Expatriates and UK inheritance tax

news: Expatriates and UK inheritance tax

A simple guide to this complex law

What is inheritance tax (IHT)?

IHT is basically a tax on an individual’s wealth at death.

Who is liable for UK inheritance tax?

Individuals domiciled in the UK are liable to IHT on the value of their worldwide assets. Individuals not domiciled in the UK are liable to IHT on the value of assets situated in the UK. The concept of residence is largely irrelevant in IHT – domicile is the key factor. Expatriates will generally not be liable for UK income tax or capital gains tax, but may well still be within the IHT ‘net’.

What is domicile?

The concept of domicile was developed (centuries ago) because of a need to link individuals to specific legal systems. The legal system to which an individual was linked was the law of his permanent home or domicile. An individual’s domicile is decided as follows:

When a child is born, he or she acquires a domicile of origin. This is the domicile of the child’s father.

When the child reaches age 16, he or she may lose that domicile of origin and acquire a domicile of choice.

Acquisition of a domicile of choice involves two aspects:

1. The individual must physically reside in his/her new jurisdiction;

2. The individual must form the intention of living there permanently, having no real intention of living anywhere else.

The first aspect is clearly a matter of fact, but the second involves intention and is, therefore, difficult to prove one way or another. When interpreting the legislation, the courts adopt the approach that the acquisition of a domicile of choice is only to be accepted based on clear and unequivocal evidence. In any dispute, the burden of proof lies with the person who alleges that a domicile of choice has replaced a domicile of origin. In other words it is very difficult to shake off a domicile of origin!

How does this apply in practice?

Towards the end of his life, Sir Charles Clore moved to Monaco, with the intention of residing there and losing his English domicile of origin. However, there was evidence that he missed living in London and often thought of returning to England, which in his letters he called ‘home’. The Court held that at the time of his death, he had not lost his English domicile of origin – Sir Charles could not be said to have intended to live permanently in Monaco, while he expressed thoughts of returning ‘home’ to London.

Mr X, who had a UK domicile of origin, moved to Hong Kong in 1960. He rented accommodation there and built a holiday home in Fiji. In 1977, he disposed of his UK property. In the 80s, his visits to the UK varied from nil to 36 days each year. In 1990, he established two discretionary Channel Island trusts and, shortly afterwards, returned to the UK with the intention of remaining there permanently.

He claimed he had acquired a Hong Kong domicile of choice at the time the trusts were established.

The Special Commissioner (the first stage in the UK tax appeals system) rejected his claim. It could not be said that Mr X intended to remain permanently in Hong Kong to the exclusion of anywhere else.

‘Deemed domicile’

For inheritance tax purposes only, individuals who are not domiciled in the UK are treated as being UK domiciled in two situations:

1. an individual is deemed to remain UK domiciled for three years following the acquisition of a non-UK domicile of choice

2. an individual is deemed to acquire a UK domicile if they are tax resident in the UK for at least 17 out of the last 20 tax years

The first situation applies to emigrants, the second to long term residents who have not acquired a UK domicile of choice.

What assets fall within the scope

of inheritance tax?

For a UK domiciled individual, all assets are within the scope of IHT, although there are certain exemptions and reliefs. Some people tried to avoid the tax by making lifetime gifts and, consequently, the scope of the tax was widened to include gifts made in a specified period before death (currently seven years). Others tried to avoid the tax by making legal gifts during lifetime, but retaining beneficial ownership of the gifted assets: this led to the introduction of rules which included in the taxable amount assets that had been given away but where the original owner retained a benefit.

What are the rates of

inheritance tax*?

The first £275,000 of wealth (augmented by gifts in the seven years before death and gifts where a benefit has been retained) is taxed at 0 per cent. The excess is taxed at 40 per cent (this £275,000 is colloquially known as the ‘nil rate band’).

*all figures relate to the UK tax year 2005/2006

Can IHT be avoided?

Planning can reduce an individual’s IHT exposure. Planning strategies are frequently based on making lifetime gifts more than seven years before death. For increased flexibility, such gifts are often made to trusts rather than to individuals.

My own company offers a range of planning solutions which combine the tax, administrative and investment advantages of an offshore investment scheme with suitable trusts.

It is also possible to offer trusts that include arrangements which allow inheritance tax planning to be undertaken, while retaining some degree of access for the investor to his or her investment. This can be a complex matter, however, with some thoughtful planning, a great deal can be achieved to alleviate this tax.

• John Westwood can be contacted by telephone on 289 417 267 or via email at [email protected]