Inheritance tax – gifts to non-UK domiciled spouses or civil partners

 In Tax

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Inheritance tax - gifts to non-UK domiciled spouses or civil partnersBackground

A transfer of UK situs assets between UK domiciled spouses (or civil partners) is exempt from inheritance tax.

A full spousal exemption also applies on transfers of any assets from non-UK domiciled spouses to UK domiciled spouses because such a transfer brings assets within the UK inheritance tax net.

However, prior to 6 April 2013 the amount that a UK domiciled individual could transfer to their non UK domiciled spouse or civil partner during their lifetime was limited to £55,000. This was to prevent assets from leaving the UK inheritance tax net. Any gifts over this limit were treated as a potentially exempt transfer and would only be exempt from inheritance tax after seven years.

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This exemption also applied on death, so that if a UK domiciled spouse left their estate to a non-UK domiciled spouse, (assuming no prior gifts had been made) the spouse exemption (£55,000) was available in addition to the nil rate band. The first £325,000 transferred benefited from the nil rate band and the next £55,000 was spouse exempt.

Changing the cap

The 2013 Finance Bill introduced some welcome changes to address fairness within the EU. After 5 April 2013 the inheritance tax exempt amount that a UK domiciled individual can transfer to their non-UK domiciled spouse or civil partner has been increased to equal the nil rate band ie. £325,000.  As a result a UK domiciled individual can now gift up to £650,000 to a non-UK domiciled spouse or civil partner free of inheritance tax. (Nil rate band £325,000 plus spouse exemption £325,000). This is still not treating European non-domiciled spouses the same as UK domiciled spouses.

The spouse exemption is still a lifetime exemption. This means lifetime gifts exceeding £325,000 are potentially exempt transfers. After 5 April 2013 if a spouse leaves their entire estate to a non-UK domiciled spouse or civil partner and they have not made any lifetime transfers, any excess over £650,000 is liable to inheritance tax. The increase in the exemption saves some £108,000 inheritance tax, but clearly for those with significant wealth the position is not greatly improved.

Elections to be treated as UK domiciled for IHT

A non-UK domiciled spouse can now elect to be treated as UK domiciled for inheritance tax purposes. There are two types of election, both of which are irrevocable:

  • Lifetime election – takes effect from the date of the election.
  • Death election – takes effect from the date of death of the UK domiciled spouse.

Once an election is made any assets inherited from a UK domiciled spouse are exempt from inheritance tax. If made on death the election must be made within two years of the death of the UK domiciled spouse, and the death must have occurred after 5 April 2013. By making the election the non UK domiciled spouse saves tax on the estate of their spouse as illustrated below.

Death before 6 April 2013 Death after 5 April 2013
No election
Death after  5 April 2013
With election
£ £ £
Chargeable estate

1,000,000

1,000,000

1,000,000
Less: nil rate band (325,000) (325,000)
Spouse exemption (55,000) (325,000)  (1,000,000)
Taxable estate £620,000 £350,000

 £0

 
Inheritance tax due £248,000

 

£140,000 £0

The example assumes that there have been no other transfers during the deceased lifetime.

A note of caution is needed however because, although by making the election the non UK domiciled spouse benefits from uncapped transfers from the domiciled spouse, they have also elected to have their entire estate, including any overseas assets subject to the UK inheritance tax regime.

The election remains in force while the electing spouse remains resident in the UK. This is to avoid the electing spouse immediately restoring their non UK domicile and avoiding inheritance tax on their non UK situs assets. Nevertheless, the election ceases to have effect on non UK assets once the individual has been non UK resident for more than three consecutive tax years.

Where a valid death election is made the commencement of the period for determining residence for this purpose is the date of the death of the UK domiciled spouse. This is helpful and means that where the surviving spouse leaves the UK for at least four tax years their foreign domicile will revert and non UK assets will cease to be liable to UK inheritance tax.

Conclusion

Many mixed domiciled couples will pay less UK inheritance tax following these new rules. However a range of factors will need to be considered in deciding whether to make the election. Where most of the wealth is held by the UK domiciled spouse, then the election is likely to be beneficial. But where most of the wealth is offshore and held by the non-UK domiciled spouse then it may not be advantageous. Factors such as age, life expectancy, size and location of assets and future plans will need to be considered.

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