Inheritance tax planning: the importance of domicile
Domicile - a non-tax concept
An individual’s domicile is a concept that is enshrined in general law, though it does have an impact for tax purposes. Unlike for residence, there is no test in the tax statutes for common law domicile. As a result, it is not uncommon for clients to be unsure of their domicile status, or to believe they aren’t UK domiciled, only for HMRC to challenge this when looking at the inheritance tax (IHT) account after death. Knowledge of your client’s domicile is crucial for IHT planning purposes. There are also income tax and capital gains tax (CGT) issues, e.g. for using the remittance basis (see Follow up ), but we are only considering the IHT rules here.
IHT impact
If a client is UK domiciled, or deemed domiciled, all of their assets will fall within the remit of UK IHT, irrespective of where it is located in the world. In contrast, a non-UK domiciled client’s assets are only caught by the UK IHT net to the extent that they are in the UK. Assets that escape IHT in this way are said to be “excluded assets” - an important concept we will return to later on.
Practice point. “Located” here doesn’t just mean physical location. The legal situs of assets is subject to particular rules, for example shares are located where they are registered, not where the share certificates are kept. HMRC’s indexed guidance at IHTM27000 (see Follow up provides helpful information on this.
Example. Marco died in 2021. He was UK resident, but non-domiciled here. He owned a house worth £300,000 and had £60,000 in a savings account. He also owned land overseas valued at £500,000. The land will be an excluded asset for UK IHT purposes.Let’s now look at the different types of domicile that an individual may have or acquire.
Domicile of origin
An individual acquires a domicile of origin at birth. In England and Wales, where the parents are married, this is automatically the father’s domicile at the birth date. However, where the parents are unmarried or if the father died before the birth, the domicile of origin would be that of the mother at the birth date.
The situation in Scotland is different for births on or after 4 May 2006. Here, the child’s domicile depends on both parents, and may require looking into the relationships with both parents to see which is the closest connection.
Practice point. A domicile of origin remains with an individual for their entire life. In cases where a domicile of choice is later acquired, the domicile of origin remains dormant and acts as a default domicile if the domicile of choice is later abandoned. This is to ensure an individual cannot be without a domicile at any time.
Domicile of dependency
A child may acquire a new domicile where they are under 16 and the parent who their domicile of origin stems from acquires a new domicile of choice. There are similar provisions for individuals that lack the mental capacity to change their own domicile.
A further category of domicile of dependence may have applied to women who were married before 1 January 1974 as, prior to this date, a woman acquired her new husband’s domicile upon marriage. Her domicile would then automatically change if her husband acquired a new domicile of choice. However, these became domiciles of choice (and so could be changed) automatically on 1 January 1974.
Domicile of choice
A domicile of choice may be acquired by an individual after they turn 16 (under UK law). This is more complicated than simply making a statement that they consider themself to be domiciled in a particular territory. There needs to be both:
- a physical presence in the territory
- the intention to remain permanently.
The physical presence needs to be of sufficient quality to constitute living in the other country. Going on holiday or having a vague intention to move there will not be enough. The intention to remain must be such that the individual intends to live in the new territory for the rest of their life, though of course this can change later on and a new domicile of choice may be acquired.
If both these components are missing, the domicile of origin automatically applies. Remember, it is in HMRC’s interests to argue as strongly as possible that a client has not shed their UK domicile for a new domicile of choice, and it’s unlikely that it will accept this has been done if the individual has not severed all ties with the UK. In the case of the late actor Richard Burton, the UK tax authorities successfully attested that he had retained a UK domicile of origin due to the fact he owned a house in Wales, and his funeral had a very patriotic Welsh theme. This was despite his living in Switzerland for 26 years prior to his death.
Deemed domicile
The domiciles discussed above are all “common law”. However, there is one form of statutory UK domicile - the deemed domicile. This permits HMRC to treat an individual who is genuinely not domiciled in the UK as if they were domiciled here for IHT purposes. The concept of deemed domicile was expanded in 2017.
Long-term residents. An individual will be deemed domiciled as a long-term resident in a tax year if they have been resident in the UK under the statutory residence test (see Follow up ) for 15 out of the previous 20 tax years.
Formerly domiciled residents. Some individuals will become deemed domiciled in the UK from the first day of their second period of residence. This will affect individuals that:
- were born in the UK with a UK domicile of origin
- are resident in the UK for the tax year being examined; and
- were resident in the UK in one of the previous tax years.
Practice point. This will affect lifetime transfers as well as those made upon death.
One problem with deemed domicile is that it doesn’t take into account the intention of the client, only the circumstances set out in the legislation. This can potentially lead to unwanted results.
