UK Inheritance Tax Rules for British Expats - What You Need to Know
British citizen living abroad? It’s essential to understand the UK inheritance tax rules because they probably do apply to you!
NB. These rules apply even if you are not British, but have assets or investments based in UK!!
Much like making a will, planning for inheritance tax is one of those things we usually prefer not to think about. However, it’s an area where a little bit of forward planning can make a huge difference to how much of our wealth the tax man gets his hands on - to the tune of thousands of pounds, or even hundreds of thousands.
Currently inheritance tax (IHT) in the UK is 40% on assets over the £325,000 threshold.
But wait a minute, I don’t live in the UK, don’t own any assets there, and haven’t even been back for years. I won’t be due for IHT, right? Right?
UK IHT depends on your domicile - and for expats that’s generally not the same thing as residence
The concept of domicile has it’s roots in UK common law. Domicile means something different from and is separate from other factors such as nationality or residence. So, it is possible to be a national of the UK, presently resident in Spain but domiciled in Jersey.
Two key types of common law domicile include:
- Domicile of origin - ascribed to every individual at birth; if a child’s parents were married when he was born then his domicile of origin is usually the same as his father’s domicile at the time of his birth. If a child’s parents were not married when he was born, then his domicile of origin is usually the same as his mother’s domicile at the time of his birth. (Though note that from 2017 individuals born in the UK will no longer be able to inherit the foreign domicile of their parents.)
- Domicile of choice - can be acquired when (i) you are resident in a new territory subject to a distinctive legal system, and (ii) you intend to reside there indefinitely (the intention does not need to be irrevocable).
Under the Inheritance Tax Act 1984, it is possible for an individual to be ‘deemed’ to be domiciled in the UK for the purposes of Inheritance Tax only, while being domiciled at common law in a territory outside the UK.
HMRC: “An individual who abandons a domicile of choice without acquiring another one will be held to be domiciled in his or her domicile of origin during any intervening period, because an individual must always have a domicile.”
You may have lived for years in a domicile of choice, but if you move to another country then your deemed domicile for IHT reverts back to your domicile of origin. Under the current ‘three year rule’, you need to live for three years in your new country before it can be considered your new domicile of choice.
Notwithstanding the ‘domicile of choice’ concept, in reality it can be extremely difficult to become non-UK domciled for IHT purposes if you are British. Domicile contains a dual element of actual residence in a place and the intention to remain there permanently. Demonstrating this intention is key, and could include such actions as:
- relinquishing your UK passport;
- severing all links with social organisations and joining new organisations in your country of residence;
- purchase property in your country of residence and selling all your UK based property;
- closing UK bank accounts.
In assessing a person’s domicile all the relevant evidence is taken into account, the onus of proof is on the person seeking to show that a change of domicile has taken place; but it is the HMRC’s decision how you will be assessed. This can make it somewhat uncertain to rely wholly on the ‘domicile of choice’ rules for inheritance tax planning.
Nil Rate Band
As mentioned above, every person, UK domiciled or not, is entitled to the full nil rate band to be set against their estate that is subject to IHT. The current threshold is £325,000, if your estate value is below this, then no IHT will be due.
If you are UK domiciled or deemed domiciled, then the IHT tax rate is 40% of all your worldwide assets above £325,000 in value.
However, there are a few inheritance tax exemptions and reliefs that might be available…
Spouse or civil partner exemption
Generally for British couples, transfers of value between spouses or civil partners are wholly exempt from inheritance tax - i.e. they can give gifts to each other, in their lifetime or on death, without creating an inheritance tax liability.
Note this exemption applies only to legally married spouses or formal civil partnerships, not to de facto relationships.
There is no limit on the value of these exempt transfers, except in one situation:
Restriction on exempt transfers to a non-UK domiciled spouse
If the transferor’s spouse is not UK domiciled, then the exemption is limited to the value of the nil rate band - currently £325,000 as mentioned above.
Since the exemption applies to transfers made by a individual, if that person has been married or in civil partnership with more than person, the restriction applies to the cumulative total of all transfers to all spouses or civil partners.
Gifts and the 7-year rule
Any transfer that is made to another individual is a ‘potentially exempt transfer’ (PET). A PET only becomes chargeable if the donor dies within seven years of making the gift. If the donor survives for seven years then the PET becomes exempt and can be completely ignored. Hence such a transfer has the potential to be exempt.
If the donor dies within seven years of making a PET then it becomes chargeable for IHT. Tax will be charged according to the rates and allowances applicable to the tax year in which the donor dies. However, the value of a PET is fixed at the time that the gift is made.
Taper relief reduces the amount of tax payable where a donor lives for more than three years, but less than seven years, after making a gift. The reduction is as follows:
- gift is made 3-4 years before death - 20% reduction
- gift is made 4-5 years before death - 40% reduction
- gift is made 5-6 years before death - 60% reduction
- gift is made 6-7 years before death - 80% reduction
The UK inheritance tax rules give each individual an annual exemption of £3,000. Transfers of up to this amount each tax year (6-April one year to 5-April the next) are exempt from IHT.
Any part of the annual exemption which is not used in the tax year is carried forward (rolled-over) into the next tax year. It can only be carried forward to the next year and cannot be used in any later years.
Normal Out of Income Exemption
Inheritance tax is supposed to apply to capital assets and not to income. Hence the rules allow an exemption for regular gifts (which can be of higher value than the £3,000 exemption), as long as each transfer
- formed part of the transferor’s normal expenditure,
- was made out of income, and
- left the transferor with enough income for them to maintain their normal standard of living
‘Normal’ means what the donor is used to, so will vary from person to person. A typical way to use this exemption is for an individual to set up a regular monthly savings plan placed in trust for the benefit of a child.
UK inheritance tax if you are non-UK domiciled
If you are non UK domiciled, your UK inheritance tax liability will generally be assessed based on your UK assets.
Contact me to discuss solutions for reducing UK inheritance tax liabilities.
Important Disclaimer. I do not provide tax advice. This article is sourced from materials provided to me by relevant regulated institutions in Singapore, in addition to the HMRC website. This article presents general information only, and you should obtain your own independent tax advice appropriate to your specific circumstances. Whilst I believe this information to be accurate at time of publication, I bear no liability whatsoever for any actions reliant upon this information.