Inhertitance Tax Rules, Why You Need a Will, and Domicile - A Complete Guide - Investment International

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1 The following article is written by Andrew Coyne and aims to answer questions such as how does inheritance tax work? What does Domicile really mean? and Do I need a will? The taxman s global reach It would be stretching things to suggest that dealing with UK inheritance tax (IHT) under any circumstances is straightforward, but an added layer of complexity is brought to bear when UK expatriates are involved. And expatriates living in Spain face additional concerns as that country has its own inheritance tax, which in some respects is tougher than the UK one. (more on this later). But perhaps the biggest danger facing expatriates with regard to this tax is complacency. They may take an out of sight out of mind attitude; unfortunately the UK Exchequer does not. As with much relating to UK expatriate finance, the key to understanding IHT is the thorny old issue of UK Domicile and residency. UK citizens who move abroad may well be treated as Non-resident but losing UK Domicile status is a whole different ball game. Domicile usually relates to a Domicile of origin, acquired at birth (or even your father s birth). Living in another country is not conclusive proof of an intention to change Domicile. This can have a major impact on IHT as an individual who is UK domiciled is liable to inhertitance tax on chargeable property on a worldwide basis. A non-uk domiciled individual is only liable to inheritance tax on chargeable property in the UK. An individual can be deemed domiciled in the UK for IHT purposes if he or she was UK domiciled at any time in the three years immediately preceding the time at which the question of Domicile is to be decided or, alternatively, UK resident for at least 17 out of the last 20 years. Simply put, any UK citizen, wherever based, remains UK domiciled unless permanently emigrating through official channels. Choosing a Domicile of choice' in this way requires strong proof of having moved to the other country permanently. It is worth repeating that living in another country is not conclusive evidence of an intention to change Domicile. It is crucial for UK expatriates to understand this question of Domicile if they are to successfully 1 / 7

2 dispose of their assets in the way they desire. As Sean Scahill, chief executive of the London-based wealth management firm The Fisher Family Office, says: Inheritance tax is all about Domicile. For UK individuals it is very difficult to lose that. If you go to live in France, inheritance tax will be applicable in the UK. It is as stark as that. How inheritance tax works Inheritance tax is the tax that is paid on an estate. This is usually taken to mean everything owned at the time of your death, less what you owe. IHT is also sometimes payable on assets you may have given away during your lifetime. Assets include things like property, possessions, money and investments. But, as we shall see, if disposed of properly, assets given away should not trigger an IHT charge. Not everyone pays IHT on death. It only applies if the taxable value of your estate (including your share of any jointly owned assets and assets held in some types of trusts) when you die is above 300,000 ( tax year). This 40 per cent tax is only payable on the excess above the nil rate ( 300,000) band. There are a number of exemptions which allow you to pass on amounts (during your lifetime or in your will) without any IHT being due. These include: 2 / 7

3 * If the estate passes to spouse or civil partner and you are both UK domiciled * Gifts made more than seven years before death * Sums of money given away each year tax free (currently 3,000 a year). If any of this allowance is unused it can be carried forward into the next tax year (but no further). In other words, you could give away up to 6,000 in any one year if you hadn't used any of your exemption from the year before. * Gifts of up to 250 to as many people as you wish but such gifts are only exempt if the total given to one person in a given tax year does not exceed 250. As Scahill at The Fisher Family Office says: There are a quite a plethora of products and ideas out there. It normally involves taking something and turning it into a gift, putting it into trust or using the seven year rule. But his first advice is simple but crucial. Everyone needs a good will, he says. Where there s a will, there s a way Advance planning is the key to mitigating the effect of IHT. We re starting to get into complicated areas which is why Scahill suggests everybody needs to get good advice. It could be the best money you ever spend. 3 / 7

4 Essentially, the will has to be written tax efficiently. A married couple are better off having their assets in their own name rather than jointly held because if an allowance is not used it is lost. Jointly held assets would pass automatically to the survivor. You might consider rewriting your will, leaving assets up to the value of the nil rate band directly to the children, or alternatively use a discretionary trust. Trusts - and in particular the control they give over the timing of the release of assets - can be useful when minors are potential beneficiaries or when money left to another beneficiary might tip them over the edge in terms of their own tax burden. Whatever route you choose, getting your affairs in order is absolutely essential to avoid losing a large chunk of your assets to the taxman. If you don t make a will then the taxman will decide who gets what. And if you aren t married or in a civil partnership your partner will not inherit automatically. A will can ensure your partner is provided for. Equally if you re divorced you can decide whether to leave anything to an ex-partner. One final point on wills, Scahill suggests it is is important to take into account where you are living and not just your country of Domicile (ie the UK). You may need to have a will for your country of residence as well as you may find they have the Napoleonic Code in place. It is sound advice as the Napoleonic Code - in place in many countries in Latin America (as well as France) has a different take on property, inheritance and succession. French laws on inheritance give the taxman there a much greater say in who will inherit your estate and in what proportions. The laws often prohibit you from leaving assets to the 4 / 7

