I’m surprised sometimes by the amount of misconceptions there are about UK inheritance tax. Many people who are otherwise financially aware fail to look into inheritance tax planning, because they either do not realise how much it affects them, or know that it can be legally avoided. To help separate facts from fiction, here are some common questions and answers on inheritance tax.
Q. What exactly is inheritance tax?
Inheritance tax (IHT) is a combination of death duty and gifts tax. It is payable on the value of all the assets you own on death, plus assets gifted during the seven years preceding death and on certain lifetime gifts.
Q. Who is liable and who is not?
All transfers between spouses are free of IHT. This exemption does not apply to common-law or same sex partners. All other gifts are potentially liable to IHT and all transfers at death are taxable.
Q. How much tax will my dependants have to pay when they inherit my estate?
The rate is 40 per cent on everything above the current nil rate band of £263,000. This significantly reduces the amount of money your dependants will inherit (in some cases the taxman can receive more from your estate than a loved one). However, sensible and timely planning will exempt your wealth for the benefit of your family and friends.
Q. Is IHT only payable on my UK assets?
No, if you are a UK domicile (and most expatriates are) IHT is payable on your worldwide assets. You may also be liable for Portuguese inheritance taxes (stamp duty) on some of your assets, depending on where they are located and who the recipient is.
Q. I thought only the very rich paid IHT?
This is a common misconception and many people (or their dependants anyway) are shocked to discover that they owe the taxman significant sums of money. The number of people eligible for IHT increases yearly, especially at the moment thanks to increased property values. An NOP World Survey in October 2003 found that 1.5 million UK homeowners were potentially liable for IHT. In July this year, Halifax calculated that this figure was 2.4 million – an increase of 60 per cent in less than a year!
Q. Surely the nil rate band of £263,000 makes a big difference?
This threshold isn’t really that generous. Consider that IHT is payable on the value of all assets you own on death, wherever they are in the world – including real estate, investments, savings, cars, furniture, jewellery, personal effects, life assurances etc. Many people are surprised at how much their estate is worth when they add it all up.
Q. I have been resident in Portugal for many years. As far as I know I am therefore no longer liable to UK inheritance tax.
This is another common misconception and another reason why dependants get a nasty shock. Residency alone has no bearing on whether or not you fall into the UK IHT net – it all depends on domicile. It’s much harder to change your domicile status than it is to change your residency. You can live outside the UK for many years and remain domiciled in the UK – this is the case for most expatriates.
Q. What exactly is domicile?
Domicile is a legal concept. It’s essentially concerned with the idea of ‘belonging’ to a particular country and is often described as the country you regard as your homeland, or the place where you intend to die.
Q. How can I become domiciled in Portugal instead of the UK?
It’s not easy. You must be physically present in Portugal and a tax resident, and have formed an intention to reside here permanently. For IHT purposes, however, you need to build up evidence to prove you’ve severed material connections with the UK. There is a wealth of case law that demonstrates how difficult it is to shake off your UK domicile as far as the Inland Revenue is concerned.
Q. How can I make my new domicile status official?
It’s not possible to simply ask the Inland Revenue for a ruling. They will only do so if a tax liability is due. The only way to find out for sure is to create a situation where tax is due. Seek professional advice. If you don’t want to resort to such measures, a professional tax adviser should be able to give you a good indication of where you are domiciled, but make sure that he has many years of experience.
Professional advice is essential if you base your tax planning around your domicile status, as the Revenue will impose IHT on anyone it deems domiciled in the UK. It’s very possible that you will have one opinion on your status and the Revenue another. If you get this wrong, your dependants will be lumbered with a large – and totally unexpected – tax bill.
Q. How easy is it to regain my UK domicile?
It’s very easy. If you decide or intend to return to the UK in your later years (around 80 per cent of expatriates do) you’ll immediately become a UK domicile again. Since for IHT purposes domicile is only established on death, all those years of being a Portuguese domicile will count for nothing. Your dependants will pay IHT on all your worldwide assets.
Q. I’m confident that I’m no longer a UK domicile.Will IHT be due on my UK property?
Yes, even if you are a UK non-domicile, IHT is still payable on any assets situated in the UK.
Q. How easy is it to plan to avoid IHT?
It’s easier than many people realise. With the right advice, IHT planning doesn’t have to be a headache. Trusts, for example, are remarkably effective vehicles for all tax planning. They also allow you to give away your assets as and when you wish and speed up the probate process.
Q. Is this legal?
Yes, IHT is often called a ‘voluntary’ tax because with careful planning you can legally avoid it. However, I recommend that you seek advice from an experienced professional, as some ‘off-the-shelf’ solutions are not appropriate. The UK government is tightening up on tax avoidance, so make sure your planning is based on a solid analysis of tax legislation, both in the UK and here in Portugal.