Inheritance tax and non-doms: all change?

Inheritance tax and non-doms: all change?

At Spring Budget 2024, the Government announced proposals to change inheritance tax from a domicile-based to a residence-based tax from 6 April 2025, subject to consultation. This article looks at the detail that has been announced so far, the implications both for those who are currently UK-domiciled and those who are not, and the areas of uncertainty that will (hopefully) be addressed by the consultation (expected in Summer 2024).

Comparison of current and proposed new rules (non-trust property)

IHT is currently charged on the worldwide assets of individuals who are either domiciled in the UK under general law or deemed domiciled for IHT purposes and on the UK-situs assets only of non-domiciliaries (subject to anti-avoidance rules that may apply where UK residential property is held via an overseas structure). The deemed domicile rules (in  IHTA 1984, s. 267 ) apply where an individual:

(1)was domiciled in the UK within the three immediately preceding years;

(2)is a formerly domiciled resident for the tax year; or

(3)was UK resident for at least fifteen of the twenty immediately preceding tax years and for at least one of the four years ending with the current tax year (the 15 out of 20 year rule).

The combined effect of points (1) and (3) is that it currently takes at least three years to ‘shed’ UK domicile status: the general rule being ((1) above) that an individual treated as remaining UK-domiciled for a further three years after ceasing to be domiciled for other purposes and, for individuals who are deemed domiciled under the 15 out of 20 year rule, the effect of rule (3) being that, after three complete tax years of non-residence, the second leg of the test is not met for the following year. (An individual is a formerly domiciled resident if born in the UK with a UK domicile of origin and UK resident both in the tax year concerned and in one of the two preceding ones – the FDR provisions.)

The new proposals are set out in a technical note published on 6 March 2024. They provide for IHT to be charged on worldwide assets of a person who has been UK-resident for ten years (the residence criteria) and for such a person to remain in scope on worldwide assets for a further ten years after leaving the UK (the tail provision). The treatment of UK-situs assets is unchanged, so that they remain within the scope. (It is assumed, although this is not confirmed in the technical note, that residence will be determined by applying the statutory residence test.) It can therefore be seen that it will take a minimum of ten years to ‘escape’ the IHT net, once within the residence criteria.

Some examples

Alan has a UK domicile of origin and has been UK-resident since birth. If he moves abroad permanently, under the new proposals, he will remain within the scope of inheritance tax on his overseas assets (technically, his ‘non-UK situs assets’) for ten years, whereas under the current rules such assets would cease to be within scope after three years (assuming, of course, that he was able to demonstrate that he had ceased to be UK-domiciled under general law immediately on leaving the UK).

Beatrice was born in the UK with a UK domicile of origin but moved abroad with her parents as a small child and has since lived in various different jurisdictions. She is now aged 30 and returns to the UK. Under the new rules, her non-UK situs assets will not be within the scope of IHT until she has been UK-resident for ten years (unless the FDR rules are retained; see ‘some questions’ below). It is likely that she would not have lost her UK domicile of origin, therefore under the current rules her overseas assets would have remained within the scope of IHT. (Alternatively, if she had succeeded in establishing an overseas domicile, under the current rules, her overseas assets would be brought within the scope in her second tax year of residence, under the FDR provisions.)

Adil was born outside the UK with a foreign domicile of origin. If he comes to the UK, his overseas assets will be within scope after ten years of residence under the new rules (fifteen years under the current rules) and will remain in scope for a further ten years after leaving the UK (three years under current rules).

Some questions

The proposed new rules give no further detail in relation to the residence criteria. It is assumed that the ten years refers to a continuous period of residence, but this clearly could provide opportunities for internationally mobile individuals to avoid meeting the residence criteria by adopting a pattern of one year’s non-residence after nine years’ continuous residence. On the other hand, if the ten year period applies over an individual’s lifetime, it could have (possibly unintended) effects (for example, an individual who had studied/been educated in the UK and later returns for a brief work-related posting many years later who could then potentially be within the scope of IHT on overseas assets for a further ten years after leaving the UK under the tail provision). It would presumably also raise practical difficulties, both for individuals who would have to retain records and for HMRC in checking residence periods.

