It is important that UK inheritance tax is taken into careful consideration, in particular by individuals who have assets in the UK.
This Information Note examines how, with careful planning, some UK inheritance tax obligations can be mitigated for certain individuals.
What is UK Inheritance Tax?
UK inheritance tax (IHT) is a tax on money or assets held at death, and on some gifts made during a lifetime (most importantly those gifts made less than 7 years prior to death).
A certain amount can however be passed on tax-free. This is known as the 'tax-free allowance' and/or the 'nil rate band'.
Each individual has a tax-free inheritance tax allowance of £325,000. This allowance has remained the same since 2010/11.
On death, inheritance tax in the UK is at a rate of 40%.
Additional Nil Rate Allowance
Individuals, with an estate value greater than their tax-free allowance of £325,000, due to the value of their home, may be able to take advantage of an additional tax-free allowance known as the residence nil rate band (RNRB).
This additional tax allowance is worth up to £175,000 (2023/24), and is available when an individual's main residence is passed to their children or grandchildren.
Does UK Inheritance Tax Apply to a Non-UK Tax Resident?
The UK inheritance rules are different depending on a person's domicile. The concept of domicile is based on a complex set of laws (outside the scope of this note). However as a broad overview, an individual is domiciled where he/she considers his/her home to be. There may also be estate or inheritance taxation liabilities in other jurisdictions. Therefore local advice should be taken in any jurisdiction where taxes might be chargeable.
For UK inheritance tax purposes, there are three categories of domicile:
- UK Domiciled – the worldwide assets of the individual will be subject to UK inheritance tax, whether the individual is UK resident or not.
- Non UK Domiciled ("non-dom") – the assets of the individual, situated in the UK, will be subject to UK inheritance tax irrespective of whether the individual is UK resident or not.
- Deemed UK Domiciled – where an individual is a non-dom but has lived in the UK in 15 out of 20 tax years. According to UK inheritance tax rules he/she is considered to be UK domiciled and his/her worldwide assets will therefore be subject to inheritance tax on his/her death.
When an individual moves to the UK, dependent on all of the circumstances of the move and the new life adopted in the UK, there may be an argument that an individual has immediately become UK domiciled. When this is not the situation, once an individual has lived in the UK for 15 years he/she will be deemed domiciled for UK inheritance tax purposes.
As is often the case, a complex set of laws is best considered through explanatory examples.
Tom is an Australian citizen, he was born in Australia and has always lived and worked there. He is a non-dom in the UK and has a net worth of £5m. He is divorced with one child aged 19.
Tom's child, Harry, chooses to study at a university in the UK and Tom is aware that UK real estate has, over the last few years, shown some good returns.
Tom purchases a property in his sole name, mortgage free, near to his son's university in the UK for £500,000, for his child to live in while studying in the UK.
Planning opportunity – 1
Even though Tom is not UK tax resident and is a UK non-dom, any assets that he has in his own name situated in the UK are subject to UK inheritance tax on his death. If Tom dies while owning the property, leaving his whole estate to Harry, there will be a tax liability of £70,000 on his death. This is 40% of the value of the property above the £325,000 nil rate band, assuming that Tom has no other UK assets.
- Tom could have considered purchasing the property jointly in the name of himself and his son. Had he done so, on his death, the value of his UK asset would have been £250,000. This is below the nil rate band threshold and therefore no UK inheritance tax would be payable.
Planning opportunity – 2
Tom is getting close to retirement and decides to move to the UK to be with his child, who has settled in the UK after finishing university. He sells his Australian home but keeps his Australian bank accounts and other investments and is still considering that he may return to Australia at some point in the future. He sends £1m over to a newly opened UK bank account before moving to the UK, to live on, once in the UK.
- Tom would be better advised to remit these funds to a tax neutral, sterling jurisdiction, such as Guernsey or the Isle of Man. If Tom was to die before becoming domiciled for UK inheritance tax purposes, these funds would then be outside the inheritance tax net.
- By structuring such an account correctly, Tom could bring 'capital only' to the UK and thereby avoid any obligation to pay income tax. Please contact Dixcart to take advice on this topic, prior to moving to the UK.
Planning opportunity – 3
Tom dies having lived in the UK for 25 years of his retirement. He leaves his whole estate to his son. As Tom was deemed domiciled at death, his entire worldwide estate, not just his UK situated assets, will be subject to UK inheritance tax at 40%, except for the nil rate band at the time of his death. If his estate is still worth £5m, the inheritance tax payable will be £1.87m at current rates and nil rate band.
- Before Tom became deemed domiciled in the UK, he could have settled the non-UK assets he still had, into a non-UK resident discretionary trust (traditionally in a tax neutral jurisdiction). This would place those assets outside his UK estate for UK inheritance tax purposes. Following Tom's death the trustees could have distributed the trust assets to Harry; achieving the same results as a will, but passing on the assets free from inheritance tax liabilities.
Planning opportunity – 4
Following Tom's death, his son Harry, decides to leave the UK for New Zealand, having lived in the UK for the previous 30 years. He sells all of his properties and other assets and deposits the proceeds in a New Zealand bank account. He dies within a year of moving to New Zealand.
As Harry only left the UK a year prior to his death, he will still have been UK resident for more than 15 of the previous 20 years. He will therefore still be considered UK deemed-domiciled at death and his entire estate would be taxable to UK inheritance tax at 40%, even though he had no assets in the UK on his death.
- Rather than the trustees distributing the assets to Harry on his father's death, it might have been prudent for the trustees to only distribute assets as needed by Harry over time. This would mean that the entire estate would not be in his name on his death and would not therefore be subject to inheritance tax in the UK. The assets would remain in the trust and be available for future generations of the family. Advice should be taken on distributions from a trust to ensure that these are as tax efficient as possible.
Summary and Additional Information
UK inheritance tax is a complex issue. In particular for individuals with assets in the UK. Careful consideration and advice need to be taken regarding the best manner to structure the holding of these assets.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.