Domicile issues & inheritance tax

04/01/2010

This case study demonstrates the expertise of our Wills, Trusts & Tax Planning team who have recently advised married couples on inheritance tax and the law of domicile.

Transfers between married couples generally benefit from a 100% exemption from Inheritance Tax (IHT). IHT is therefore deferred until both spouses have died.

However it is a significantly different picture for married couples where one spouse is domiciled outside the UK. In one example, our client was a married couple where the husband was UK domiciled and the wife was Spanish having moved to the UK six years ago. Unless steps were taken by her in order to acquire a domicile of choice in the UK, the Spanish wife would retain her domicile of origin in France. She does not acquire a deemed domicile in the UK for IHT purposes until she has been resident here for 17 out of the previous 20 years. If the husband were to die leaving his assets to his wife before his wife acquired a deemed domicile, then the 100% spouse exemption would not be available.

In such a case, the individual nil rate band (£325,000 in 2009) passes free of IHT together with a limited spouse exemption of only £55,000. The rest is taxable to IHT at 40% and as in this case the husband's estate was in excess of this amount, the wife would have to find the amount to pay the tax even though the main asset may be the family home in which she still wishes to live.

We considered various steps:

• If the wife did not need to retain her Spanish domicile for other reasons (such as other tax considerations, implications under the local law of domicile, or indeed because she simply did not wish to relinquish her existing ‘identity’) she could declare a domicile of choice in the UK. In order to do so, she would need to establish that she had made the UK her permanent home. This is judged evidentially and she should consider the severance of as many links as possible with the home country - for example, she should not continue to own property or pay annual subscriptions to clubs or organisations over there, she could join local clubs and societies in the UK, apply for a British passport, ensure that as many of her assets as possible were in the UK, acquire a burial plot here and, if possible, submit a Tax Return and declare a UK domicile.
• The family assets could be placed into the sole name of the non-domiciled spouse.When a non-domiciled spouse dies and leaves assets to a UK-domiciled spouse, the normal 100% exemption is still available. The restriction only applies when assets pass from a UK domiciled spouse to a non-domiciled survivor. There may, however, be many other reasons why it would not be appropriate for all of the assets to be held in one spouse's sole name.
• Many clients will address this problem by taking out term life assurance on the life of the UK domiciled person, in order to cover the period until the date when deemed domicile will begin to apply for IHT purposes to the spouse. The cost of doing so will of course depend on the age and health of the person concerned.
• The husband'sWill could be drafted in the form of a discretionary trust. This will not affect the tax position on the first death if the husband predeceases his wife, but she can be a beneficiary of the trust and benefit fully from it and despite that on her subsequent death she will not suffer IHT on the value of the assets in the trust, even if by then she has become UK domiciled, as they will be outside her estate for IHT purposes. This avoids the same assets being taxed twice.
• Whilst the wife remains non domiciled (and not deemed domiciled for IHT) she could place any significant non-UK property into what is known as an excluded property trust. The effect of this would be that those non-UK assets would not form part of the wife's taxable estate even after she acquires a UK domicile, and she and her husband would still be able to benefit from the assets settled.