For High Net Worth Individuals (HNWIs) and Ultra High Net Worth Individuals (UHNWIs), wealth retention is an important consideration when deciding to get married or enter into a civil partnership.
Unsurprisingly, when considering whether or not to make this commitment, the fiscal consequences of doing so are often overlooked. While marrying for financial reasons is not the most romantic notion, seeking advice at the early stages is essential—not only in terms of wealth protection, but also wealth planning.
It is often said that money and emotions do not mix, but for those with significant wealth, failing to consider what may happen after you say “I do,” could be costly.
We outline below some of the key points to consider when deciding whether getting married is wise (financially speaking) and if so, how to make marriages or civil partnerships work financially.
At present, inheritance tax (IHT) is 40% of the estate at death (provided that the estate is valued at over the IHT Allowance of 325,000 pounds ($414,600). However, if assets are transferred to a spouse, the transfer is potentially tax-free. This is a huge draw for many considering whether or not to “tie the knot.”
Many people are under the impression that anything they gift to their partner, whether during their lifetime or on death, is fully exempt from IHT. However, the tax status of any spousal gift depends on the domicile status of the individuals involved.
Generally speaking, issues most commonly arise with mixed domicile couples, i.e. where one partner is U.K. domiciled and the other is not.
Awareness of these issues allows HNWI/UHNWIs the opportunity to take steps to mitigate the impact of these rules to avoid a hefty tax charge.
Where a U.K. domiciled partner transfers assets to a partner that is U.K. non-domiciled, the tax-free amount is restricted. There is another allowance of 325,000 pounds in addition to the IHT allowance of 325,000 pounds, meaning that the maximum amount that can be transferred to a U.K. non-domiciled partner without attracting a tax charge is 650,000 pounds.
The legislation allows a U.K. non-domiciled partner to make an election to be treated as U.K. domiciled, which enables the couple to benefit from the full spousal exemption. Helpfully, the election has no impact on any remittance basis claim that the U.K. non-domiciled spouse may make.
However, this election needs to be approached with caution. Although the election can be extremely useful in some cases, in others it could be equally harmful. This is because the election goes much wider than merely giving the U.K. non-domiciled individual the benefit of the spousal exemption. The election treats the U.K. non-domiciled partner as if they were U.K. domiciled for all IHT purposes. This means that the U.K. non-domiciled partner’s worldwide assets (previously outside the scope of U.K. IHT) come fully within the scope and past gifts may need to be re-examined.
Issues also arise when both parties are U.K. non-domiciled (therefore outside the scope of U.K. IHT save for U.K. situs assets) but one inadvertently becomes U.K. domiciled, thus creating a mixed domicile relationship. With the complex deemed domicile and Formerly Domicile Residents (FDR) rules, couples could find themselves caught by the mixed domicile restrictions without realizing.
Before getting married or entering into a civil partnership it is wise to seek advice to consider whether the couple is, or is likely to become, a mixed domicile couple to determine whether there are any opportunities to improve the couple’s overall tax position.
Until April 1990, married couples were taxed as one person. Although this has changed and all couples are now taxed as individuals, there are still certain opportunities available to spouses and civil partners which can assist in reducing the couple’s overall income tax liability and in turn improving their financial position.
Once married or within a civil partnership, various income-producing assets can be transferred to a spouse or partner (who pays a lower rate of tax, to take advantage of all available tax-free allowances). A pre-nuptial agreement (see further below) could be crucial here to ensure that despite any asset or income shifting, the ownership of the underlying assets on divorce or separation is clear.
Due to anti-avoidance legislation, planning of this nature only works within a marriage or in a civil partnership. Were an individual to attempt to enter into such an arrangement with a cohabiting partner, they would be unable to benefit from the asset in any way once it has been given away. Furthermore, should the relationship end, the asset would be owned by the other person outright.
For those HNWIs and UHNWIs who want to take advantage of the wealth protection measures that marriage or civil partnership may bring to them, but do not want to ultimately lose control of assets that they own before the marriage or civil partnership, there are a number of steps that they can take to protect themselves.
Some proactive HNWI/UHNWIs seek to protect their assets by establishing a discretionary trust. One key benefit of establishing a trust is that it does not require the agreement of your partner/spouse.
Separation of the legal and beneficial ownership of the trust assets may provide some protection ownership challenges in the future.
It is, however, important to note the costs of setting up a discretionary trust, over and above entering into a pre-nuptial agreement as an alternative. In addition to adviser fees, there may be periodic IHT charges during the lifetime of any trust, together with an immediate IHT charge of 20% on the initial transfer of the asset, should the value of the gift (or the value of gifts made within the relevant tax year) exceed 325,000 pounds.
In addition, while a trust may offer some protections, it is not an ironclad form of asset protection. The courts will look at a number of factors when deciding whether a trust asset should form part of any divorce settlement, including what benefit has been derived from the trust during the relationship.
Family Investment Companies
While potentially advantageous as a wealth protection mechanism for some, trusts have fallen out of favor with those who are deterred by the potential 20% IHT charge upon settling assets into trust. Accordingly, some families have sought to use corporate structures such as Family Investment Companies (FICs) as a tax efficient way of managing and protecting family’s wealth.
