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Case study: Changes to IHT spouse exemption

The problem: My clients are an elderly married couple, one of whom is a UK national, UK-domiciled tax payer and one of whom is a non-dom. How can this affect inheritance tax planning?

The solution: The Finance Act 2013 has radically reformed the IHT treatment of transfers between spouses/civil partners where the recipient spouse is domiciled outside the UK.

Until 5 April 2013, such transfers were subject to a lifetime limit of £55,000, an amount that had remained unchanged since 1982. The provisions of the Finance Act 2013 have changed the position in respect of transfers on or after 6 April 2013. The changes are:

  • An increase in the IHT-exempt amount that a UK-domiciled individual can transfer to a non-UK domiciled spouse or civil partner.
  • To allow non-UK domiciled individuals with a UK-domiciled spouse/civil partner to elect to be treated as UK-domiciled for IHT.

The lifetime limit has been increased to the level of the inheritance tax nil rate band at the time of the transfer, currently £325,000. This limit will increase as the nil-rate band increases.

UK domiciled elections can be made either during the lifetime of the UK domiciled spouse/civil partner, or after that individual’s death. 

The election is made by or on behalf of the non-UK domiciled spouse.

Elections can take effect from a specified date. This date can be up to seven years before the election is made – seven years before death in the case of a post-death election. No election can be effective before 6 April 2013.

The election must be made in writing to HM Revenue & Customs, with:

  • the full name and address of the individual/personal representatives making the election; 
  • that individual’s date of birth and, if appropriate, date of death; 
  • the name of the individual’s spouse/ civil partner domiciled in the UK; 
  • and the date it takes effect.

Post-death elections will be valid if made within two years.

The election will be irrevocable while the electing individual remains tax resident in the UK but will cease to be effective if the individual making the election lives outside the UK for more than four successive tax years. It ceases to have effect after the four years.

The consequence of an election is that assets can be passed between spouses without an inheritance tax charge with benefits for planning.

Let’s say Victoria is UK-domiciled; her spouse Albert is domiciled in Germany but has been UK-resident for the past nine years.

Victoria has assets of £5m. Albert owns an apartment in Heidelberg worth £400,000 and has £400,000 managed by a Swiss private bank. He has £100,000 in various UK Oeics and £50,000 in cash Isas. Victoria’s will leaves all her assets to Albert.

If Victoria had died in 2012 the IHT due would be: net assets £5,000,000; nil-rate band £325,000; taxable £4,675,000; 40 per cent tax £1,870,000.

If Victoria had died on or after 6 April 2013 Albert could elect to be treated as UK-domiciled. All her assets would pass to Albert under spouse exemption.

Albert could return to Germany and after four successive tax years resident there his election to be treated as UK domiciled would lapse.

During his time in the UK he would have been exposed to inheritance tax only in respect of the balance in his various Isas. His other assets would have ranked as excluded property.

Following the election, all of his own assets and those inherited from Victoria, regardless of location, would have been exposed to inheritance tax until the election lapsed. Even after the election had lapsed he would be exposed to the tax in relation to UK assets except for his UK Oeics, which would be seen as ‘excluded property’.

Eventually, if non-resident, UK assets could be disposed of without incurring a UK capital gains tax charge.

Gerry Brown is technical manager at Prudentiale

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