IHT exemption for non-domiciled spouses: draft Finance Bill 2013 provisions

Practical Law UK Legal Update 8-523-3095 (Approx. 7 pages)

IHT exemption for non-domiciled spouses: draft Finance Bill 2013 provisions

by PLC Private Client

Background

IHT spouse exemption

Transfers of value between spouses (and civil partners) are normally exempt from inheritance tax (IHT). However, there is a limit of £55,000 on this exemption for transfers made by UK domiciled individuals to non-UK domiciled spouses or civil partners. This limit applies to the cumulative total of all transfers made by the same transferor to one or more spouses or civil partners during his lifetime and on death (Section 18, Inheritance Tax Act 1984 (IHTA 1984).)

For more information about the spouse or civil partner exemption, see Practice note, Inheritance tax: overview: Gifts to a spouse or civil partner.

Domicile

There is no statutory definition of domicile, for tax purposes. Rather, it is a common law concept that the courts use to determine which legal system applies to an individual, where that individual has connections with more than one jurisdiction. Broadly, domicile is where an individual has his permanent home or intends to settle permanently.

For more information about domicile, see Practice note, Domicile.

Deemed domicile

Regardless of an individual's actual domicile, section 267 of IHTA 1984 sets out two rules which operate to treat a non-UK domiciled individual as being UK domiciled for IHT purposes if he has:

Been UK domiciled in a three year period prior to a relevant transfer.
Lived in the UK for 17 out of 20 years ending with the year of assessment in which the relevant transfer occurs.

For more information about deemed domicile, see Practice note, Domicile: How is domicile determined: Deemed domicile.

Reform of IHT treatment of transfers to a non-UK domiciled spouse or civil partner

In the 2012 Budget, the government announced that it would legislate in the Finance Bill 2013 to:

Increase the £55,000 limit on IHT exempt transfers to the value of the IHT nil rate band (currently £325,000).
Allow non-UK domiciled spouses to elect to be treated as deemed domiciled for IHT, so that they can benefit from an unlimited spouse exemption.

The Budget announcement stated that there would be a consultation on these proposals in summer 2012 but no consultation took place (see Private client tax legislation tracker 2012-13: IHT: exemption for non-domiciled spouses). In October 2012, the European Commission (EC) formally requested the UK to review the IHT spouse exemption on the ground that the £55,000 limit on the exemption for gifts by UK domiciled to non-UK domiciled spouses was discriminatory (see Legal update, IHT spouse exemption discriminatory, says European Commission).

Draft Finance Bill 2013: increase in the IHT exempt limit

Draft legislation published on 11 December 2012 amends section 18 of IHTA 1984, increasing the amount that a UK domiciled individual can transfer to his non-UK domiciled spouse or civil partner free from IHT. Initally, the measure will raise the current limit on the value of assets that can be transferred free of IHT from its current level of £55,000 to £325,000. Going forward, the limit will be defined by reference to the level of the prevailing IHT nil rate band.

The increased limit will apply to transfers on or after 6 April 2013.

Draft Finance Bill 2013: electing to be treated as UK domiciled for IHT purposes

The draft legislation allows non-UK domiciled individuals to elect to be treated as domiciled in the UK for IHT purposes. Its purpose is to address the risk of non-UK domiciled individuals taking assets outside the UK and thereby outside the scope of IHT.

The draft legislation sets out:

The conditions to make an election where:
- both the non-UK domiciled individual and his UK domiciled spouse or civil partner (the couple) are alive (see Conditions for making an election: Lifetime election);
- the UK domiciled spouse or civil partner of the couple has died (see Conditions for making an election: Death election).
How and when to make an election (see Making an election).
The period within which an election is effective (see Effective elections).
The statutory provisions and arrangements relating to domicile that are unaffected by making an election (see Statutory provisions and arrangements unaffected by election).

Conditions for making an election

To establish whether or not an individual is qualified to make an election, the draft legislation provides that domicile status is to be determined without reference to any deemed domicile treatment arising from the operation of section 267 of IHTA 1984 (see Background: Domicile: Deemed domicile).

Lifetime election

To make an election where the couple are alive, both the following conditions must be satisfied:

The spouse or civil partner of the individual making the election must be domiciled in the UK at the time the election is made.
The individual making the election must not be domiciled in the UK at the time the election is made.

Death election

To make an election following the death of one of the couple, both the following conditions must be satisfied:

The spouse or civil partner of the individual making the election died on or after 6 April 2013 and was UK domiciled when he died.
The individual making the election was not domiciled in the UK at the time the spouse or civil partner died.

Making an election

How to make an election

An election must be made in writing to HMRC.

