Generally, when an individual leaves their entire estate to a spouse, it is exempt from IHT. The position has further improved in recent years, due to the ability for the surviving spouse to inherit the unused nil rate band (NRB) of the deceased’s spouse’s estate. Assuming that the total NRB was intact on the first death, this means that up to (£325,000 x 2) £650,000 ($983,500) can be left free of IHT on the second death.
The position is not so favourable where the married couple or civil partners are of different domiciles. In this case, where the estate passes from a UK-domiciled individual to their non-UK-domiciled spouse or civil partner, the spousal exemption is limited to £55,000, a limit that has not changed since 1982.
This feature of UK law has been deemed discriminatory under EU law.
In response, the UK Government announced that it would consult on amending the law. The proposed amendments are now contained in the Draft Finance Bill 2013 and contain two key elements:
- Increasing the spousal exemption where a UK-domiciled individual transfers assets to a non¬-UK domiciled spouse from the current £55,000 to match the nil-rate band – currently £325,000, and
- An option for a non-UK-domiciled individual who is married to a UK-domiciled individual to make a voluntary election to be treated as UK domiciled, which would enable them to receive transfers from the UK-domiciled spouse, free of IHT.
IHT exempt amount
The increase in the non-domiciled spousal exemption is automatic, and will apply to any transfers of value on, or after, 6 April, 2013. However, a trap to be wary of is that lifetime gifts will deplete the value of the exemption available on death.
Transfers may occur during the lifetime of the marriage without the couple even being aware that they are relevant for IHT purposes.
For example, if they purchase a property in joint names, but the purchase price is provided in total by the UK-domiciled spouse, this is technically a gift that will use up part, or all, of the exemption.
However, the change represents a welcome uplift, and will, with relatively simple planning, result in many smaller estates now being free of IHT.
Election UK-domicile
The draft legislation sets out two possible circumstances where an election can be made; a lifetime election, and a death election.
A lifetime election can be made at any time during the marriage or civil partnership. A death election can be made either
on the death of the UK-domiciled spouse, or at any time within two years of the death (or, following the Budget on 20th March, a longer period as determined by an officer of HMRC
A lifetime election will take effect from the date of the election and a death election will be deemed to take effect immediately prior to the death of the deceased spouse. However, recently announced in the Budget of 20th March, is a proposal to opt for the election to take effect up to 7 years prior to it being made. The first opportunity to make an election will be when the Finance Act 2013 receives Royal Assent (likely to be in July 2013).
In both cases, the election must be made in writing to HMRC. There is no prescribed format for the election, and there is no indication that an acknowledgement of the election will be sent from HMRC. It is intended that a record will be retained by HMRC and will be made available, on request, to the personal representatives of the deceased.
Making the election will have two consequences:
- The person making the election will be able to receive a transfer of value from their spouse free of IHT, and
- The worldwide estate of the person making the election will, from that date onwards, potentially be subject to UK IHT.
In order to prevent an individual electing to be treated as UK-domiciled purely to receive a transfer free of IHT and then immediately reverting back to their non-UK-domiciled status, the election will be irrevocable.
However, where the electing spouse is, or becomes, non-UK resident for tax purposes, the election will automatically fall away once the individual has been non-UK-resident for four consecutive tax years (the original proposal was three years).
| Conditions and advantages | Advantages of offshore bond in EPT |
| A trust settled by a non-UK-domiciled individual | Tax free inside build-up |
| Holds non-UK assets | Low maintenance, reducing trustee costs |
| Outside the settlor’s estate for IHT, even if subsequently he becomes UK domiciled | No need to keep detailed, segregated income and capital accounts |
| Settlor can be a beneficiary | Use of 5% withdrawal allowance to provide tax efficient capital distributions |
| Tax-efficient exit strategies |
This means that an individual who is resident in the UK when they make the election, will be subject to UK IHT on their worldwide estate, unless they leave the UK and remain abroad for at least four consecutive tax years.
An individual who is non-UK-resident will merely need to wait four years following the election for the UK IHT liability on their estate to fall away.
Planning ahead
The proposed rules present some interesting questions for mixed domicile couples. Should the non-domiciled spouse make an election or not, bearing in mind that this places their own estate into the UK IHT net? Where there have been no lifetime transfers, and the total assets passing from the domiciled spouse are below £650,000, the election may initially appear to have little relevance, as the non-domiciled spouse will inherit these tax free. However, the advantage of an election will be that the domiciled spouse’s nil-rate band would remain intact, thus increasing the available nil-rate band on the second death.
Other factors to take into account are whether the couple are resident in the UK, the value of the non-domiciled spouse’s own assets and whether these assets are UK assets or not.
