How are the Inheritance tax (“IHT”) rules changing?
The Labour government confirmed in its Autumn Budget on 30 October 2024 that, from 6 April 2025, the UK tax system will move away from using domicile as a connecting factor for liability to applicable UK taxes, including IHT, and instead adopt a residence based regime. By way of broad summary, from 6 April 2025:
- individuals who have been UK resident for at least ten out of the past twenty tax years (defined as a “long-term resident” or “LTR“) will be exposed to IHT on their worldwide assets; and
- the IHT status of trusts created by non-UK domiciled individuals (known as “excluded property trusts“) will no longer reflect the domicile status of the settlor at the time that assets were added to the settlement; instead, the IHT status of the trust will follow the LTR status of the settlor at the date of the relevant IHT event.
The proposed changes, in more detail, are as follows.
Individuals
The position for UK-situs assets (and indirect interests in UK residential property, including “relevant loans” in connection with such) remains unchanged and these will continue to be subject to IHT irrespective of an individual’s residence status.
From 6 April 2025, however, non UK-situs assets will be subject to IHT if an individual is an LTR for the tax year of the chargeable event (such as on death or an IHT chargeable lifetime transfer). Once an individual is an LTR, potential IHT exposure will continue for a “tail” period after the LTR ceases to be UK resident. Subject to transitional rules, the duration of that tail period will be between three and ten tax years, depending on the number of tax years that the LTR was UK resident over the twenty tax years prior to their departure from the UK. For example, if the LTR was UK resident for ten, eleven, twelve or thirteen tax years, the IHT tail will be three years. The tail then increases by one tax year for each additional year of residence. For example, for fourteen years of prior UK residence, the IHT tail will be four years; fifteen years and the tail is five years, and so on. An LTR who has been UK resident for all of the previous twenty tax years prior to their departure will have the maximum IHT tail of ten years. To “shake off” LTR status after leaving the UK, an LTR will need to be non-UK resident for the duration of their tail period. For those arriving in the UK, an individual can avoid becoming an LTR in the tax year of their arrival (and for the relevant period after that) provided they have been non-UK resident for ten consecutive tax years during the nineteen tax years before the current tax year.
There are transitional rules that disapply this LTR status for those who are non-UK domiciled under the current IHT rules as at 30 October 2024, and non-UK resident for tax year 2025/26 and subsequent, even if they would be LTR under the new rules because they have been UK resident for the required ten year period in the tax year of their departure. In this case, the test for whether or not the individual is an LTR is the existing UK “deemed domicile” test (broadly, residence for fifteen of the last twenty tax years, and for at least one of the preceding four tax years). If the individual is not UK deemed domiciled, they will not be an LTR in tax year 2025/26 and will not have an IHT tail period: their worldwide assets will remain outside the scope of IHT. If they return to the UK, however, the new LTR test will apply to them.
Trusts
At present, trusts that qualify as excluded property trusts (loosely, those settled by non-UK domiciled individuals and holding non-UK situated assets) are not subject to IHT on their non-UK situated assets unless these include indirect interests in UK residential property (including “relevant loans”).
From 6 April 2025, where such trusts have a settlor who is an LTR, the assets in the trust (whether UK situated or not) will be within the scope of IHT and subject to the IHT “relevant property regime”. The effect will be that such trusts will be subject to ten-yearly anniversary charges and proportionate exit charges (both at a maximum rate of 6% on value above the available nil-rate band).
Importantly, where a settlor becomes an LTR after 6 April 2025, an exit charge will be triggered when the settlor’s IHT tail period expires and the trust’s non-UK situated assets come out of the IHT relevant property regime and become “excluded property” again.
If a settlor can benefit from their trust (a “settlor-interested trust”) and the trust was settled before 30 October 2024, by concession under the draft legislation, the assets of the trust will not be deemed to be within their estate for IHT purposes on their death. This would otherwise be the case as a result of the IHT “gift with reservation of benefit” (“GWR“) rules, potentially resulting in double IHT charges: both at trust level under the relevant property regime (a maximum of 6%), and as part of the settlor’s personal estate on death (a maximum of 40%). Settlor-interested trusts set up or funded on or after 30 October 2024 could be subject to these double IHT charges; however, this will not be the case for as long as the settlor remains a non-LTR and where the trust was fully funded before 30 October 2024, provided in each case the trust fund is entirely non-UK situated (i.e. does not comprise indirect interests in UK residential property, including “relevant loans”).
From the documentation and commentary currently available, it appears that this “grandfathering” provision for trusts in existence before 30 October 2024 will not apply to any additions to a pre-30 October 2024 trust. It is currently unclear whether such an addition will taint the entire trust for GWR purposes, or create a separate sub-fund within the trust which is subject to the GWR rules for as long as the settlor is an LTR.
Implications for individuals and trustees from 6 April 2025
The above changes are set out in draft legislation in Finance Bill 2025 and therefore subject to amendment; however, major alterations are not expected and, as a result, once Finance Bill 2025 becomes law on 6 April 2025, the implications are likely to be far-reaching for individuals and trustees of excluded property trusts.
For individuals thinking of leaving the UK before 6 April 2025 to prevent (i) their non-UK situated assets coming within the scope of IHT from that date; and (ii) the acquisition of an IHT tail period if they leave the UK in future, thought will need to be given to where it may be best for them to settle. Managing their UK day count will be important (assuming some continuing presence in the UK) to ensure such individuals do not unintentionally remain UK tax resident, despite no longer treating the UK as their country of primary residence. Tax residence in the UK is determined under the UK’s statutory residence test which is multi-faceted and complex, and can result in an individual being UK resident after a relatively short period of time if they have several “ties” to the UK. You can read more about the UK statutory residence test on our website here.
For trustees of excluded property trusts, such trusts will be affected if they have a settlor who is not planning on leaving the UK imminently and so will become an LTR from 6 April 2025 or later tax year. The trust fund of such excluded property trusts could be subject to IHT charges from 6 April 2025. Trustees will need to take advice on how the IHT relevant property regime will apply to the trust assets, including taking note of when the trust was created to consider when the first ten-yearly anniversary charge will arise. Due consideration should be given, in good time, to how any IHT charges will be funded, especially if liquidity will need to be available; bearing in mind that raising such liquidity could result in UK income tax or capital gains tax charges from 6 April 2025 for a UK resident settlor (for more information on which, please see the article “Non-dom reforms: to stay or to go?“. Trustees will also need to be alive to the IHT implications for the trust should the settlor leave the UK and cease to be an LTR, as this will result in an IHT exit charge, and they will need to ensure that planning is in place to avoid any unintentional IHT charges arising.
The analysis in this note is based on the new non-dom rules as announced in the Autumn Budget on 30 October 2024, as detailed in the government’s technical note published on 30 October 2024 and the draft legislation published on 7 November 2024. These have given clarity about the framework of the non-dom reforms, although technical changes may be introduced between now and the implementation of the rules on 6 April 2025.