Chapter 6 - How to Avoid Inheritance Tax

6.1 INTRODUCTION

The general rule is that an individual domiciled in the UK will be subject to inheritance tax on his or her worldwide assets. Non-UK domiciled individuals are only subject to UK inheritance tax on their UK assets.

In order to lose your UK domicile you will need to build up evidence to show that you have abandoned your UK domicile of origin and have acquired a new domicile of choice. In layman's terms, this involves 'cutting your ties' with the UK and establishing a new permanent home overseas. In any case, for expats who are UK 'born and bred', it makes sense to reduce any ongoing connection with the UK as part of the process of establishing residence overseas.

This is something that many who leave the country do not do... with disastrous tax consequences. Frequently they return to the UK on many occasions, keeping within the permitted number of days for income tax purposes. This pattern of behaviour is likely to indicate that you have not abandoned your domicile of origin, with the result that you will be subject to UK inheritance tax on your worldwide assets.

In order to safeguard your overseas estate from inheritance tax, you are likely to have to make some significant changes to your lifestyle in order to produce evidence that you have a new domicile of choice.

6.2 HOW TO LOSE YOUR UK DOMICILE

You should take as many of the following steps as possible to show evidence of an intention to acquire a new domicile of choice:

• Take up nationality in the new country.
• Join clubs and other social organisations in the new country.
• Dispose of UK investments.
• Resign from clubs in the UK.
• Close UK bank accounts.
• Buy an overseas burial plot.
• Avoid subscriptions to British newspapers.
• Dispose of all UK private residences.
• Buy a new residence in the new country.
• Make a will under the laws of the new country.
• Build up a new circle of friends in the new country.
• Avoid retaining directorships in the UK.
• Exercise any vote in the new country.

It should be noted that none of the above factors are in themselves conclusive. However, Revenue and Customs will look at all the factors that can be put in evidence to determine whether there is a real intention to reside permanently in the new country.

Obtaining a non-UK domicile of choice does not protect you completely from UK inheritance tax. You will still be liable to tax on your UK assets. If the value of these assets is less than the nil rate band (currently £325,000) it is probably not worth taking any further action, unless you expect your assets to rise significantly in value.

If you wish to keep significant UK assets, one option would be to place an overseas company between yourself and your assets. What you would then own are shares in an overseas company -- a non-UK asset. Care must, however, be taken with the disposal, to ensure that any gain falls outside of the scope of UK capital gains tax. The use of offshore companies is explained in detail later on.

A case to determine domicile status came before the Court of Appeal in 2006. This case actually had nothing to do with tax; rather it focused on how domicile affects someone's will. However, it is equally relevant for UK tax purposes.

The case concerned Mr. N who died while living in England. Originally born in Cyprus, he had lived in England for the last 28 years of his life. While living in the UK he established a very successful business and acquired a British passport.

He also retained strong connections with his country of birth and lived in the UK essentially as a Cypriot. He watched Cypriot TV, spoke in Greek with friends, had a Cyprus bank account and sent his daughter to school in Cyprus. He also had two buy-to-let flats in Cyprus.

After he died his fiancée claimed that he was domiciled in England and Wales and that the court had jurisdiction to vary his estate. (The case was concerned with how his estate was distributed on his death).

Many who emigrate to the UK will identify with Mr. N's circumstances: while living in the UK, they still retain a strong bond with their country of birth.

6.3 HOW DOMICILE STATUS IS DETERMINED

As we know there are two main types of domicile (with the third type, domicile of dependency, being a variation on the domicile of choice).

Firstly there is the domicile of origin which is the domicile an individual acquires when born. Normally, it is the father's domicile, although if the parents are not married, it will be the mother's domicile.

Domicile of origin is the default domicile and will continue to apply until it is changed. The main way to change it would be to acquire a domicile of choice. This essentially means that a person would need to show a clear intention to live permanently in a new jurisdiction.

So a foreigner coming to live in the UK could establish a UK domicile of choice that would override the domicile of origin. This would then continue until it is abandoned, in which case the domicile of origin would revive, unless a new domicile of choice was established in another jurisdiction.

It is important to note, however, that overriding your domicile of origin is very difficult and is not something that should be taken lightly.