5 beneficiaries of your choice and in the proportions you may wish. If you want to leave French property to the person of your choice, the best way is probably to buy it in joint names in a manner designed to leave the survivor with the ownership of the whole property. Beating the "inheritance" taxman - Offshore Trusts To beat the UK taxman, you need to ensure that when you die, everything you own totals less than the nil tax band of 300,000. It may be something that is distasteful to consider but because gifts between husband and wife are tax free, assets should be passed to the partner likely to live the longest. As already stated, the transfer of assets into offshore or discretionary trusts could also be a useful tool although it should be noted that such transfers would be subject to an immediate IHT charge if they exceed the nil rate band (taking into account the previous seven years' chargeable gifts and transfers). Such trusts, then, need to be carefully structured. A smart adviser should be able to feed your assets into trusts in such a way as to avoid triggering an IHT charge. There are a range of different types of trust, some of which can be linked to school fee planning or Insurance. Whilst there are common types of offshore trusts, certain offshore jurisdictions have structured trust vehicles unique to their jurisdiction. Often they compete on how difficult it is for onshore taxmen to overrule them. Your adviser should be able to tell you what is available in the market and what is best suited to your particular circumstances. But suffice it to say that the whole idea of a trust is to protect your assets and to distribute those assets in line with your wishes. In this sense it might be well worth considering in relation to IHT. It may also be possible to use an Offshore company to protect assets. An Offshore trust would own the shares in the Offshore company. 5 / 7

6 The key thing for the taxman is to recognise your disassociation from the assets held in trust. The UK s pre-owned assets tax (POAT) was introduced in April, 2005 and is intended to deter people from attempting to get around the rules on gifts with reservation. The POAT imposes income tax charges on the benefit people are deemed to have derived from assets they have given away but continue to have an interest in living in a house, for example. In the case of property, the charge is on the estimated market rent, at the taxpayer s highest rate. As mentioned earlier, giving away money to family and friends is another option. You might consider gifting money to children on an annual basis - to help them get onto the property ladder, for example. If your children are undeserving, then there s always charity. Charitable gifts are tax free as are gifts to museums and universities (and political parties). Wedding gifts are another option and can be made tax free to children ( 5,000), grandchildren ( 2,500) and anyone else ( 1,000). In a wedding year the 3,000 annual lump sum could be added to your child s wedding gift to provide an asset disposal of 8,000. Larger transfers of capital - known as Potentially Exempt Transfers (PETs) - should be made as early in life as possible to avoid an IHT charge. They become free of a charge seven years after being made. In practice this is a difficult thing to judge, given that few of us know how much we can afford to give away that far in advance and even fewer of us know seven years in advance when we are going to die! The Spanish inquisition - Difference between UK and Spanish Inheritance Tax For expatriates living in Spain - and there are estimated to be 75,000 British pensioners residing 6 / 7

7 there - there is a further factor to be considered: the country s own inheritance tax. And as Scahill at The Fisher Family Office says: If anything, inheritance tax in Spain is more onerous than the UK version. If you manage to lose your UK Domicile and take up Spanish Domicile, you will be subjected to Spanish inheritance tax on all of your assets. For Spanish residents the liability is on their worldwide assets when they pass to the inheritor but it should be noted that where there is both UK and Spanish liability to inheritance tax, one can be offset against the other. For Non-resident property owners in Spain, the liability is on their Spanish assets. The big difference between UK and Spanish inheritance tax is that there is no spousal exemption in Spanish law. In other words, there is no automatic exemption on transfers between spouses. Under Spanish law, if a property is owned in joint names and one of the spouses was to die, the surviving spouse would inherit the remaining spouse's 50 per cent share, as with UK law, but the surviving spouse would be subjected to inheritance tax upon the other half of the property that they have inherited. The UK exempts this charge. Spanish IHT also kicks in at a lower level than in the UK and doesn t work on a flat rate. The top level of tax (34 per cent) applies on amounts over 79, (around 50,000) The Spanish taxman also has the ability to ratchet up the chargeable sum if the assets are not left to a close relative. 7 / 7