/UK estate tax treaty (the “Treaty”), it may be possible to shorten this tail. If certain conditions are met, they may be able immediately to limit their IHT exposure to their UK real estate and business property only, and there will be no tail of IHT on all other assets. As one of the relevant conditions includes not being a UK citizen, this will only work for some people. But for US citizens moving back to the US, this could be a particularly helpful provision. Notably, under the newly published draft legislation it appears that the concepts of common law domicile and deemed domicile will continue to apply (and not the LTR concept) when deciding where an individual is domiciled for the purposes of the Treaty.

The IHT treatment of trusts 

US taxpayers may be familiar with the idea that the generous estate and gift tax credit amount (currently $13.61m, increasing to $13.99m in 2025, at Federal level) is due to halve in 2026. Estate planners have been encouraging US taxpayers who will be affected by this reduction to make gifts into trust before the end of 2025. 

However, any such US taxpayers who are also connected to the UK will need to take care.  If the settlor is LTR at certain crucial points in the lifetime of any such trusts, this can trigger IHT charges. The most relevant occasions of charge, in broad terms, after the rules change from 6 April 2025 are likely to be:

• When assets are settled on trust: a charge at up to an effective rate of 25% if the settlor is LTR at that point. This might be relevant, for example, where someone has moved from the UK to the US and carried out relatively basic estate planning, without taking appropriate UK advice.
• 10-year anniversaries and distributions from the trust: a charge of up to 6%, depending on the circumstances, if the settlor is LTR at these points (even if the settlor is excluded from benefitting from the trust). In addition, if the settlor is LTR on their death, the trust’s exposure to IHT becomes fixed on the settlor’s death and these charges will continue to apply for the lifetime of the trust.
  
  These types of anniversary and exit taxes are peculiar to the UK tax system, with no US equivalent. Therefore, if they do apply, they cannot be credited against any other US transfer taxes such as GST or estate tax. 
• On the settlor ceasing to be LTR (at the end of the “tail”): a charge of up to 6%, depending on the length of time since the last ten-year anniversary.
  Again, as there is no US equivalent of this tax, they cannot be credited against any other taxes due.
• On the settlor’s death, if they have reserved a benefit in the trust: a 40% charge. This is because, broadly, where the settlor retains a benefit in settled property at the date of death, the settlement assets at death are deemed to be part of the settlor’s estate for IHT purposes. The meaning of retaining a benefit for the purposes of these rules is complex and broadly defined but will capture trusts where the settlor is a beneficiary, including almost all grantor trusts.
  
  Notably, however, certain trusts are exempt from this rule: those funded before 30 October 2024 with non-UK assets which under existing rules are exempt from IHT. Given how valuable this exemption may prove, US persons should take particular care to preserve the IHT benefits of any such trusts and take advice before restructuring such trusts in case those benefits are inadvertently lost.
• When certain types of “life interest” trusts terminate: 40% charge, if the settlor or the income beneficiary are LTR at the relevant time. Again, there is an exemption for certain types of “life interest” trusts where those trusts had IHT-exempt status before 30 October 2024. Given the nature of many grantor or marital trusts, this rule should be treated with extreme care.

Once again, the Treaty might assist here: for those who are domiciled in the US under the terms of the US/UK estate treaty, and not a UK national, it may be possible for many assets (other than UK real estate and UK business assets) that are held in trusts created even after 6 April 2025 to be sheltered from IHT. This treaty provision is only likely to assist a limited group of people, and the application of the treaty domicile tie-breaker provisions are not always straightforward. As noted above, it appears that the concepts of common law domicile and deemed domicile will continue to apply when deciding where an individual is domiciled for the purposes of the Treaty.

So, although this treaty provision is extremely generous in the right circumstances, it should be treated with caution and particularly in light of the apparent intention of the UK Government to prevent trusts settled by LTRs being used to shelter non-UK assets from IHT. 

Impact on lifetime gifts to individuals

Consideration should be given to the timing of lifetime gifts by US taxpayers of non-UK assets; this is not only to make use of the estate and gift tax credit amount before it halves but also to ensure it is made at the time which is most favourable from an IHT perspective in the context of the new LTR rule. That is because the IHT status of such gifts will be tested as at the time of the gift. US gift planning already in the pipeline may, therefore, need to be accelerated in certain cases; for example, where an individual with fall within the LTR rule for the first time on 6 April 2025. 

Trusts and income tax 

Despite the many advantages of using trusts for planning, they have always been tricky for US taxpayers living in the UK. It is notoriously difficult to arrange for the UK and US income tax treatment of trusts to match up, with the US/UK income tax treaty providing very little assistance. Without thoughtful planning – either in how the trust is established or in how it is invested – this can result in double taxation. 

Since 2017, one option that US taxpayers living in the UK have used is to “taint” certain types of grantor trusts. If done properly, this has allowed the US and UK income tax treatment of these trusts to line up, making it easier to claim foreign tax credits, and therefore reduce the risk of double taxation.

Under the new regime, this type of planning will become even easier. During the initial four-year period, income and gains generated on non-UK assets within the trust will simply not be subject to UK tax. After the four-year period, we anticipate that the settlor will pay UK tax on all trust income and gains; and this could match up neatly with the grantor trust tax rules in the US. With suitable planning, this could mean that the US and UK income tax treatment of many types of common trusts could align. 

The timing of pre-immigration tax planning 

In fact, the proposed four-year initial special tax regime works well to “buy” time for certain types of pre-immigration tax planning opportunities that can often be missed. 

For example, a well-advised US taxpayer moving to the UK might collapse their trusts before arrival, to avoid the complicated UK anti-avoidance rules relating to trusts. In the worst case, if the trusts are not collapsed before becoming UK tax resident, these anti-avoidance rules could result in UK taxes being paid on income / gains generated within a trust many years prior to the move to the UK. 

