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Long-term UK expats may face huge UK tax charges

“The latest numbers from HMRC show people are passing on more and more to the taxman rather than their loved ones” – The Daily Mail.

UK expats who have lived abroad for many years often remain UK-domiciled and, therefore, liable to UK Inheritance Tax (IHT). The rate of this tax might be considered penal. It is currently 40% on the total value of the estate of a deceased after the exemptions. It is an additional tax payable on capital accumulated during lifetime upon which tax has already been paid.

Many UK nationals who have lived abroad long term may assume their liabilities to UK tax have ended. Probably they are no longer liable to UK income and capital gains tax except on UK source gains and income – but they may well remain liable to UK IHT!

It is difficult to change a domicile. The default position is that those who acquired a UK domicile of origin at birth – 99% of all UK nationals born in the UK – will keep that UK domicile for their entire lives and, with it, their liability to UK IHT.

It is possible for UK persons to acquire a new domicile of choice and it is hugely advantageous to do so. Any long-term foreign residents can potentially lose their UK domicile and acquire a new domicile of choice in their new country of long-term residence. That is the only way to lose their liability to UK IHT.

Legally, the test is simple and there is only one. Has the taxpayer formed the intent to remain in their new country indefinitely? If the answer is ‘yes’, that person is now domiciled in this new country. All the facts and circumstances are evidential, but none of them are definitive apart from this test of ‘intent’. But convincing the UK tax authority (HMRC) of this is not so simple.

If the evidence to support the claim of a new domicile of choice is not accumulated and documented during the lifetime of the taxpayer, it will be very difficult for their executors to convince HMRC that there has been a change of domicile. It is vital that steps are taken during the taxpayer’s lifetime to properly document their intentions and obtain an opinion from UK counsel that a new domicile has been acquired.

That opinion will rarely be challenged unless the facts and circumstances change or it has been obtained under false pretences by, for example, giving counsel incorrect facts or, much more importantly, misleading counsel about intent.

An opinion confirming that a new domicile has been established is the Holy Grail and will give the best possible protection. It used to be the case that HMRC would confirm a domicile. They will no longer do that.

All a person’s facts and circumstances are relevant, but none are definitive. Generally, it will be impossible to get HMRC to agree that a new domicile has been acquired for the first six or seven years of a taxpayer living abroad, but, thereafter, if the facts and circumstances corroborate that statement of intent, there is a good chance that a new domicile has been or can be acquired.

For this to happen, it is necessary to show permanence in the new country through such things as acquiring property and establishing social and economic ties.

One such strong tie is marrying a local resident, but that brings its own trap. Transfers between spouses are normally exempt. The rationale here is that the spouse may well need the wealth for support, so the tax bites only when the assets are passed to the next generation, so the tax is only delayed and not avoided.

However, that applies only if both are UK domiciled. If the donee is not domiciled, there would be no UK IHT on the next gift, so the tax is charged immediately. Thus, if a UK domiciled person marries a foreign national, the likelihood is that the exemption does not apply.

Losing ties with the UK is also extremely helpful, but it is not essential. For instance, owning UK residential property is by no means fatal. It is necessary only to show that the taxpayer has greater connections with a new country than he or she has retained with the UK. But still, it is the question of intent that is definitive in law.

One of the leading cases on domicile involves a Cypriot man, the late Andreas Nathanael, who died suddenly in London in 2003. In Cyganik v Agulian, the Court of Appeal held that the deceased had retained his foreign domicile of origin in Cyprus despite being habitually resident in the UK for 43 years before his death.

His retention of strong ties with his country of origin carried weight with the court. These ties included the ownership of two flats in Cyprus, close family members in Cyprus (daughter and granddaughter), lengthy return trips to Cyprus, a Cyprus identity card providing him with local rights, and documented attempts to purchase a home and a hotel in Cyprus.

It is easy to see – and logical – that the reverse should also be true. A UK national spending 40 years in a new country may not necessarily lose his or her UK domicile.

Other leading cases are Gaines-Cooper and Barlow Clowes International Ltd & Ors v Henwood. Both those cases involved UK nationals who had spent long periods of time abroad but had retained UK connections and failed to establish sufficient connections in one place (because they had travelled extensively) to convince HMRC that they had truly lost their UK domicile. In both cases, this failure had severe tax consequences.

UK IHT is obviously only payable after death, so while the taxpayer may not suffer, their surviving family members certainly will. Most (if not all) taxpayers would much sooner that their hard-earned assets went to their families rather than to HMRC.

Long-term expats can face another trap. Even if they have done sufficient to establish a new domicile of choice wherever they currently live, if they leave that country and move elsewhere, they will lose that new domicile and revert back to their UK domicile of origin. The revived UK domicile is likely to remain in place unless and until they have been in their new country of residence for sufficient time to claim a new domicile of choice in their new country. That is likely to take some time.

The risk is obvious. The liability to UK IHT at 40% is revived and remains in place for several years until a second and new domicile of choice can be established. This is why the standard advice is that, as soon as UK domicile is lost, that opportunity is used to transfer wealth into trust.

Assets held in trust remain outside the scope of UK IHT forever unless the UK person returns to the UK. If they go to a third country, their UK taxable estate does not include assets in trust, so UK IHT is reduced accordingly.

A reviving UK domicile has caught out many long-term UK expats. For example, there are many who were living for many years in Hong Kong but have now moved to Portugal and elsewhere following Covid in Hong Kong and certain political changes. They had lost their UK IHT liability, but it has now been revived. If they have not done the appropriate planning, their estates are at risk.

Those who cannot establish a new domicile can still substantially reduce their UK IHT liability in other ways.

Increasingly, wealthy individuals are setting up Family Investment Companies (FICs). This is relatively simple. Assets are transferred to an offshore or UK company. The rights and obligations attaching to the shares of that company are divided between shares which carry votes only, shares which carry the right to income (dividends) only and shares which carry the right to the underlying assets (capital).

The transferor retains the voting shares and, thereby, controls the assets and the affairs of the company. He/she may also retain some or all of the income shares, so they can receive dividends during lifetime. But the capital shares are immediately or progressively given away to family members. The gift of the capital shares would be a Potentially Exempt Transfer (PET), so would be tax free if the donor survives the gift by seven years.

We strongly recommend that anyone who has any doubt about their domicile should seek expert advice at the earliest opportunity. IHT can be planned out relatively easily – but the key to any planning is to first get certainty on domicile. There is never a convenient time to start this process and clearly many people never get round to it. The results are obvious from the headline at the start of this article. The message is: ‘Get on with it or lose it.’

By Howard Bilton

Howard Bilton is an UK barrister, Chairman of The Sovereign Group and a visiting Professor at Texas A&M University. To arrange a personal consultation, please contact [email protected] at Sovereign Portugal