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The UK Inheritance Tax Traps That British Expats Should Avoid

Aug. 12, 2022, 7:00 AM

Every few years, the media in the UK becomes ablaze with stories about so called “non-doms”—wealthy foreign nationals who reside in the UK but are domiciled elsewhere.

This status can confer significant tax advantages if the non-doms’ sources of wealth are kept outside the UK. “Ordinary” Brits living in the UK have no choice but to pay income, capital gains and inheritance taxes on a worldwide basis.

The optics of this tax advantage might attract the attention of the press if, for example, you are the Chancellor of the Exchequer and your spouse is a wealthy non-dom.

However, this article is not going to comment on the politics around the controversial leak of Akshata Muthy’s (wife of former Chancellor Rishi Sunak) tax status, but rather explain why it’s important for Brits who no longer reside in the UK, to consider the technicalities around domicile status.

Brief Overview

When we hear the word “domicile” we often consider it to mean something like “the place where I live, at the moment.”

In English law, however, it has a much a more powerful and enduring meaning. Think of it as more like “the country which you are deeply and strongly connected to, no matter where you happen to be living right now.”

This is important, as it can have all sorts of legal and, in particular, tax consequences.

Domicile Status

Under English law, everyone has a domicile somewhere, and only in one place at any particular time.

We are all regarded—again under English law—as obtaining a “domicile of origin” when we are born. Reflecting the times in which the domicile laws were drawn up, we normally acquire our domicile of origin at birth from the domicile of our father.

Leaving aside the somewhat sexist application of the law, this domicile of origin stays with us throughout our life unless replaced by an acquired “domicile of choice” when we are adults.

In order to displace an existing domicile, such as a domicile of origin, with a new domicile of choice, an individual is required to move to another jurisdiction with an intention to remain there permanently or indefinitely.

Tax Traps

It is a fact not always fully appreciated that, while a Brit ceasing to be a UK tax resident generally becomes much less, or sometimes not at all, exposed to UK income tax or capital gains tax, such a person’s estate remains fully exposed to UK inheritance tax (IHT) (headline rate: 40%)—on a worldwide basis. Unless, that is, they (or rather, more typically, their trustees or executors) can demonstrate that a change of domicile occurred before the relevant “IHT event” took place. Relevant IHT events are mainly either transferring valuable assets to a trust or death itself.

To put it another way, a British national could leave the UK to reside in a new location, die many years later without ever having returned to live in the UK, and yet still have their entire estate—not just any assets left in the UK—taxed at 40% by HM Revenue & Customs.

In our experience, there are many long-term British expats residing internationally who aren’t fully aware of this potentially very costly trap. The obvious way to avoid that trap is for a person to claim that they have changed their domicile. In other words (going back to our technical introduction), that their domicile of origin has been replaced by a domicile of choice. Unfortunately, however, that is not always an easy thing to demonstrate.

The first hurdle is that, for the first three or so years after leaving the UK, the tax law says that you will be treated as UK domiciled for IHT purposes in any event.

Assuming you survive those first few years, the next hurdle is reaching the evidence threshold needed to show that your domicile of origin in the UK has been abandoned for a new domicile of choice. The standard of proof required is the same as the one used in criminal proceedings—“beyond reasonable doubt”, rather than the civil test of “on the balance of probabilities.”

This means that HMRC will pursue any case where there is a reasonable amount of IHT at stake and the taxpayer’s submissions regarding change of domicile are considered to be weak.

Evidence Required

There is no prescribed checklist for changing your domicile status, but ultimately you must have a demonstrable intention to remain permanently in the place where you claim to be domiciled. This must be supported by evidence of strong personal, family, social and, as the case may be, investment and business connections in your new domicile location. There also must be proof that any equivalent connections in the UK have been severed.

When the clubhouse chat about domicile takes place, the old story about having a burial plot in the local cemetery usually gets trotted out. Of course, it is helpful to have one lined up, but, on its own, a burial plot, or any other single piece of evidence, will not suffice.

It is advisable for clients to consider preparing a signed statutory declaration stating their domicile position. This will act as a contemporaneous record of all the relevant facts and circumstances, ready to be deployed in defense of a new domicile claim when the time eventually comes.

Other Domicile Traps

There are a couple of other traps to be aware of.

Firstly, even careful planning to ensure a credible case for a change of domicile can be undone if a person becomes a UK tax resident again—even for a short period of time.

Under a relatively recent change in the rules, in such a case the domicile of origin will be deemed to be revived while the person is a UK resident. This risks HMRC taking an adverse position, even if the person concerned subsequently ceases being a UK tax resident and never stops living in their domicile of choice.

Secondly, it is worth noting that the normal, unlimited IHT exemption for transfers between spouses is disapplied if the donor spouse is UK domiciled and the surviving spouse is not UK domiciled.

For example, a country such as Monaco is a place where nationals of many countries coexist. It is not uncommon for a British expat to marry a non-British spouse. If the British spouse dies while considered UK domiciled—even if they are living at the time in Monaco, as described above—leaving significant wealth to the non-British spouse, then up to 40% IHT may get charged on the value of the transfer.

A discussion of some potential measures that can avoid this scenario is beyond the scope of this article, but it should nevertheless be borne in mind when considering IHT and estate planning generally.

This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Andrew Faulkes is Group CEO of Abacus Trust Group.

The author may be contacted at: andrew.faulkes@abacustrustgroup.com