When to make an election

An election may be made at any time after marriage or registration of a civil partnership. The first opportunity to make an election will be the date that Finance Act 2013 receives Royal Assent.

A death election must be made within two years of the death of the UK domiciled spouse or civil partner.

Effective elections

Lifetime election

An election made while the couple are alive will take effect from the date the election is made.

Death election

A death election will be treated as taking effect immediately before any transfer treated by section 4 of IHTA 1984 as made by a deceased immediately before death. That is, where a non-UK domiciled spouse makes a death election within two years of the death of his UK domiciled spouse or civil partner, he will be considered to have made the election immediately before his spouse or civil partner died.

If any disposition or other event occurs after the election is deemed to have taken place (that is, immediately before the UK domiciled spouse or civil partner dies) but before the electing individual actually makes the election, the electing individual is treated as having made a transfer of value and consequently, he is liable to IHT that may arise from that transfer. The time limits for submitting an IHT account and paying any IHT plus interest are calculated from the date the election was made.

Records of elections

HMRC will keep a record of elections that can be disclosed to the personal representatives of a deceased taxpayer (HMRC: Inheritance tax: spouses and civil partners domiciled outside the UK: Technical Note, paragraph 29 ).

Effective elections and UK residency

For the purposes of the draft legislation, whether an individual is considered to be UK resident will be determined by the statutory residence rules to be introduced in Finance Bill 2013 (see Private client tax legislation tracker 2012-13: International individuals: Statutory residence test).

An election will be irrevocable while the electing individual remains resident in the UK. This is to prevent an individual electing to be treated as UK domiciled for IHT purposes to avail of the uncapped limit on transfers from his spouse or civil partner and then immediately reverting to non-UK domiciled status to restore beneficial IHT treatment of his non-UK assets.

An election will cease to be effective if the electing individual is non-UK resident for more than three full consecutive tax years. For death elections, any years between the date of death and the date of the election for which the electing individual is not UK resident will count towards the three year period of non-UK residence. Where the period of non-residence applies, the election will have no effect from the end of the third consecutive tax year of non-UK residence. Consequently, subject to the operation of section 267 of IHTA 1984, an electing individual will not remain liable to IHT on his non-UK assets after the end of the three year period.

Statutory provisions and arrangements unaffected by election

An election will not affect the following:

Statutory provisions for deeming UK domicile for IHT purposes, based on an individual's history of UK domicile or residence status (see Background: Domicile: Deemed domicile). Therefore, section 267 of IHTA 1984 may operate to treat an individual as UK domiciled where an election to be treated as UK domiciled is no longer effective.
An individual's domicile for the purposes of treating government securities and certain types of savings as property excluded from IHT under sections 6(2) and (3) and 48(4) of IHTA 1984. For further information on excluded property, see Practice note, Inheritance tax: overview: Excluded property.
An individual's domicile status for income tax or capital gains tax purposes. An election relates only to an individual's treatment for IHT purposes. Therefore, it will not affect an individual's eligibility to be taxed on the remittance basis of taxation rather than on the arising basis (HMRC: Inheritance tax: spouses and civil partners domiciled outside the UK: Technical Note , paragraph 19). For further information on the remittance basis of taxation, see Practice note, Remittance basis: what is a remittance?.

An election is to be ignored when interpreting or applying estate duty conventions and double taxation treaties which determine an individual's domicile for the purposes of qualifying for double taxation relief from IHT. For more information about double taxation treaties relating to inheritance tax, capital transfer tax and estate duty, see Practice note, Double taxation treaties: inheritance tax, capital transfer tax and estate duty.

Comment

The increased IHT exempt limit on transfers between spouses or civil partners, without consultation, is perhaps unsurprising, given the EU's criticism of the current limit last October, on the ground that it was discriminatory. Deciding whether to make an election will need careful consideration. Remaining non-UK domiciled for IHT purposes may still be attractive for those whose worldwide assets are or may reach such value that the combined benefits of an increased IHT exempt limit and escaping a worldwide charge to IHT outweigh the advantage of unlimited IHT exempt transfers to a spouse or civil partner. Practitioners whose clients elect to be treated as UK domiciled should consider whether their clients' wills need to be changed to reflect this decision (for example, where a will contains a statement as to domicile).

Sources

HMRC: Inheritance tax: spouses and civil partners domiciled overseas.

HMRC and HM Treasury: Overview of legislation in draft, paragraph 1.24.

HMRC: Inheritance tax: spouses and civil partners domiciled outside the UK: Technical Note.

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IHT exemption for non-domiciled spouses: draft Finance Bill 2013 provisions | Practical Law