How does this affect long-term ex-pats? For example, an individual with a UK domicile of origin who retires to Spain might currently find it difficult to ‘lose’ their UK domicile status under general law where they retained a UK property and made frequent UK visits to see family, so that they would remain within the scope of IHT on their worldwide assets. Under the proposed new rules, as long as they did not breach the statutory residence test (so, for example, they ensured that any return visits to the UK did not breach the automatic UK tests), their overseas assets would cease to be within scope after ten years. It seems likely that this will be addressed during the consultation, as it has been announced that ‘connecting factors’ other than residence will be taken into account in designing the system.

If the new system is based entirely on residence, the current FDR rules would seem to be redundant (as IHT is no longer to be a domicile-based tax). Nevertheless, the technical note suggests that the treatment of formerly domiciled residents will be further considered during the consultation; however, it is possible that this may be only in relation to trust property (see below).

Currently, the spouse exemption is limited to £325,000 where the transferee spouse or civil partner is domiciled outside the UK but the transferee (or their personal representatives) may elect to be treated as UK-domiciled in order for intra-spouse transfers to be exempt (with the quid pro quo that all of the transferee’s overseas are thereby brought into scope). It is not clear whether a similar rule will apply where the transferee spouse or civil partner is not within the scope of IHT on overseas assets due to non-residence, nor whether there will be an equivalent election (although it is possibly less likely that spouses and civil partners will have different residence status).

How will settled property be affected?

Currently, overseas property that is settled when the settlor is non-UK domiciled is excluded property and remains outside the scope of IHT, even if the settlor subsequently becomes UK-domiciled (again, subject to anti-avoidance rules for UK residential property held in an overseas structure). Under the new proposals outlined in the technical note, chargeability will depend on whether the settlor meets the residence criteria or is within the tail provision either when the assets are settled and/or when trust charges arise.

This suggests that creating a settlement, say, before the residence criteria are met, will not necessarily protect overseas assets within the settlement from future trust charges at the ten year anniversary or when property leaves the trust; however, the consultation is expected to address the ‘calculation of trust charges’, indicating, possibly, that there may be scope for a reduction in the charge if the property has been excluded property for part of the period on which the charge is based.

The technical note does, however, confirm that overseas assets settled by a non-domiciled settlor before 6 April 2025 that meet the conditions to be excluded property will continue to be treated as such, so that no IHT charges arise (subject to continuing to meet those conditions and to any future anti-avoidance legislation), and that, as is currently the case, the trust property will not be brought into charge on the settlor’s death even if a benefit has been reserved (because it is excluded property). However, there is a suggestion that, subject to consultation, the FDR rules will be retained (meaning that, if the settlor was born in the UK with a UK domicile of origin, the trust property will not be excluded property for any tax year in which the settlor is UK-resident for that year and at least one of the two previous ones).

Conclusion

As can be seen from the above, there are many uncertainties surrounding the current proposals (not least, the possibility of a change of Government, although it seems highly unlikely that, whichever party is elected, the current non-domicile rules will be retained). Some of the areas that require clarification are examined above: in addition, the consultation will address possible transitional provisions, the length of the residence and tail criteria and gifts with reservation (will this address the issue of gifts with reservation made at a time when an individual has no connection to the UK but that potentially are brought within scope if the donor dies (whilst the reservation still subsists) whilst either meeting the residence criteria or falling within the tail provision?). There will be an opportunity for interested parties to participate in the consultation: until then it is possible to raise queries or make comments by e-mailing HMRC at this address.

Useful links

For commentary on the current treatment of overseas assets held by non-domiciliaries (or excluded property trusts), see Direct Tax In-Depth at ¶684-000ff.

Contributed by Stephanie Webber ACA, CTA, Senior Tax Writer, Croner-i Ltd