UK inheritance tax: now it’s happening to YOU!
WHEREAS INCOME tax and capital gains tax are immediate issues and, therefore, often considered on a regular basis, inheritance tax (IHT) is usually only payable on death. Since we commonly are loath to consider our own mortality, this issue can be easily swept under the carpet and the out of sight, out of mind rule applied. This can prove to be a serious mistake that costs our families a small fortune – a mistake that could be avoided with a little effort and professional advice.
Not too long ago, it could be said that this pernicious tax only applied to the rich and famous, but the growth in UK property prices, combined with the failure of governments to raise the nil rate band in line with inflation, means this is no longer the case.
A survey carried out in October 2003 found that 1.5 million UK homeowners were potentially liable for IHT, but less than a year later that figure was revised upwards to 2.4 million, an increase of 60 per cent. Property, investments, savings, cars, furniture, jewellery, life assurances and all personal effects are liable. You may be surprised at how much you are worth when you add it all up.
Currently, the first 275,000 pounds sterling of your estate is taxed at nil rate and the balance at 40 per cent, whatever the amount. Proposals have been made to the government to introduce a top rate of 50 per cent, applicable to amounts over 763,000 pounds sterling, so the signs are that the pain may get worse.
If you are a UK domicile, you are liable to IHT on your worldwide estate. There is a big difference between residence and domicile. Residency relates to where you live, whereas domicile relates to who you were born to – principally your father – and where he lived. Anyone born in the UK of a British father has a UK domicile of origin.
If you live overseas on a permanent basis, it is possible to adopt a domicile of choice in another country. To lose a UK domicile, you essentially need to be resident elsewhere with no intention of returning. After three years, you can adopt a new domicile.
It is not necessarily easy to change your domicile, especially if you are working overseas, rather than in retirement. The burden of proof is on you. You are in effect required to have completely cut your ties with the UK and established them elsewhere. The UK Revenue looks at a balance of factors such as whether you have taken out a will, personal insurance, healthcare, driving licence, and learned the language in your new country. Retention of a UK current account and property for investment purposes are allowed.
The reason for changing your domicile status is that non UK domiciles are only liable to UK IHT on the value of assets physically left in the UK, above the nil rate band. If you own property in the UK worth more than 275,000 pounds sterling, it is possible for non UK domiciled individuals to remove it from the IHT net through the use of offshore companies and trusts.
Another, less immediate way to reduce your liability is to give assets away during your lifetime, either directly or by way of a trust. To be effective, you must have made the gift absolutely – you cannot be entitled to any benefit from the assets concerned – and you must survive a period of seven years. The tax liability reduces on a sliding scale from the third anniversary. Care must be taken because gifts of amounts in excess of the nil rate band into a discretionary trust will incur an immediate liability to IHT at half of the normal death rates, currently 20 per cent.
Gifts between spouses are free of IHT as long as they have the same domicile status. Gifts from a UK domiciled spouse to a non UK domiciled spouse are allowed tax free up to the amount of the nil rate band, plus a lifetime gift allowance of a further 55,000 pounds sterling. Any excess is taxable at normal rates.
One thing many married couples either forget to do, or are never aware of the opportunity, is to have a nil rate clause inserted in their wills. While both spouses are alive, they have a nil rate band each. Most wills, however, say that the assets will pass to the surviving spouse on the first death. This means that he or she now has the entire estate and only one nil rate band to set against it. Having a nil rate clause inserted in your wills means that, on the first death, assets up to the current nil rate band can be passed to other beneficiaries, effectively utilising the deceased spouses nil rate allowance. Currently, this could mean a saving of up to 110,000 pounds sterling (275,000 pounds sterling x 40 per cent).
If you cannot afford to give assets away or prefer not to, you could consider covering the potential liability with life insurance. Calculate your potential IHT liability, then take out a life policy with a sum assured equal to that liability. The benefits of the policy must be written in trust for your beneficiaries, so the policy proceeds do not become liable to tax. While this does not reduce your liability in any way, it does provide your beneficiaries with the means to pay the bill without having to liquidate assets.
IHT planning is a highly specialised field and you should seek expert advice before taking any action.
Blevins Franks Trustees