This Note touches on particular changes to the IHT rules made in the Finance Act 2013 (“FA 2013”) concerning transfers of property between spouses. (References below to “spouses” include civil partners, and references to “marriage” include a civil partnership.) Before turning to the changes with which this Note is concerned some background points are made to put the changes in context.
Background points
The scope of IHT
- Two of the principles of IHT are that:
1. IHT is chargeable on all property situated in the UK – regardless of where the owner is “domiciled”; and
2. IHT is chargeable on all property of someone “domiciled” in the UK – wherever the property is situated.
- In other words, in principle, IHT is a worldwide tax which extends to all property other than property which is both (1) situated in the UK, and (2) owned by someone “domiciled” outside the UK.
What is “domicile”?
- It’s clear from the above that the question of where someone is “domiciled” is crucial. Much judicial and legal writers’ ink has been spilled discussing the question of “domicile”. But this is how HM Revenue and Customs (HMRC) summarise it (and such summary may suffice for present purposes):
“Domicile is not the same as nationality or residence. Your domicile is decided under general law, which means it must be interpreted according to previous rulings of the courts.
Questions of domicile can be complex but broadly speaking you have your domicile in the country that is your ‘real’ or permanent home which, if you have left, you intend to return to.
You cannot be without a domicile, and you can only have one domicile at a time.”
- It may happen that if a UK domiciled person marries a foreign (non UK-domiciled) person the foreign spouse may acquire a UK domicile such that both spouses will then be UK domiciled. But that would not automatically follow: the foreign spouse may well retain his or her original foreign domicile. It will depend on a combination of the facts and intentions.
IHT and the spouse exemption
- In principle, IHT is charged on the value of an individual’s property on death and also on certain lifetime gifts. The first £325,000 worth of transfers made in any seven year period does not give rise to any IHT liability. This is known as “the nil rate band”. And, outright lifetime gifts between individuals are not charged to IHT provided the donor survives for at least seven years after the date of the gift. Such gifts are known as “potentially exempt transfers” (PETs).
- Importantly however, the general rule is that all transfers between spouses – whether made in life or on death – are exempt from IHT altogether. So, the nil rate band is not eaten up by inter-spouse transfers.
Special rules about the IHT spouse exemption in cases of “mixed marriages” – pre-FA 2013
- In this Note “mixed marriages” means a marriage where one spouse is UK-domiciled but the other is not.
- As mentioned above, the general rule is that all transfers between spouses (whether in lifetime or on death) are exempt from IHT.
- If, however, the donor spouse was domiciled in the UK but the donee spouse was not UK-domiciled then the exemption was restricted to only £55,000.
- The rationale for that significantly restricted exemption was that assets going from a UK domiciled spouse to his or her non UK-domiciled spouse would be much more likely to escape the IHT net because, as mentioned above, IHT is charged on the worldwide assets of someone who is UK domiciled, but it is only charged on UK situated assets of someone who is not UK-domiciled. So, a UK-domiciled spouse could transfer property to his or her non UK-domiciled spouse who, in principle at least, could then avoid IHT altogether by ensuring that none of those assets were situated in the UK.
- The FA 2013 made various changes in relation to the IHT rules in relation to mixed marriages: (1) to give a more generous IHT exemption, and (2) to allow a non UK-domiciled spouse to make an election to HMRC to be treated as UK domiciled for IHT purposes.
(1) FA 2013 and increase of IHT exemption for mixed marriages
- As mentioned above:
“In principle, IHT is charged on the value of an individual’s property on death and also on certain lifetime gifts. The first £325,000 worth of transfers made in any seven year period does not give rise to any IHT liability. This is known as ‘the nil rate band’.”
- Again, as indicated above, that “nil rate band” applies to transfers between individuals who are not spouses whereas, in general, all transfers between spouses are altogether exempt from IHT.
- But, from 6th April 2013, transfers from a UK domiciled spouse to his or her non UK-domiciled spouse will be exempt from IHT up to the amount of the “nil rate band” – instead of the mere £55,000 limit as previously. And that exemption will thereafter be linked to the amount of the nil rate band as and when it is increased in future years.
(2) Election to be treated as UK domiciled
- FA 2013 also introduces the scope for a non UK-domiciled spouse to elect to be treated as UK-domiciled for IHT purposes. That could allow the full IHT spouse exemption. But it would also mean that his or her worldwide assets would come within the IHT net. Such an election is, in principle, irrevocable. So care would be needed before any such election were made. For example, an election could prove disadvantageous for a non UK-domiciled individual with substantial property situated outside the UK.
- Ultimately, the issue as to whether an election should be made will depend on a range of factors some of which will not be known until the death of the UK domiciled spouse (e.g. the location and value of the couple’s assets at the time of their respective deaths). An election does not have to be made until two years after the death of the UK domiciled spouse. So, it may be sensible to defer any decision until just before the two-year deadline for a death election as the potential benefits may be clearer at that stage.
Note: This material is for information purposes only and does not constitute any form of advice or recommendation by us. You should not rely upon it in making any decisions or taking or refraining from taking any action. If you would like us to advise you on any of the matters covered in this material, please contact Neil Mackenzie: email njm@mitchells-roberton.co.uk