“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 is penal. It is currently 40% on the total value of the estate (after exemptions) and is an additional tax on capital accumulated during lifetime upon which tax has already been paid.
Many UK nationals who have lived abroad for a long time 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 your 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. But it is possible for UK persons to acquire a new ‘domicile of choice’ in their new country of long-term residence – and it is hugely advantageous to do so.
Legally, the test (and there is only one) is simple. 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’.
Convincing the UK tax authority (HMRC) is not so straightforward. It is therefore essential that steps should be 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. It will be immeasurably harder for their executors or beneficiaries to do this after their death.
It used to be the case that HMRC would confirm a domicile. It will no longer do so. However, a UK counsel opinion will rarely be challenged unless the facts and circumstances have changed or it was obtained under false pretenses. An opinion is, therefore, the ‘Holy Grail’ and provides the best possible protection.
HMRC is unlikely to agree that a new domicile has been acquired during the first six or seven years that a taxpayer is living abroad. After that, if the facts and circumstances corroborate the statement of intent, there is a good chance that a new domicile has been or can be acquired. It is typically necessary to show permanence in the new country by acquiring property and establishing social and economic ties.
Losing such ties in the UK is also very helpful but it is not essential. Owning UK residential property, for instance, is by no means fatal. It is only necessary to show that the taxpayer has greater connections with their new country of residence than he or she has retained with the UK. But still, it is only the question of intent that is definitive in law.
Long-term expats can also fall into another trap. Even where they have established a new domicile of choice in their current place of residence, if they leave that country they will lose their new domicile and revert to their UK domicile of origin. This revived UK domicile will then remain in place until such time as they have resided in a new country for sufficient time to claim a new domicile of choice. That is likely to take several years, and the risk is obvious.
To avoid this disastrous trap, it is essential that any long-term UK expat who has successfully obtained UK counsel opinion confirming a new domicile of choice should use the opportunity to transfer the bulk of their wealth into trust. Assets held in trust will remain outside the scope of UK IHT forever, unless the settlor returns to the UK. If the settlor moves to a third country and revives his/her UK domicile of origin, those assets transferred into trust while they had a domicile of choice will not form part of UK taxable estate.
For those who cannot establish a new domicile, there may be another way to substantially reduce their UK IHT liability. Family Investment Companies (FICs) are relatively simple structures. Assets are transferred to an offshore or UK company and the rights and obligations attaching to the shares of that company are divided between shares that carry only voting rights, shares that carry only rights to income (dividends), and shares that carry only rights to the underlying assets (capital).
If the transferor retains the voting shares, he or she can continue to control the assets and the affairs of the company. The transferor may also retain some or all of the income shares, so he/she can receive dividends during lifetime. The capital shares, which are the only ones carrying real value for IHT purposes, should be immediately or progressively gifted to family members.
The gift of these capital shares will be a Potentially Exempt Transfer (PET), so will become tax exempt provided that the transferor survives the gift by seven years. On death, the voting and income shares held by the transferor will have little or no value for IHT purposes.
We strongly recommend that any UK expat who has any doubt about their domicile should seek expert advice at the earliest opportunity. IHT can be planned out, but the key to any planning is to first get certainty on domicile. As the Daily Mail headline quoted at the start of this article makes clear, many people never get round to IHT planning. So, the message is: “Get on with it now!”.
Howard Bilton is an UK barrister, Chairman of The Sovereign Group and a visiting Professor at Texas A&M University.
By Howard Bilton