In this case, Mr. N clearly had a Cypriot domicile of origin. In order for his fiancée to be successful, she would need to show that he had established England as his domicile of choice.

The Court of Appeal stated:

"...the court must look back at the whole of Mr. N's life, at what he had done with his life, at what life had done to him and at what were his inferred intentions in order to decide whether he had acquired a domicile of choice in England by the date of his death..."

The court then went on to reiterate that a domicile of origin has an 'adhesive' quality and the burden of proof falls with the person who is arguing for the domicile of choice.

In essence, the court looked at evidence to substantiate the fact that Mr. N was to live permanently or indefinitely in England, and they stated that "clear, cogent and compelling evidence" was required in order to override the domicile of origin.

In this case, the Court of Appeal found that Mr. N was a non-UK domiciliary, although this was pretty much expected, and is in line with the position prior to the case. The comments of the judges are, however, useful to bear in mind. It should also be noted that Mr. N had no definite intention to eventually return to Cyprus. The fact that he had strong links with Cyprus and the lack of any strong evidence from his fiancée to fix his permanent residence in the UK, seems to have swung the balance in favour of non-UK domicile status.

Based on this court decision, most foreign nationals in similar positions and with strong overseas links should feel more confident in their non-domicile status.

A recent court of appeal case in 2008 (Henwood v Barlow Clowes International) reinforced just how close your ties have to be to a country to support a change in domicile. It also made clear that it is just as hard to show a change in your domicile of choice as it is to show a change from a domicile of origin to a domicile of choice.

In either case, you would have to show very close ties with a particular jurisdiction. Simply having a strong overseas presence is not, in itself, enough. You need to be able to show that, not only are you resident in a particular country, but also that you intend to live there permanently.

If you do have multiple homes overseas, clearly establishing one as your real home (i.e., your 'chief residence') would therefore be advisable.

6.4 HOW TO ESTABLISH AN OVERSEAS DOMICILE

In practical terms, it is difficult for UK emigrants to convince the UK taxman that they have become non-UK domiciled.

The main way that you would declare that you are non-UK domiciled would be via your UK self-assessment tax return.

However, it is only necessary for Revenue and Customs to consider your domicile status if it is immediately relevant in determining your UK income tax or capital gains tax liability. If you are non-resident this will not be an issue, as you will not in any event be subject to UK capital gains tax or income tax on overseas capital gains and income.

For a non-resident, the only impact of non-domicile status is for UK inheritance tax.

You cannot assume that you are non-UK domiciled just because HMRC does not look into the issue during your lifetime. If you wish to determine your domicile status prior to death, there are a few things you can do.

If you are non-UK domiciled and living in the UK, the simplest way to establish non-UK domicile status with the taxman is to ensure that you have a small amount of overseas income that is not fully remitted to the UK.

You can then apply the remittance basis, and HMRC would need to look into your circumstances to decide whether you should be taxed on the full interest earned (like a UK domiciliary) or only on the interest actually brought into the UK.

The easiest way to achieve this is to ensure you place some funds in an overseas interest-bearing account and do not remit all the interest generated.

However, a non UK domiciliary (who is also UK resident) is subject to a number of new rules as of 6th April 2008.

It suffices to say that using this technique to establish a non UK domicile will only be an option for many, provided the income retained overseas is less than £2,000. If it exceeds this, there would then be a whole raft of further tax considerations including the potential loss of personal allowances and an additional £30,000/£50,000 annual tax charge.

The other scenario is where a UK domiciliary emigrates and wants to establish an overseas domicile of choice.

Testing your domicile status in this case is more difficult. One method would be to gift cash or assets (above the £325,000 nil rate band) to a discretionary trust or company. Provided the cash or assets are situated overseas, inheritance tax would be payable unless you have lost your UK domicile. Accordingly, if the taxman does not attempt to make you pay inheritance tax, it will be clear that he accepts that you have acquired a foreign domicile.

In order to do this, you would complete a form IHT 100 and also an additional form (Form D31) to enable the Revenue to gather the information they need to consider your domicile status.

6.5 RETAINING YOUR DOMICILE OF ORIGIN

Many UK immigrants and their children are non-UK domiciled. There are substantial tax advantages to be had from retaining this status. In particular:

• Overseas assets can be passed though the family free from UK inheritance tax.
• Overseas assets can be used to generate income offshore. Provided the income is not brought into the UK, there may be no liability to UK taxation.
• There are greater opportunities to use offshore trusts and companies, as many of the anti-avoidance rules apply only in a restricted form to non UK domiciliaries.