Example. Mary was born in the UK with a UK domicile of origin. She moved to Australia in 1979 to marry, acquiring an Australian domicile of choice. Mary’s husband died in February 2019, and she came to stay with her daughter who moved to London for work. Mary intended to return to Sydney after Christmas 2021 but fell ill and died in November 2021. Despite the clear intention to return, Mary will be deemed domiciled in the UK for 2021/22, meaning all her Australian assets would be within the scope of UK IHT.
Practice point. Certain double tax treaties have clauses that override the deemed domicile rules. Seek specialist advice if your client has a domicile in France, Italy, Pakistan or India.
Advising non-domiciled clients
Hopefully, the above information helps to give you a starting point for your client. If they have a common law UK domicile, their worldwide estate will be subject to IHT, and so any advice would surround shedding this for a new domicile of choice if that is desired.
Practice point. If you are advising clients looking to permanently leave the UK and shed a UK deemed domicile, the time this will take depends on whether that status was acquired under the formerly domiciled resident provisions, or as a long-term resident. If it’s the latter, it can take up to four complete tax years to shed the domicile tail due to the “previous years” test.
Practice point. Where there is such a tail, your clients could use liquid assets to purchase qualifying UK Treasury securities designated as FOTRA securities until the deemed domicile status expires. Such assets are virtually risk-free, and do not attract UK tax if held by residents abroad.
However, we are going to assume that your client does not have a UK domicile of origin and has only been resident here for ten tax years. They have not yet acquired a domicile of choice in the UK as they intend to move overseas eventually. What IHT planning opportunities exist?
Excluded property
As mentioned earlier, assets which are sited outside the UK are “excluded assets” for UK IHT purposes. This means that they are completely outside the scope of the IHT net and can be transferred in life or upon death with no exposure to UK IHT. It would therefore be prudent for non-domiciled clients to hold as much of their assets as possible outside the UK where this is realistically possible.
UK residential property is always within the charge to IHT, regardless of the residence or domicile of the owner, or any offshore structure. It is not therefore possible to use an offshore company to purchase, say, a house in the UK and rely on the situs rules to exclude the underlying value, which would of course be reflected in the share value.
Practice point. There are no equivalent restrictions on commercial property, which could be a good option for UK investment via an offshore structure, particularly a trust (see below).
Chattels are sited where they are physically located, so if these are usually kept overseas they will be excluded property. There are also provisions which waive any liability to UK IHT if foreign works of art are brought to the UK for exhibition, cleaning or restoration if the owner is non-domiciled and dies while the assets are here for those purposes.
Savings are another easy asset to move. The situs of funds in a bank account is determined by the location of the branch that maintains the account, so a non-domiciled client can remove cash deposits from the UK IHT net by moving to an overseas bank.
Practice point. HMRC’s view is that cryptocurrency is an intangible asset and that its situs follows the residence of the person holding it.
It is also feasible to sell UK shares and reinvest the proceeds into non-UK shares.
Example. John, who is not domiciled or deemed domiciled in the UK, owns shares in Acom Ltd, a listed UK company. The shares are currently worth £500,000 and will be within the scope of UK IHT because they are registered in the UK. John could sell the shares and transfer the proceeds to an offshore account, or purchase shares not registered in the UK to remove this value from the IHT net.
Practice point. Of course, liquidating assets may have CGT consequences so don’t overlook this.
As a cautionary note, certain interests in foreign close companies or partnerships will not be excluded property if the entity derives its value from UK residential property. In addition, the sale of a relevant interest will lead to a two-year “taint” for the proceeds, and any assets purchased using the proceeds even if they would be excluded under the general rule. HMRC’s guidance on this is at IHTM04311 (see Follow up ).
Example. Germaine is non-UK domiciled and owns shares in a foreign close company whose only assets are UK residential property. She sells her shares for £1 million in October 2021, and uses the proceeds to purchase land in Spain, which she gifts to her son (who resides there) 18 months later. The gift will be a chargeable lifetime transfer in the UK because the two-year rule applies.
Deemed domicile trap
The above strategy to maximise excluded property works while your client remains non-domiciled. However, the longer they reside in the UK, the more likely it is that they will trigger a deemed domicile status as a long-term resident. This would immediately bring their worldwide estate into the UK IHT net.
A well-established planning mechanism for such clients approaching the deemed domicile threshold is to place excluded assets into an offshore trust, i.e. an “excluded property trust”. It is essential that this occurs before the tax year that the deemed domicile status kicks in.
Practice point. A major advantage of this type of arrangement is that the trust beneficiaries won’t become liable to UK IHT, even if they are UK-domiciled, until such time as the trust assets are transferred to them.
Following the Court of Appeal hearing in Barclays Wealth Trustees (Jersey) Ltd and another v HMRC [2017] EWCA Civ 1512 , Finance Act 2020 contained changes which made clear that the test for excluded property is measured at the time the asset is settled, not the date the settlor becomes UK domiciled or deemed domiciled.
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