With wealthy families being more mobile and international, their tax and financial planning has become more complex.
One of the biggest issues they face is establishing an inheritance strategy, which takes into account all of their liabilities and potential taxes, plus the domicile and the location of their assets.
Domicile is a “tricky subject”, Graeme Robb, senior technical manager at Prudential UK, told International Adviser.
People have been trying to grasp the concept for centuries, as evidenced by the UK’s Domicile Act of 1861.
While inheritance tax (IHT) targets the individual gifting their assets or money, their domicile is what determines what needs to be taken into consideration when seeking financial planning.
Devil’s in the details
“UK IHT is a donor-based tax. If the deceased is a UK domicile, the liability is on the worldwide estate – less exemption and reliefs. And for a non-domicile their UK estate – less exemptions and reliefs,” David Denton, international tax expert at Quilter International, told IA.
“The amount chargeable in the UK does not depend upon the domicile or residence of someone who inherits.
“However, where the recipient is resident or domiciled could determine whether a tax is chargeable in that country if their system is based upon the recipient – as opposed the deceased, as per the UK – which could be in addition to UK IHT.”
For instance, most European countries differ from the UK, as their way of dealing with inheritance issues is rooted in civil law, which has different concepts and procedures for handling such matters.
The European case
When it comes to cross-border planning, unsurprisingly, provisions can become more complex, despite several efforts aiming to harmonise international laws, especially within the European bloc.
“It is still relatively easy to come unstuck when making plans to transfer assets to their heirs,” Andrew Dixon, head of UK & international wealth planning at Kleinwort Hambros, told IA.
“For example, ‘forced heirship’ and ‘usufruct’ are not concepts we understand in the UK, but are common in Europe where civil law dominates.
“Similarly, many countries limit the amounts an individual can gift by applying a tax charge above a certain threshold. By contrast, the UK does not limit gifts to other individuals, but retrospectively taxes those gifts if donor fails to outlive the gift by seven years.”
And navigating any treaties or relationships the UK may have with other countries when it comes to taxation, could make planning even more difficult, Quilter’s Denton added.
“Given that the UK has but 10 double taxation agreements to accommodate this, such cross-border issues can be complex.
“There is the possibility of what is called ‘unilateral relief’ which is the granting of relief from the effects of international double taxation on the basis of domestic legislation rather than the provisions of a tax treaty.
“If unilateral relief does apply, a good solicitor fully understanding cross border nuances will be needed,” he said.
Don’t get things mixed up
The problem is that simply moving assets outside the UK won’t exonerate wealthy families from their IHT liabilities.
The chief executive of the Aisa Group, James Pearcy-Caldwell, warned that there are three main misconceptions people need to be aware of when it comes to inheritance tax:
- UK IHT rules apply for several years even after moving overseas or ceasing to be UK domiciled.
- The country you are now domiciled in, will have its own trust and IHT rules that need to be considered in planning and Wills, which may conflict with UK rules. Some countries do not recognise trusts for example.
- Often, and the most pressing, is the issue of ill health or beneficiaries and where they live.
He continued: “The third point is relevant especially where an individual is compelled to return to the UK. It can destroy all their planning very quickly.
“If beneficiaries or executers live in the UK, then they have a legal requirement to report any inheritance received. This often negates the so-called ‘tax planning’ that has taken place overseas.”
Solve the problem
When asked about what wealthy families can do to avoid being in HM Revenue & Customs’ (HMRC) crosshairs, many told IA of one particular vehicle.
Prudential UK’s Robb; Edward Grant, director of tax consultancy firm Technical Connection; and law firm Irwin Mitchell’s tax, trust and estate associate Yousafa Hazara, all agree that one of the best solutions is establishing an excluded property trust.
“[It] is commonly used by non-UK domiciles where non-UK property, such as an offshore bond, is settled into trust; and if the client later becomes domiciled in the UK, then the trust fund can remain outside the scope of IHT,” said Robb.
But there is a strict procedure that has to be followed for it to work correctly, Hazara told IA.
“The key is that these trusts must be set up before the settlor becomes domiciled or a long-term UK resident – those who have been in the UK for 15 years or more – so forward planning is required,” she added.
This is because once a person becomes domiciled in the UK, their assets will be subject to IHT, meaning that such matters need taking care of before a change in domicile.
Hazara continued: “The assets must be kept outside the UK to remain protected from IHT, and must not include non-excluded overseas property.
“Global tax position can be made more complicated if children are beneficiaries and live in countries which don’t recognise [or] like trusts.
“Full use of all available exemptions and reliefs should be made, and non-doms can always consider taking out life insurance to cover their potential IHT liability.”
Plan ahead and then plan some more
Besides issues relating to taxation treaties or cross-border differences in legislation, there are also personal matters that people must be prepared for, warned Lana Corrienne Mallon, senior wealth planner at Lombard International Assurance.
“Other issues can intensify the discussions around inheritance planning. Sometimes it is personal; such as divorce, age and retirement, the international movement of children and grandchildren or climate.
“Sometimes it is financial; performance of the stock markets, the ‘health and wealth’ of a county’s currency or changes in a jurisdiction’s tax regime.”
This is why planning ahead is imperative.
“The UK government’s stance may have hardened significantly over the years, but there are still considerable planning opportunities available for international clients to minimise or avoid liability to IHT,” Irwin Mitchell’s Hazara added.
“Non-UK domiciled status gives particular scope for IHT planning, because assets situated outside the UK, other than an interest in a close company/partnership or loan that derives value from UK residential property, are outside IHT.
“Because liability to IHT is based on domicile, a non-domicile status is more valuable for IHT than for other UK taxes.
“But IHT planning cannot be undertaken in a vacuum. Measures taken may have an impact on an individual’s [capital gains tax (CGT)] or [income tax] liability.
“Any planning should therefore always take into account all the tax effects as well as the individual’s circumstances as a whole,” Hazara said.