Interesting opportunities present themselves in the case of lifetime transfers, especially where the couple are non-UK-resident. A lifetime gift from a UK-domiciled individual to a non-UK-domiciled spouse will first deplete the spousal exemption and, to the extent that they exceed this, will be potentially exempt transfers.
If a large lifetime gift is contemplated, then a lifetime election might be advantageous. The main advantage lies in the fact that the UK domicile of the electing party will automatically fall away after four years (providing he or she remains non-UK-resident), leaving scope to undertake further planning, such as creation of an excluded property trust. See case study 3, and the table ‘Excluded property trusts (EPT)’, page 37.
Case study 1
Harry (UK-domiciled) and Sally (non-UK-domiciled) are resident in Dubai. They own their apartment jointly which is worth £500,000. Sally has no other significant assets in her name, and Harry has accumulated savings of £300,000.
Harry dies on 1 Sep, 2013, leaving his estate to Sally. Harry had not made any lifetime transfers to Sally. The table (below) shows the IHT position before and after the Finance Bill 2013 changes, assuming they are enacted.
| Current posit (£) | Posit after 6 Apr ’13 (£) | |
| Property | 250,000 | 500,000 |
| Savings | 300,000 | 300,000 |
| Total | 550,000 | 550,000 |
| Less spouse exemption | 55,000 | 325,000 |
| Nil rate band | 325,000 | 325,000 |
| Total | 170,000 | 0 |
| Tax @ 40% | 68,000 | Nil |
| As long as Sally retains her non-UK-domicile and ensures her assets are non-UK situs, there will be no IHT on her death either. |
Case study 2
Jack and Jill have been resident in the UK for 15 years. Jack is UK-domiciled and Jill is Canadian, and Jill does not plan to return to Canada in the near future. They have two adult children.
The family home is jointly held and worth £650,000, and Jack has investments worth £325,000. Jack dies on 10 Oct, 2013, leaving his estate to Jill.
If Jill does not make a UK-domicile election, there would be no IHT, as the estate is within the new spouse exemption, plus Jack’s nil-rate band. As Jill intends to remain in the UK, she will become deemed domiciled in the UK for IHT after residing there for 17 years.
This will bring her worldwide estate into the IHT net. As she was non-UK-domiciled when she inherited Jack’s estate, her estate would only benefit from one nil-rate band, giving a potential liability of (650,000 + 325,000 – 325,000) x 40% = £260,000.
If Jill makes a domicile election, the transfer will be exempt, which means that she will inherit Jack’s unused nil-rate band. Electing to become domiciled earlier ensures that she will have the use of two nil-rate bands. This represents a £130,000 IHT saving on the second death ((650,000 + 325,000 – 650,000) x 40% = 130,000). This liability could be covered by effecting an insurance policy in trust.
Case study 3
Bob (UK-domiciled) and Sue (Hong Kong domiciled) are resident in Singapore.
They have two children and intend to retire in the UK in six years’ time. They jointly own a UK property worth £500,000 and Bob has assets in his name worth £700,000. Sue has assets in her name worth £400,000.
Assuming all assets other than the property are non-UK assets, the IHT position on Bob’s death would be as detailed in the table below.
Bob could transfer some of his assets to Sue to take advantage of her non-UK domiciled status. However, by doing so, he will deplete the spousal exemption, and it will take seven years for any excess above the spousal exemption to fall out of Bob’s estate. Instead, Sue makes an election to be UK-domiciled on 1 Nov, 2013, and Bob gifts £400,000 to her on 20 Dec, 2013.
| Half share in house: | £250,000 |
| Other assets: | £700,000 |
| Total: | £950,000 |
| Less spouse exemption | £325,000 |
| Nil rate band | £325,000 |
| Taxable | £300,000 |
| IHT @ 40% | £120,000 |
The transfer from Bob is an exempt transfer, and the remainder of his estate can pass to Sue free of IHT if he dies within the next four years.
Assuming they do not take up residence in the UK in the meantime, Sue will become non-UK domiciled again on 6 April, 2018. If Bob dies after that date, his estate left to Sue will be free of IHT as it falls below the (intact) spousal exemption and the nil-rate band.
After 6 April, 2018, in contemplation of their move to the UK, Sue creates an excluded property trust. This will ensure that, should she become deemed domiciled for IHT purposes in the future, the assets in the trust would be outside her estate for IHT.
Assuming Bob predeceases Sue, a potential IHT liability remains on Sue’s death in respect of the family home in the UK ((500,000 – 325,000) x 40% = 70,000). This liability could be covered by effecting a life insurance policy in trust.
Conclusion
It remains to be seen whether the proposals will proceed to law without further amendment. The position of mixed-domiciled couples will become much more favourable, and advice will be necessary when assessing future strategies. The perfect opportunity for financial advisers to make contact.