As a limited company, a FIC has directors and shareholders who are commonly individual family members. Careful drafting can determine who receives capital or income and whether or not shares can be transferred outside of the family.
The FIC’s founder transfers assets into the company and may wish to relinquish control of the assets by holding shares that carry limited or nil rights to income but full voting rights. This has the added benefit of meaning that the founder’s shares hold very little economic value, meaning that the value of the shares is nominal from an IHT perspective.
In the event of a divorce, the U.K. Supreme Court confirmed in Prest v Petrodel  UKSC 34 that the family courts can only “pierce the corporate veil” (i.e. look through the corporate legal entity) to the assets that lie within this company structure in very limited circumstances.
While structuring of this type may at first glance seem inoffensive, last year, HM Revenue & Customs (HMRC) set up a FIC Unit. The FIC Unit is tasked with conducting risk reviews of private companies used by family offices and HNWIs to manage their wealth, making sure that they are operating in line with U.K. tax laws and that the settlements legislation on income has been taken into account upon setting up the company.
Given the numerous tax issues associated with this type of structure and HMRC’s increased focus in this area, families who are considering planning of this nature need to ensure that proper tax advice is taken in respect of not only the limited company position, but also that of the family members who may receive some form of benefit.
Pre-nuptial and post-nuptial agreements have long been around, but they are gaining weight in the Family Courts in England and Wales and are increasingly popular for HNWIs and UHNWIs who want to get married.
As most will know, the basic premise of nuptial agreements is that they enable couples who want to get married or enter into a civil partnership to agree in advance what they would want to happen to their finances if the relationship ended.
A family lawyer will advise that to give these agreements the best chance of being upheld by a court (the ultimate arbiter) in England and Wales, they must comply with certain requirements and meet the needs of the financially weaker spouse. Needs shift, relative to each marriage.
Subject to this caveat, nuptial agreements can provide great flexibility as to how assets are retained or shared by spouses, including for tax purposes. For example, while a HNWI/UHNWI may wish to be married or in a civil partnership to take advantage of potentially significant IHT savings, they may not want their spouse to benefit from their assets in the same way on divorce as they would on death. Nuptial agreements can protect assets on divorce, while also providing the spouse(s) and their family with the above IHT benefits.
This includes business interests. If either spouse is heavily invested in a business, absent a nuptial agreement, that investment could form part of the matrimonial pot, available for division in the event of divorce. However, nuptial agreements can ring-fence these interests, protecting the business and the invested spouse.
Marrying is a risky business for HNWIs and UHNWIs—especially if their partner is less wealthy. The court can make invasive orders in respect of global assets to provide a settlement to a financially weaker party. While there are other options to protect wealth, nuptial agreements offer the greatest security for many—provided that they are properly negotiated and signed sufficiently in advance of the wedding. However, HNWIs and UHNWIs looking to wealth protect should think very carefully about whether getting married is the best option for them and be aware that if the marriage breaks down, it could be costly.
Entering into a marriage or civil partnership is an event that renders any existing will invalid. Couples should look at setting up a new will which sets out how assets are to be distributed upon death. Where a person dies intestate (i.e. without a will), the rules of intestacy will be used to distribute assets. The rules of intestacy in England and Wales do not recognize cohabiting partners, meaning that assets may not be distributed in a way that is in keeping with the deceased’s wishes and may give rise to an unforeseen tax liability for their loved ones.
Planning ahead is of the utmost importance, as will be seen in the next article in this series when we look at the issues that arise during divorce.
While many may be forgiven for thinking that these issues do not need to be dealt with before getting married or entering into a civil partnership, if the relationship starts to break down, it is simply too late. If someone suspects that their partner is transferring assets out of their sole name to protect them from any potential divorce settlement, then court applications can be made to have assets frozen or added back into the matrimonial pot.
Tax planning is in no way a one-time process. It must be continuously reviewed to ensure compliance with the laws and regulations that keep evolving.
However, there are other factors to consider when considering getting married or entering into a civil partnership (alongside the romantic ones, of course). Enshrining those issues within a nuptial agreement may offer much-needed certainty should the relationship break down.
Similarly, for those who are not married or in a civil partnership, it may still be beneficial to set out the terms of any living arrangements by entering into a cohabitation agreement to formalize what may have been agreed, but not yet recorded anywhere.
In respect of all the issues discussed above, expert advice is advised.
- Assess whether a pre-nuptial or post-nuptial agreement is appropriate.
- Look at how certain assets are held and whether any transfers need to be made in advance of any marriage or civil partnership.
- Seek advice as to the domicile status of the couple to assist in any IHT planning.
- Consider the tax rate paid by each spouse or partner and whether assets can be held in a more efficient way.
- Discuss how you intend for any assets to be transferred upon death to inform planning decisions.
- Prepare a new will.
(Please note all of the above tax allowances are based on the 2020–21 tax year.)
Morag Ofili and Daisy Minns Shearer are Senior Associates with Harbottle & Lewis.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.