Inheritance Tax – spouses and civil partners domiciled overseas

March 8th, 2013

As announced by the government in the autumn statement on 5 December 2012, legislation is to be introduced in Finance Bill 2013 to:

• Increase the IHT exempt limit on transfers from a UK domiciled spouse to a non-UK domiciled spouse from £55,000 to the level of the IHT NRB (currently £325,000), which effectively increases the maximum amount that can be passed IHT free on first death from £380,000 to £650,000; and

• Enable non-UK domiciled spouses to elect to be treated as UK domiciled for IHT purposes

Careful thought will be needed though before a non-UK domiciled spouse does make an election to be treated as UK domiciled lest a short-term benefit is outweighed by long-term consequences

Background

It is an individual’s domicile (actual or deemed) rather than their nationality or residence that is important for inheritance tax purposes.

Each party to a marriage or civil partnership can have different domiciles but whilst an individual who is UK domiciled or ‘deemed’ UK domiciled is subject to IHT on their worldwide assets a non-UK domiciled individual, who is not deemed UK domiciled either, is only subject to IHT on their UK assets.

Importantly, an individual who is not UK domiciled is still deemed to be UK domiciled if they have been UK resident for 17 out of the last 20 tax years, including the current tax year
Current law

At present, the total of all transfers (whether made during lifetime or on death) from a UK domiciled spouse to a spouse who is neither UK domiciled nor deemed UK domiciled is subject to an IHT exempt cap of just £55,000.

The purpose of imposing this cap, which hasn’t changed since 1982, is to prevent UK domiciled spouses from transferring substantial assets to their non-UK domiciled spouse who in turn transfers them overseas to escape IHT.

Impact of changes from April 2013

Where a non-UK domiciled spouse chooses not to elect for UK domicile treatment their overseas assets would, as now, be exempt from IHT but any transfers received from their UK domiciled spouse would be subject to the increased exempt cap.

Conversely, non-UK domiciled spouses who do choose to make an election would benefit from uncapped exempt IHT transfers from their spouse, but any subsequent transfers by them could potentially be subject to IHT regardless of whether the transferred assets are located in the UK or overseas.

Given that transfers between UK domiciled spouses are wholly IHT exempt, without limit, making such an election is therefore likely to be of particular appeal where a non-UK domiciled spouse expects to receive large gifts from their UK domiciled spouse during lifetime and/or (more likely) a large inheritance on death.

Great care should be taken though if a non-UK domiciled spouse has significant overseas wealth in their own right because if an election is made to be treated as UK domiciled, this of course would then bring their overseas assets into charge for IHT in the UK.

For non-UK domiciled spouses who feel that they would benefit from making such an election, however, there are a number of important points to note:- 
• The election applies for inheritance purposes only. It does not affect the income and capital gains tax treatment of UK resident foreign domiciles. Lifetime elections, made on or after 6 April 2013, will have immediate effect
• If a UK domiciled spouse dies on or after 6 April 2013, and an election had not been made during lifetime, an election can still be made after the UK domiciled spouse has died. In order to be effective, the election must be made within 2 years of death – in which case the election will be deemed to take effect immediately before any transfer that arises as a result of their death.
• The election is irrevocable while the electing individual continues to remain resident in the UK. This therefore prevents individuals from electing to be treated as UK-domiciled for IHT purposes to get an immediate benefit of an uncapped transfer from their spouse/civil partner, then later reverting to non-UK domiciled status when still living in the UK to regain beneficial IHT treatment for their overseas assets.
• Any election will cease to have effect if at any time following the making of the election, the non-UK domiciled spouse becomes non-UK resident for income tax purposes for at least three successive tax years. Where this is the case, the spouse will be treated as being Non-UK domiciled again from the end of the third full tax year of non-residence.

Summary

Whilst making such an election could produce a favourable outcome for some people, caution should be exercised in this area, particularly where a non-UK domiciled spouse who intends to remain in the UK has significant overseas wealth, and it is for this reason that it is strongly recommended that professional advice should always be sought before any action is taken.