By Anthony Diosdi
The United Kingdom or UK imposes an inheritance tax on the estate of deceased persons that were domiciled in that country. The tax rate is normally 40 percent. The inheritance tax is typically levied on estate values over 325,000 British Sterling Pounds or $402,000 U.S. Dollars. The UK inheritance tax on a decedent’s worldwide estate. A transfer of money or property from a U.K. spouse to a spouse domiciled in another country can also trigger the tax.
Even if a person is domiciled outside the UK, two special rules apply to those who have emigrated from the UK or to those who have been resident in the UK for tax purposes for many years (IHTA84/S267). If either rule applies then, in most cases, HM Revenue & Customs may treat them as domiciled within the UK for Inheritance Tax purposes.
According to the HMRC Inheritance Tax Manual, provides three examples as to how individuals domiciled outside the UK can be subject to the UK inheritance tax.
Example 1
Paula has an English domicile and lives in England. She retires from work and decides she wants to live for the rest of her life in Spain. She goes to Spain and takes a Spanish domicile of choice on 31 January 2007. She dies on 1 January 2010 still in Spain. Because of the deemed docile ‘three year rule’ she is deemed domiciled in the UK at her death and her world wide estate is [subject to the UK inheritance tax].
Example 2
Bronislaw has a Polish domicile – He works in the UK and is UK tax resident. He has lived and worked in the UK since 2 February 1993 but he has always intended to return home to Poland. He starts to feel ill and returns home to Poland to be with his family on 8 April 2011 and unfortunately dies on 2 May 2011. Because of his common law domicile his world wide estate would not be [subject to the inheritance tax]. However the ‘17 out of 20’ tax year deemed domicile rule means that he is deemed to be domiciled in the UK at his death and his entire world wide estate is [subject to the inheritance tax].
Example 3
Humberto is 70 – he has a Portuguese domicile but has been Tax resident in England since he was 20. He decides that he wants to move back to Portugal and he leaves the UK for good on 1 January 2007. On 2 January 2010 he makes a gift of 400,000 pounds to a Gibraltar discretionary settlement from his Jersey Bank account. Without the deemed domicile provisions this would be a gift of excluded property. However the ‘17 of 20’ year rule will apply to this transfer as Humberto was tax resident in the UK for part of the Tax year before he left the UK. There is no provision in the Income Tax Acts for splitting a Tax year in relation to residence, Humberto is assessed and charged Income Tax as if he was UK Tax resident for the whole year. As a result he was non-resident in 2007/08, 2008/09 and 2009/10 only and the transfer is caught by the 17/20 rule.
The HMRC acknowledges an individual that was domiciled in the UK may not be subject to the inheritance tax if he or she becomes domiciled in the US in RDRM24030.
In RDRM24030, Domicile: Illustrative Scenarios: Mrs E, the HM Revenue & Customs discusses the application of the US-UK Estate, Gift, and Generation Skipping Tax Treaty to an individual who could domiciled in both the UK and the US. In this example, E is a US citizen with a domicile of origin in Texas who married, in July 1972, a man domiciled in Scotland. E has lived since then in Scotland, although she has a holiday home in Florida, bought in 1997, where she spent several months a year following her husband’s retirement in 1998.
E’s husband is eleven years older than she is and has recently been in poor health. E has always wished to return to the USA, but her husband will not contemplate leaving Scotland permanently. E would be happy to live out her days in Florida.
The couple’s only daughter emigrated to British Columbia during 2004. At common law E’s domicile is Scotland, as she has not taken the steps necessary to lose the domicile of choice there imposed upon her by section 4 of the DMPA 1973. When applying the US-UK Estate, Gift, and Generation Skipping Tax Treaty, E’s marriage is deemed to have taken place on 1 January 1974. In the absence of an intention on her part at any time to remain in Scotland indefinitely, E’s domicile of origin in Texas will still be operative for the purpose of the treaty.
