Scope of Inheritance Tax for non-Domicile UK asset holders

From 6th April 2017, an individual is deemed to be domiciled in the UK (even though they may continue to have a non-UK domicile under general law) if they have been UK resident for at least 15 out of the past 20 tax years.

Where an individual is UK domiciled or deemed domiciled at the date of the taxable event, his global assets are within the charge to inheritance tax, subject to any specific reliefs or exemptions.

Individuals who are neither domiciled nor deemed domiciled in the UK are only liable to inheritance tax in respect of their UK assets. Their non-UK assets are ‘excluded property’ and outside the scope of IHT.

From 6 April 2017, the shares of an overseas company holding UK residential property are regarded as UK assets for IHT purposes. At present, there is no charge to IHT on shares in overseas companies owning UK commercial property.

The domicile or residence status of the beneficiary is not relevant for UK inheritance tax purposes.

Rate of Tax

Every individual has a Nil Rate Band (currently £325,000) to offset against his chargeable assets.

From 6 April 2017, an additional Residential Nil Rate Band may be available if the deceased’s main residence (or equivalent value if it has been sold) is included in their chargeable estate and is left to one or more direct descendants.

The Residential Nil Rate Band increases each year up to a maximum of £175,000 in 2020/21 but gradually tapers away where the chargeable estate is worth more than £2 million.

Inheritance Tax Amount

The IHT rate is 40% above the nil rate band applicable to your estate.

Spouses and civil partners

Assets passing to a spouse or civil partner are generally exempt from UK IHT without limit. However, there is one exception to this rule, and that is where assets pass from a UK domiciled spouse to a non-UK domiciled spouse. In this instance, the spouse exemption is limited to £325,000.

If some or all of an individual’s nil rate band is unused on his or her death, the proportion of the deceased’s unused nil rate band (including any unused residential nil rate band) can be transferred to the surviving spouse.

For example, if none of the nil rate band is used (because, for example, the deceased’s assets pass to the surviving spouse who is exempt, the surviving spouse will have double the nil rate band on their death (i.e. £650,000, based on current rates), plus potentially double the residential nil rate band, if available.

Election for non-domiciled spouse to be treated as UK domiciled

A non-domiciled spouse or civil partner can, at any time, make an election to be treated as UK domiciled for the purposes of inheritance tax. This may be a favourable option for a mixed domicile couple where the UK domiciled spouse passes away first. In this case, if an election is made by the non-domiciled surviving spouse to be treated as UK domiciled for IHT purposes, any assets received by that spouse will be exempt from inheritance tax.

If the election were not made by the surviving spouse, only assets up to a value of £325,000 would be exempt.

Therefore, by making the election, inheritance tax can be deferred to the second death.

The potential drawback to making the election is that the worldwide assets of the surviving spouse would then be brought within the charge to inheritance tax, as for any other UK domiciled individual.

Nevertheless, the election automatically lapses once the electing spouse has been non-UK resident for four successive tax years, at which point they regain their non-UK domicile status for IHT purposes. In this instance, their non-UK assets (including those inherited from the UK domiciled spouse) will fall outside the scope of UK inheritance tax altogether, allowing potentially significant IHT savings to be achieved.

This type of planning can be particularly useful where a mixed domicile couple is resident overseas, or where the electing spouse returns to their home country (or elsewhere) following the death of their UK domiciled spouse.

Offshore Trusts

Non-UK assets settled into an offshore trust by a non-domiciled individual before they become deemed domiciled are ‘excluded property’ and are outside the charge to UK inheritance tax (provided there is no underlying UK residential property).

The assets of the trust will continue to enjoy excluded property status even after the settlor has become deemed domiciled in the UK as a result of having been UK resident for 15 out of the last 20 tax years.

Trusts settled by non-UK domiciled individuals can also benefit from significant income tax and capital gains tax advantages.

UK residential property interests

It was common planning for non-domiciled individuals to hold UK real estate through an offshore company (which may, in turn, have been held by offshore trustees) in order to avoid a charge to IHT on the real estate. The overseas shares were non-UK assets, and therefore excluded property, in the hands of the non-domiciled individual or trustees (if held through a trust structure). There was no look-through to the underlying UK real estate.

However, changes to the legislation, which became effective from 6 April 2017, now bring all UK residential property within the scope of UK IHT, as well as certain loans used to purchase UK residential property. A property under construction or being adapted for residential use is treated as residential property for these purposes.

Two Year Tail

In circumstances where the shares of a non-UK company or an interest in an overseas partnership that holds UK residential property are sold, the sale proceeds remain within the scope of inheritance tax for the following two years.

In addition, where a loan is taken out to invest in UK residential property, or assets are used as security for such a loan, and the loan is repaid or the security/guarantee released, the consideration received (or any asset purchased with that consideration) will continue to be subject to IHT for a two year period following the loan repayment or release of security.

Double Tax Treaties

Where the terms of a tax treaty provide for exemption from UK IHT in relation to a UK residential property interest, the UK legislation will override the terms of the tax treaty unless a liability to inheritance tax or an equivalent tax (however small an amount) arises in the other jurisdiction.

Summary

Non-UK domiciled individuals benefit from significant planning opportunities to minimise or avoid liability to UK inheritance tax.

In particular, non-UK assets can be sheltered from inheritance tax by settling those assets into an offshore trust before acquiring deemed domicile status in the UK.

The protection from inheritance tax can continue even after the settlor has become deemed domiciled, allowing the assets to be passed down to future generations free of UK inheritance tax.