As I described last week, the changes due to come into effect from 6 April 2013 will reform the IHT treatment of transfers between UK-domiciled individuals and their non-UK domiciled spouses or civil partners in two ways:
- the exempt transfer cap will be increased to the level of the prevailing nil rate band at the time of the transfer, and
- under a new election regime, individuals domiciled other than in the UK and who are married or in a civil partnership will be able to elect to be treated as UK-domiciled for IHT purposes.
Where an individual chooses not to elect for UK-domicile treatment their overseas assets would, as now, be exempt from IHT but any transfers from their spouse or civil partner to them would be subject to the increased cap. Individuals who choose to make an election would benefit from uncapped IHT-exempt transfers from their spouse or civil partner, but subsequent disposals by them would be liable to IHT (subject to their own nil rate band), irrespective of the location of the assets.
Taken together, it is HMRC’s view that these changes will provide a balanced approach to the risk that an individual whose domicile is outside the UK may remove assets from the scope of IHT by placing them offshore. Where that risk exists, the amount that can be transferred exempt from IHT to a non-UK domiciled spouse or civil partner will be capped at a level equivalent to the prevailing nil rate band . Where there is no such risk, because the transferee is prepared to opt into UK-domicile treatment for IHT purposes — thereby making their worldwide assets potentially liable to IHT -– transfers will not be capped.
In relation to the increase of the cap, the limit on the amount that can be transferred exempt from IHT to a spouse or civil partner domiciled outside the UK (or treated as such for IHT purposes) will be increased from its current level of £55,000. Initially, the cap will be raised to £325,000. Going forward its level will be linked to any future changes to the nil rate band. Although, as mentioned last week, this will be frozen until 2017/18. Regardless of this, the increased cap will apply to transfers on or after 6 April 2013.
The HMRC guidance note on the new provisions for non-domiciliaries makes it clear that an election by a non-domiciliary for UK domicile status will only affect an individual’s treatment for IHT purposes. It will not, for example, affect their eligibility for remittance basis treatment in relation to income tax.
That said, electing into UK-domicile treatment for IHT purposes will mean that:
- transfers from a UK-domiciled spouse or civil partner will be exempt without limit from IHT, but
- the electing individual’s worldwide estate will henceforth be liable to UK IHT
The election will need to be made in writing to HMRC – there will be no prescribed form. It may be made at any time after marriage, or registration of a civil partnership. The first opportunity to make such an election will be the date of Royal Assent to the Finance Bill 2013 which is likely to be towards the end of July.
In practice, the first occasion on which IHT needs to be considered will often follow the death of one of the couple. To provide for this, where there has been a transfer as a result of a disposition on the death of a UK-domiciled individual a surviving spouse or civil partner who was not domiciled in the UK at that time may elect to be treated as UK-domiciled for IHT purposes. This will allow dispositions taking effect on death to benefit from the uncapped IHT exemption.
Elections that follow a death will only be valid if they are made within two years of the death, and only where death occurs on or after 6 April 2013.
Electing spouses making either a lifetime or death election will be able to choose a date the election applies from going back up to a maximum of seven years so that any lifetime gifts during that period are covered by the election. The earliest date that can be specified is 6 April 2013. Where no date is specified, a lifetime election has effect on the date it is made and a death election will be treated as taking effect immediately before any transfer as a result of a disposition on the death of a UK-domiciled individual.
Elections will be irrevocable while the electing individual continues to remain resident in the UK. This will prevent individuals from electing to be treated as UK-domiciled for IHT purposes to get an immediate benefit of an uncapped transfer from their spouse/civil partner while later reverting to non-UK domiciled status to regain beneficial IHT treatment to their overseas assets.
But an election will cease to have effect if the electing person is resident outside the UK for more than four consecutive full tax years. In such cases the election will cease to have effect from the end of the fourth full tax year of non residence. So, subject to the effect of section 267 IHT Act 1984, an electing individual will not remain indefinitely liable to IHT on their overseas assets after a four-year period which will be treated as effectively breaking their connection with the UK.
Whether an individual is considered resident outside the UK will be determined by statutory residence rules that will apply for income tax purposes. The broad effect is that a non-UK domiciled individual will be able to elect into UK-domicile treatment for IHT purposes at any time following marriage or registration of a civil partnership.
Any adviser with married clients or civil partners, where one is UK-domiciled and the other isn’t, needs to give serious thought to the impact that these new rules could have and to factor them into any “audit” of their financial plans.
Tony Wickenden is joint managing director at Technical Connection
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