This article discusses the concept of deemed domicile and explains why due to recent government proposals, it may be advisable to consider an excluded property trust sooner rather than later.
There has been much discussion over the concept of deemed domicile for UK inheritance tax (IHT) purposes and the length of time that an individual is able to reside in the UK without being regarded as deemed domicile and therefore caught by the UK IHT provisions, which are explained below.
The UK Government reviewed the concept of deemed domicile area of legislation and announced that from April 2017 the period of time after which an individual becomes UK domicile for IHT purposes will reduce from the current position of 17 years out of 20 to just 15 years out of 20 years! After 15 years, individuals will then become subject to IHT in the same way as those who are domiciled in the UK.
What does domicile mean?
Domicile is a concept that is relevant for determining the position in respect of IHT. There are various forms of domicile and even where an individual is living in the UK but claiming not to be UK domiciled it may be that they will be deemed domiciled in the UK.
Currently, an individual will be deemed UK domiciled for IHT purposes if:
- They are UK resident for 17 of the last 20 tax years (15 of the last 20 years from April 2017).
- They have lost their UK residency in which case they will be deemed domicile for three years after leaving the UK.
The importance of determining domicile means that:
- If a person is domiciled or deemed domiciled in the UK, they are potentially subject to IHT on their worldwide assets.
- If they are non-UK domiciled, they are only subject to IHT on assets situated in the UK.
Tax Planning Opportunities
An excluded property trust is a trust that makes use of ‘excluded property’ as described in section 6 Inheritance Taxes Act 1984. This defines ‘excluded property’ as assets which are exempt from UK IHT if they meet defined criteria. Provided it is established while the settlor is non-UK domiciled and it only holds excluded property, it will be outside the scope of IHT. For these purposes, excluded property covers all property situated overseas, including offshore investment bonds and offshore collectives as well as UK gilts, authorised unit trusts and OEICS.
Therefore providing the criteria are met then an excluded property trust may never be subject to any UK IHT charges.
Maria lived in Spain where she became a well-known salsa dancer. Subsequently Maria decided to move to London in January 2001 to teach salsa.
Due to her success, Maria has substantial assets in Spain and is being advised on tax planning by her financial adviser. Maria has lived in the UK for 15 years so far. Under the existing domicile provisions she is not deemed domicile for UK IHT purposes. She therefore has the option of creating an excluded property trust to ensure that her assets outside of the UK are not caught by the UK IHT provisions should she become deemed domicile in the UK. If Maria creates such a trust before she becomes UK deemed domicile then whilst the assets of the trust are held offshore within the trust, they will not be included in Maria’s estate for IHT purposes even after she becomes UK deemed domicile.
If Maria decides to leave this tax planning opportunity because she considers that she has plenty of time to think about this, then after 17 tax years (15 tax years from April 2017) of living in the UK she will be UK deemed domicile and it will not be possible for her to create an excluded property trust since she will then be subject to the IHT provisions.
If the current rules do change as suggested above, then Maria will have already missed the opportunity to create an excluded property trust as she will have been living in the UK for 15 years and will therefore already be deemed domicile.
How an offshore bond subject to an excluded property trust may help
- Protection of assets from IHT by excluding them from the non UK domiciled client’s estate before they become deemed UK domiciled.
- 5% tax deferred withdrawals available.
- Full access to these assets (subject to income tax liabilities) in your client’s lifetime.
- Avoids delays in obtaining probate in the event of your client’s death meaning those who need the money most can benefit straight away on the instruction of the trustees. The trustees retain control over who benefits from the assets at their discretion.
- Unlike taxation of discretionary trusts for UK domiciled clients, excluded property trusts are not subject to the initial, periodic or exit charges for IHT unless the assets become UK situated.
- Extensive investment choice - Old Mutual International's extensive range of MultiManager funds, which grow free from local taxes, make it possible to choose a portfolio of funds that match attitude to risk. The funds invested are not currently liable to taxes in the Isle of Man or Ireland. However, investment income accumulating in any fund may be subject to tax deduction in the country where the income was produced.
- International location - assets remain outside the UK and qualify as excluded property.
Additional points to consider
Once payments are made to a beneficiary outside of the excluded property trust, this amount (unless spent) will form part of that beneficiary's estate for IHT purposes.
When planning your client's affairs for IHT, you should as far as is practical, also give consideration to the financial regime and tax system in their likely country of residence when the trust is set up and when the investment is encashed either in full or in part.
If an individual is considering IHT planning and is currently non-UK domiciled but there is potential of them becoming UK domiciled in the future, it is clear how the use of an excluded property trust can be an extremely effective tax planning tool for IHT purposes. However, with the changes being introduced from April 2017 reducing the number of years an individual will become deemed domicile, the importance of considering this planning opportunity at an earlier stage is even more essential.