Reforms To UK Inheritance Tax: The Move To A Residence-based Regime

There have been major changes this year to the UK's tax regime for individuals with an international connection. Our separate article considers the abolition of the "non-dom" regime and its replacement, from 6 April 2025, with a new residence-based foreign income and gains (FIG) regime. In this article, we consider the UK's recent reforms to the way in which inheritance tax is charged in the UK.

Individuals

Before 6 April 2025, an individual's liability to UK inheritance tax depended on their domicile status (a concept linked, for the purposes of UK tax law, to the jurisdiction in which an individual has their "permanent home") and the location of the asset in question.

Broadly speaking, non-UK domiciled individuals were liable to UK inheritance tax only in respect of UK situs assets during their first 15 years of UK tax residence. Once the individual had lived in the UK for 15 out of the last 20 years, they were "deemed domiciled" in the UK and so their worldwide assets fell within the scope of UK inheritance tax (with the possible exception of non-UK assets held within an "excluded property" trust, considered further below).

Assets within the scope of UK inheritance tax are (subject to exemptions and reliefs) taxed at a flat rate of 40% on the individual's death. However, since 6 April 2025, domicile is no longer a connecting factor for inheritance tax and has been replaced by the concept of long-term residence.

An individual is a long-term resident once they have been UK resident for at least 10 out of the last 20 tax years. From year 11, their worldwide assets fall within the scope of inheritance tax (even if they are not UK resident in year 11) and remain as such for a certain period (a minimum of three years, rising to a maximum of 10 years for individuals who are UK resident for 20 years or more) following their departure from the UK. There are transitional rules for individuals who left the UK before 6 April 2025 which effectively apply the old rules to ascertain the duration, if any, of the inheritance tax "tail".

One effect of the new rules is that an individual who remains domiciled in the UK but who has been non-UK resident for at least 10 years is, from 6 April 2025, outside the scope of UK inheritance tax in respect of non-UK assets as they are not a long-term resident.

Trusts

As far as the inheritance tax treatment of trusts is concerned, under pre-6 April 2025 rules, non-UK assets, held in "excluded property" trust structures which were established by non-UK domiciliaries before they became deemed domiciled in the UK, fell outside the scope of inheritance tax (even after the individual became deemed domiciled).

Since 6 April 2025, whether non-UK trust assets are within the scope of inheritance tax depends primarily on whether the settlor of the trust is a long-term resident at the time the relevant inheritance tax event occurs or, if the settlor has died, whether the settlor was a long-term resident at the date of their death.

This means that non-UK trust assets can move in and out of the scope of inheritance tax in accordance with the settlor's inheritance tax status. (Note that when trust assets move outside the scope of inheritance tax (due to the settlor ceasing to be a long-term resident), an "exit" charge under the "relevant property regime" (at a maximum rate of 6%) will arise.)

There are transitional arrangements for trusts which were established prior to 30 October 2024 and were outside of the scope of inheritance tax at that date. For such trusts, there will (generally) be no inheritance tax charge on the settlor's death (irrespective of the settlor's inheritance tax status on death). However, if the settlor is (or becomes) a long-term resident, the trust assets will not be protected from ongoing inheritance tax charges arising (at rates of up to 6%) under the relevant property regime.

Considerations for clients

The reforms to inheritance tax mean that new arrivers to the UK (and individuals returning to the UK following at least 10 years' non-UK residence) will remain outside the scope of worldwide inheritance tax for their first 10 years of UK residence (as compared to 15 years under the old "non-dom" regime).

For trusts, it is clear that the reforms significantly erode the inheritance tax benefits associated with many structures. However, this is not the case in all circumstances. For example, existing "excluded property" trusts whose settlor died before the new rules came into force could remain outside the scope of inheritance tax indefinitely. The same applies to trusts whose settlor is living but is not classed as a "long-term resident" for inheritance tax purposes (perhaps because they are non-UK resident and have no intention of moving to the UK). For individuals who wish to establish a non-UK trust whilst UK resident, it remains possible to do this without an immediate charge to inheritance tax, provided this is done before the individual becomes a long-term resident. Once the settlor becomes a long-term resident, the trust assets will continue to be excluded from inheritance tax on the settlor's death (but not in relation to charges under the "relevant property regime") if the settlor is excluded from benefit under the terms of the trust.

Life insurance policies may also be of assistance in covering a potential inheritance tax liability after 10 years of UK residence. It should also be noted that double tax treaties can, in certain circumstances, block UK inheritance tax charges.

Further advice

The reforms to inheritance tax, together with the replacement of the non-dom regime with the new FIG regime, represent a significant change to the way in which individuals with an international connection are taxed in the UK. However, the most appropriate course of action for such individuals will need to be considered on a case-by-case basis so specific advice will be essential.

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.