- Inheritance Tax Planning – Offshore Factors
These notes assume you have read our leaflet Basic Inheritance Tax Planning and/or the Quickpoints Inheritance Tax - Introduction on our website. The issues addressed here in more detail concern assets a UK person may own outside the UK, and the consequences of non-UK people owning assets in the UK.
Before looking at specific problems, and tax planning opportunities, we need to consider the concepts of “domicile” and “residence” in relation to UK tax and succession laws. Tax residence is fairly straightforward, and in simple terms is where you live for 6 months or more in a given year. As a result of UK residence you become liable to UK Income Tax and Capital Gains Tax (CGT) but not necessarily Inheritance Tax (IHT). IHT is based more on domicile which is not straightforward.
Under English law the starting point to establish domicile is the status of your own father. For example, if your father was “born and bred” in Holland, but spent much of his working life in the UK where you were brought up and still live, his and your domicile of origin would probably be Dutch as far as English law is concerned. This would continue regardless of what your father did after you became an adult – eg he retired to Spain – or where you happen to live.
Your domicile may change after you reach 16 if you make a conscious decision to abandon your domicile of origin, eg if you have settled with your family permanently in England, and never want to go back to Holland. Even if you have two passports, you can only have one domicile as far as the UK is concerned.
Te relevant IHT rules affecting non-UK domiciled individuals are significantly different to those which apply for Income Tax and CGT. If you have a non-UK domicile of origin, and this has been established for Income Tax or CGT purposes, that is a very good start as far as IHT planning is concerned, but it is not necessarily conclusive.
In addition, many people who can claim non-UK domicile do not choose to do so for Income Tax or CGT purposes, or may even be unaware that special rules apply with both advantages and disadvantages for different taxes. In other words, non-UK domicile opens up a technical minefield.
Above all, regardless of your intentions, a special rule applies for assessing IHT for people of non-UK domicile, based on residence for 17 out of the past 20 years in England & Wales, Scotland or Northern Ireland, giving rise to a “deemed domicile” in the UK.
- Deemed Domicile
The deemed domicile rule catches many long term residents in the UK whether their domicile of origin was in Australia, France, India, Kenya, the USA or anywhere else. Even if caught by the deemed domicile rule, by virtue of working and living in the UK for several decades, the “non-dom” can retire anywhere they like, and recover their domicile of origin after three years residence outside the UK, as far as IHT is concerned.
Equally, the 17-year timescale before deemed domicile applies, gives a long period to develop and implement IHT planning strategies to protect family assets.
- The IHT Consequences of UK and Non-UK Domicile
For the UK domiciled (or deemed domiciled) individual the IHT rules are simple – on your death, wherever you have been living or die, your worldwide assets are subject to IHT. The same applies to any lifetime gifts you make – the “7 year rule” for absolute gifts, and 20% tax on lifetime gifts into a Trust on any vale in excess of the “nil rate band”. Of course exemptions may apply, such as gifts between spouses / civil partners, or gifts out of surplus income.
For the individual who is neither domiciled nor deemed domiciled in the UK, IHT will only apply to assets physically situated in the UK on death, and to lifetime gifts made out of such assets. The simple rule for a non-UK domiciled individual wishing to avoid IHT is to keep assets outside the UK - for example, in a bank account or investments registered in Jersey.
That does not help with a house or any moveable property in the UK unless, perhaps, ownership is transferred to a foreign company or trust. However, such “offshore structures” have long since been subjected to anti-tax avoidance rules which are difficult to escape.
- The Limited Spouse Exemption
Given that basic IHT rules provide exemption for the transfer of assets between spouses, it might be thought simple for an English spouse to transfer assets to a foreign spouse who could rapidly move them outside the country. Of course, that was anticipated by the tax authorities, and there is a limit on the “spouse exemption” of £55,000 when assets are transferred from a UK spouse to a foreign spouse. The exemption is not limited on reverse transfers where the foreign spouse transfers assets to the English spouse, as that brings them into the IHT net.
- IHT Planning for Mixed Domicile Couples
There is no simple or standard solution to IHT planning for couples (married or in civil partnership) where one has a UK domicile and the other an overseas domicile. Conventional UK Wills pass assets from one UK spouse to the other on the first death tax free. They then pass to the children following the second death with full IHT payable.
With a mixed domicile couple, if the UK spouse is the first to die, IHT becomes payable on the first death subject to the nil rate band of £325,000 plus the £55,000 exemption. If the non-UK spouse is the first to die, there is not a problem as the full spouse exemption applies.
In fact, rather than relying on Wills to achieve IHT deferral, or even avoidance, longer term strategies may be the answer.
If the UK spouse makes a lifetime gift to the non-UK spouse, this will be a “PET” (potentially exempt transfer). If the donor survives for seven years, the gift will fall out of account. The non-UK spouse could then transfer assets abroad to protect them provided he/she had not by then fallen foul of the 17/20 year deemed domiciled rule.
- Assets situated Abroad
Whether you are domiciled in the UK or elsewhere, assets which you own personally in other countries such as a holiday home in France or Spain, will be vulnerable to local taxation on your death according to local rules.
The basic rule is that local law applies in priority to the law of your home state, although that can be varied by “double tax treaties” between countries agreeing which state will take priority in collecting different taxes. The rules for Income Tax and CGT may be quite different to those applying for IHT or similar “succession taxes” in other countries.
By way of example, a property in France will be subject to local “forced heirship” rules. These will require a proportion of your house to pass on death to your children in priority to your spouse, and possibly also to your parents if still alive, regardless of your wishes. Death duties may be subject to exemptions but these may be lower than in the UK and tax rates may be higher – up to 60% in France depending on the degree of relationship between you and the heirs under local law.
To some extent, planning can alleviate the consequences of conflicting inheritance laws. The starting point is usually a local Will in the country in which you own a house/land. Tax and/or legal advice from someone qualified in the non-UK jurisdiction is essential.
- Proving Wills in Offshore Jurisdictions
In some countries, local law will recognise the right of beneficiaries to claim assets following a death, rather than executors named in a Will, as happens in the UK. However, Wills made in one country are broadly speaking recognised in other countries under international conventions, subject to problems of interpretation.
The main problem with the UK approach which creates trusts for surviving spouses and/or children, is that most European countries do not recognise trusts in the way we do in the UK. It can therefore be better to make a Will in local form dealing at the simplest level with the disposal of assets such as a holiday home, and a UK Will dealing with the rest of your assets. If that gives rise to unequal or unintended consequences amongst your family, it may be that adjustments can be made through instructions given to your trustees under a flexible Trust in a UK Will.
These notes are designed to give you an overview of a particular area of law. They should not be acted on without taking professional advice on a given situation.
Inheritance Tax Planning Offshore Elements
The law and practice referred to in this article or webinar has been paraphrased or summarised. It might not be up-to-date with changes in the law and we do not guarantee the accuracy of any information provided at the time of reading. It should not be construed or relied upon as legal advice in relation to a specific set of circumstances.