New IHT rules for non-UK domiciled spouses
On 11 December 2012, HM Treasury published draft legislation to increase the inheritance tax (“IHT”) exemption for non-UK domiciled spouses and civil partners as from 6 April 2013. This is welcome news for couples with a mixed (UK and non-UK) domicile. In the remainder of this update, the word “spouse” is used to refer to a spouse or civil partner.
At present, the general rule is that transfers between spouses (during their lifetimes or on death) are fully exempt from IHT. However, if the transferring spouse is UK domiciled and the recipient spouse is non-UK domiciled, the exemption is capped at £55,000. This means that the remainder of the UK domiciled spouse’s transfer is subject to IHT at the rate of 40% (subject to the nil-rate band and any other available reliefs or exemptions). Where the recipient spouse is UK domiciled, the transfer is fully exempt and there is no IHT to pay.
The logic for the capped spouse exemption is the risk that otherwise a non-UK domiciled spouse will avoid IHT on the assets they inherit from their UK domiciled spouse. They can do this by taking the inherited assets outside of the UK (a non-UK domiciled individual is not liable to IHT on assets situated abroad).
In October 2012, the European Commission criticised the UK’s capped spouse exemption as discriminatory.
Under the proposed new rules, from 6 April 2013, the “cap” will increase to the level of the prevailing IHT nil-rate band (currently £325,000). In addition, non-UK domiciled spouses will be given the option to benefit from an uncapped spouse exemption by making an election to be treated as UK domiciled for IHT purposes.
An election will allow a non-UK domiciled individual to receive assets from their UK domiciled spouse on death free of IHT, but comes at a price: the worldwide estate of the non-UK domiciled individual will be brought within the IHT net. If no election is made, only the UK assets of a non-domiciled individual are liable to IHT.
The election must be made by the non-UK domiciled spouse (the “Electing Spouse”) and can be done during the lifetimes of both spouses (a lifetime election) or after the death of the UK domiciled spouse (a death election). It cannot be revoked whilst the Electing Spouse remains UK resident, but will automatically cease to have effect once that spouse has been non-UK resident for three consecutive tax years either from the date of the election (in the case of a lifetime election) or from the date of death of the UK domiciled spouse (in the case of a death election).
The election will not affect the Electing Spouse’s domicile status for the purpose of the remittance basis applicable for income tax and capital gains tax. The election will have effect for IHT purposes only.
Should I make an election?
Whilst the final form of the new rules will not be known until the legislation, the Finance Bill 2013, is confirmed at Budget day (20 March 2013), it is nevertheless worthwhile for spouses with a mixed (UK and non-UK) domicile to start considering whether the non-UK domiciled spouse should make an election so that action can be taken once the legislation comes into force. Regrettably, there is no simple formula to decide whether an election will result in a lower IHT bill. An analysis will need to be made in each situation bearing in mind the following factors:-
- The value of both spouse’s estates
- The proportion of UK situated assets in those estates
- The importance to the couple of delaying any IHT until the second spouse dies
- The likelihood of the couple’s estate changing significantly, particularly if they plan to redirect their wealth outside of the UK
- The age and health of both spouses