Similarly, a US taxpayer entering the UK tax system should consider reviewing their investment strategy before moving. Many common types of investments – mutual funds, municipal bonds, as examples – can be taxed at higher rates in the UK. Presently, the only way of avoiding such higher rates of tax on any disposals after becoming UK tax resident relies on the current, complicated remittance basis regime. 

Of course, not every US taxpayer is well-advised, and these types of pre-immigration planning opportunities can be missed.  Under the proposed new regime, all will not be lost. Instead of having to complete all pre-immigration tax planning before arrival, US taxpayers can use the initial four-year period, during which non-UK income and gains are not subject to UK tax at all, to restructure many of their personal assets and holdings so that they work within the UK tax regime. 

Reviewing US entities before entering the UK

However, although certain types of investments and holdings can be restructured during the initial four years, this will not work for everything. When US citizens move to the UK, this can cause associated entities such as trusts and companies to become resident in the UK at the same time. There is no specific relief in the UK tax code for such accidentally imported entities. 

Once these entities have become UK tax resident, their profits (if companies) or income/gains (if trusts) will become subject to UK tax. Even more dramatically, if these entities subsequently leave the UK (often alongside the taxpayer, when they leave), the entities will face a mark-to-market exit tax on their assets. 

This risk theoretically exists for anyone moving to the UK from abroad, but in practice it is a particular issue for people arriving from the US, where managing a single member LLC or acting as trustee of a grantor trust is common. In the UK, the starting point for an LLC is that it will be taxed as a corporation with its own legal personality; and a grantor trust will similarly be its own taxable entity. 

Nothing in the proposed rules would change this risk for entities, including the four-year special regime. So, US taxpayers moving to the UK with these types of common entities will still need comprehensive advice before they move. 

Rebasing assets

Transitional provisions will allow previous remittance basis users to automatically rebase their long-held personal assets to their 2017 values. In doing so, taxpayers switching into the new regime will potentially eliminate a significant amount of latent capital gain. 

By contrast, assets belonging to those moving to the UK are not automatically rebased. This is likely to mean that a person moving to the UK in the future, and making a disposal of a long-held asset will pay capital gains tax on the entire gain. The automatic rebasing to 2017 values will not apply to them. This could mean that some types of traditional pre-immigration planning for US taxpayers moving to the UK, including manually rebasing assets prior to residence, will remain important. As ever, check-the-box elections are not recognised for UK tax purposes. 

Crucially, the transitional rebasing relief appears only to apply to (i) personally held assets not extended to assets held in trusts or companies) that (ii) belong to someone who has previously claimed the remittance basis for any one of the tax years running from 6 April 2017 to 5 April 2025, but (iii) was not UK domiciled or deemed UK domiciled at any time before 6 April 2025.

As noted above, it is common for US taxpayers to have transferred investments to an entity such as an LLC or a grantor trust. Even if these are tax-transparent in the US, they are unlikely to be treated as such for the purposes of the rebasing relief. Therefore, these assets will not be treated as held personally by the taxpayer.

As US taxpayers are anyway taxed in the US on their worldwide income, they do not always claim the remittance basis of taxation in the UK. It seems as if this will therefore preclude them from taking advantage of the above relief. US taxpayers who are not yet deemed UK domiciled still have the opportunity to claim the remittance basis for the UK 2023/24 or 2024/25 year – they will need to weigh up the benefits of doing so against the potential capital gains tax on any future disposals (after taking into account any US taxes that would also be payable on the disposal). 

Temporary repatriation facility (TRF) 

Where US taxpayers living in the UK are previous remittance basis users, they will be able to benefit from a relieved rate of tax when remitting untaxed foreign income and gains which arose before April 2025 to the UK. The relief will last for three UK tax years from 6 April 2025, with a 12% rate for the first two years, increasing to 15% in 2027/28. The TRF will also be available to US taxpayer settlors and beneficiaries of trusts, who are former remittance basis users. This is potentially a very valuable relief as the TRF will include certain pre-6 April 2025 foreign income and gains held within overseas structures such as non-resident companies and trusts to the extent that they are matched with benefits that they receive during the 3-year TRF period.

Deciding whether to leave the UK or stay

After the initial four-year period is over, US taxpayers will have more choices than most. 

As they will already be paying US taxes on their worldwide income (often including that generated within grantor trusts), many US taxpayers will be prepared similarly to pay UK taxes. As noted above, they will ideally have ensured that their financial strategies – including investment decisions and holding entities – are lined up in both the UK and the US. 

For others, it will make more sense to ensure that they do not remain UK tax resident. The UK statutory residence test, though complex, makes it possible to predict year on year what is needed to remain non-UK resident. And the US/UK income tax treaty will give taxpayers further opportunity to ensure that, for treaty purposes at least, they are non-UK tax resident. This could give the US exclusive taxing rights to certain types of income and capital gains, meaning that the taxpayer will not necessarily be constrained by UK tax planning. 

In fact, the US/UK income tax treaty may well remain a valuable planning tool even during the proposed initial four-year period. Even though a UK resident US taxpayer will not need to pay UK taxes, they may still benefit from the treaty (including, for example, the reduced 15% US withholding tax rate on dividends). 

For US taxpayers, the UK remains an attractive option

The impact of these proposals on US / UK individuals will be significant, although inevitably specific to their circumstances. In many cases the rules will provide planning opportunities and more certainty of tax treatment. That said, as always, it will remain vital for individuals to take specialist advice at an early stage to mitigate the risks and maximise the benefits afforded by the new tax landscape.