As always, however, you and your family need to be careful:

Firstly, the deemed domicile rules (Chapter 2) will deem you to be UK domiciled for inheritance tax purposes, after you have been here for 17 years. Many families will find that their children are subject to UK inheritance tax as a result of this rule. Note, however, that the deemed domicile rule only applies for inheritance tax purposes. Your children could still accumulate assets offshore without paying any UK tax.

The next risk is that the taxman may contend that you or your children have acquired a UK domicile of choice. This is very likely if you have stayed in the UK for a number of years. To establish that you have acquired a UK domicile of choice, the evidence would need to show that you intend to stay in the UK permanently.

There are a number of other options that could be considered to minimise UK inheritance tax. These are considered elsewhere in the book, however they include:

• Using mortgages/loans to reduce the value of your estate.
• Using an offshore structure to avoid estate taxes.
• For non-domiciliaries, disposing of UK assets and purchasing assets overseas. The capital gains tax implications (both UK and overseas) should be considered. However, for an individual who intends to remain overseas for a significant period, UK CGT would not be an issue, and dependent on the terms of any double tax treaty and domestic tax legislation, there may not, in fact, be any overseas tax charged.
• Investment in assets that qualify for Business Property Relief (BPR), for example, shares in unquoted trading companies and assets used in a trading business.

6.6 MOVING ABROAD TO LOSE UK DEEMED DOMICILE

Many non-domiciled individuals living in the UK will be within the scope of UK inheritance tax (IHT) on the basis that they have the UK as their deemed domicile. This will be the case if they have been resident in the UK for 17 or more of the last 20 tax years.

This is bad news in terms of inheritance tax as it means that their worldwide estate is then subject to UK inheritance tax. This will therefore include overseas assets as well as UK assets.

Deemed UK domicile does not affect income tax or capital gains tax -- provided they are still non-domiciled due to not making the UK their domicile of choice (and having an overseas domicile of origin). They will still be able to claim the remittance basis for income tax and capital gains tax purposes.

Non-doms in this position may consider moving abroad. In that case provided they lose their UK residency and deemed UK domiciled status, they would be exempt from UK IHT on overseas assets.

Note that for inheritance tax it is the tax position of the deceased/donor that is important, not the recipient. Therefore the fact that a non-dom makes a gift of overseas assets to a UK resident and UK domiciled individual would not prevent it being exempt from UK IHT.

Time Taken to Lose UK Deemed Domicile

To avoid inheritance tax the key issue is to ensure that UK residence status is lost.

We have covered this in detail in other sections of the book, but let us reiterate that you should be able to be classed as non UK resident from the date of departure provided your departure from the UK is genuine and is because you are working overseas or making your main home overseas.

You are deemed to be a UK domiciliary for inheritance tax purposes if:

• You were actually domiciled in the UK within the previous three years.
• You have been resident (for income tax purposes) in the UK in not fewer than 17 out of the 20 tax years ending with the tax year of gift or death.

Note that the two rules apply different tests. The first rule applies to calendar years, the second applies to tax years.

Therefore, if you are a deemed UK domiciliary due to being UK resident for at least 17 of the last 20 tax years, you would need to be non-resident for four tax years in the 20 year period (which ends with the year of any death or gift) to avoid this.

Residence for this purpose is the same as residence for income tax purposes.

Therefore, you would need to ensure that your return visits were within the day requirements.

After you have lost your deemed domicile you could always test your domicile status by making a transfer of overseas assets just above the remaining nil rate band to an offshore trust. Providing you were a non-dom (i.e., not a deemed UK domiciliary) this would be excluded property for IHT purposes and exempt from IHT. HMRC would then consider and rule on your domicile position.

If you were accepted as a non UK domiciliary from an IHT perspective it would make sense to transfer UK assets abroad to avoid IHT. You could also achieve this by transferring UK assets into an offshore company (owned by you or a trust/settlement created by you).

About the Author

He worked in Ernst & Youngs Entrepreneurial Services department for a number of years before setting up his own tax planning practice. He is now a full time tax author.

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