Although RDRM24030 illustrates HMRC’s position prior to the introduction of the 2017 deemed domicile rules, this example demonstrates how the US-UK Estate, Gift, and Generation Skipping Tax Treaty can be utilized to break the domicile of a UK resident for purposes of the inheritance tax. If a UK resident is a tax resident of the US, he or she is not exempt from the inheritance tax. A UK resident is liable for the inheritance tax as long as he or she remains domiciled in the UK. However, UK residents can take steps to terminate their UK domicile and re-establish domicile in another country such as the US.
Individuals domiciled in the US are provided with a far more generous death transfer tax. Instead of a tax that unified credit from the estate and gift tax. Instead of an inheritance tax that is typically levied on estate valued over 325,000 British Sterling Pounds or $402,000 U.S. Dollars, individuals domiciled in the US are permitted a unified credit of $12.92 million (for the 2023 calendar year) against any death transfer taxes. When it comes to taxes associated with death, this is one of those rare occasions that an individual may want to be taxed in the US rather than foreign country. Although UK persons that have established domicile in the UK way want to break their domicile status, this is often a case of “easier said than done.” Domicile is a complex and adhesive concept developed under common law and it is not easy to break one’s domicile for UK inheritance purposes.
A UK person that spends a great deal of time in the US with no definite intention of leaving may be deemed a US domiciliary. An individual that was once domiciled in the UK may believe that if he or she becomes domiciled in the US and takes steps to cut ties with the UK, he or she can shed UK domicile for inheritance tax purposes. Obtaining a US domiciliary will not automatically relieve an individual of the UK succession tax. However, obtaining a US domiciliary and properly utilizing the US-UK Estate, Gift, and Generation Skipping Tax Treaty may result in the individual not being subject to the inheritance tax to the extent of his or her assets located in the US.
The US-UK Estate, Gift, and Generation Skipping Tax Treaty contains a series of tie-breaker tests that apply for when an individual is deemed domiciled in both countries. With proper planning, an individual that was once domiciled in the UK can often avoid UK inheritance taxes on their US situs property (property located in the US) through careful structuring of their gratuitous transfers during life and death. In order to potentially avoid the UK inheritance tax on US situs assets, an individual domiciled in the US and UK must be treated as domiciled in the US under Article 4 of the treaty. In general, an dual domiciled individual will be deemed domiciled in the US if he or she is a citizen of the US and if he or she resided in the UK for fewer than 7 of 10 (or 5 of the 7) years prior to the transfer in question. If this test does not apply, an individual will be domiciled in the US if his or her permanent home was in the US, center of vital interests were in the US, habitual abode was in the US, or by mutual agreement between the US and UK taxing authorities. Each case must be carefully reviewed to determine if an individual can be treated as domiciled in the US for UK succession tax purposes.
Conclusion
If you are or have been a domiciled in the UK and either have or intend to change your domicile to the US and are considered about the UK inheritance tax, you should seek out professional counsel in both the US and UK to determine the best way to mitigate your global tax liabilities.
We have substantial experience advising clients ranging from small entrepreneurs to major multinational corporations in foreign tax planning and compliance. We have also provided assistance to many accounting and law firms (both large and small) in all areas of international taxation.
Anthony Diosdi is one of several tax attorneys and international tax attorneys at Diosdi Ching & Liu, LLP. Anthony focuses his practice on domestic and international tax planning for multinational companies, closely held businesses, and individuals. Anthony has written numerous articles on international tax planning and frequently provides continuing educational programs to other tax professionals.
He has assisted companies with a number of international tax issues, including Subpart F, GILTI, and FDII planning, foreign tax credit planning, and tax-efficient cash repatriation strategies. Anthony also regularly advises foreign individuals on tax efficient mechanisms for doing business in the United States, investing in U.S. real estate, and pre-immigration planning. Anthony is a member of the California and Florida bars. He can be reached at 415-318-3990 or adiosdi@sftaxcounsel.com.