How British expats can pass wealth to the next generation

Rupert Searle | 24 June 2018

If you're an expat, you should look seriously at inheritance tax planning. Firstly, you need to know the difference between your tax residence and your place of domicile.

Both affect the tax you pay in the country of your birth and your new home. Although, domicile is only a problem when you pass on your wealth to relatives and loved ones when you die.

If your main home (‘domicile’) is overseas, inheritance tax - IHT for short - is only due on assets held in Britain, such as a buy to let home or cash in the bank.

Some assets are ‘excluded’ for example:

  • Foreign currency accounts
  • Overseas pensions
  • Investments such as authorised unit trusts and open-ended investment companies

Tax residence dictates where expats pay local taxes on income and capital gains.

 

When you won’t count as living abroad

HM Revenue & Customs (HMRC) will consider you as UK domiciled if you:

  • Have had your main home in Britain for 15 of the last 20 years
  • Had a main home in Britain at any time during the last three years of your life

 

Inheritance tax for expats

As HMRC will look at your UK assets that are not excluded to work out if IHT is due, pinpointing where your property, cash and investments are is the next step after establishing domicile and tax residence.

This may involve some planning to ensure your wealth is distributed to those you have chosen to inherit. Different legal systems could send the proceeds of your estate to someone that you did not intend to benefit.

For example, expats in the Middle East or North Africa should expect Islamic law to apply to their estates. However, Dubai is an exception as expats can opt to have their estates treated as if drafted under British inheritance rules.

France and Spain are among European countries that have legal systems with different inheritance rules to the UK.

 

Estate planning solutions to minimise IHT

IHT rules offer several options to pass wealth on before death, including:

  • Gifts - Everyone has a £3,000 a year IHT tax-free exemption. Every tax year, you can also give: 
    • Wedding or civil ceremony gifts up to £1,000 a person and extra amounts for grandchildren (£2,500) or great-grandchildren (£5,000)
    • Normal gifts bought from income, such as Christmas or birthday presents, providing your standard of living is not affected by making the gift
    • Helping with someone’s living costs, like an elderly relative or a child under 18
    • Gifts to charities and political parties
    • As many gifts of up to £250 a person as you like if you do not claim another exemption in the same year for that person
  • Leaving money to charity - Giving a charity 10% or more of your estate reduces the IHT rate from 40% to 36%.
  • Investment tax breaks - Money invested in the Enterprise Investment Scheme and Seed Enterprise Investment Scheme qualify for Business Property Relief that reduces IHT to zero if the investments are held for more than two years.
  • Unspent pensions and QROPS - Unspent cash in British pensions or Qualifying Recognised Overseas Pension Scheme (QROPS) falls outside of UK inheritance tax rules – although some income tax may be due. The rule applies to all UK pensions. Expats also need to check any change in domicile as this may affect the tax treatment of the unspent cash in a QROPS. Some countries, such as the USA, may not recognise a QROPS as a pension under local laws, which may alter the tax treatment of the fund.
  • Setting up a trust - A popular move for many wealthy families, but one that can come with complications for expats depending on the legal status of trusts. Cash and assets left in trust are generally treated outside of your estate for IHT.
  • Life insurance - Your IHT liability can be covered through use of an insurance policy, which is written in trust. When you die, the life company will pay HMRC what you owe in tax, allowing your entire estate to pass to your beneficiaries. 

 

The seven-year tax rule on gifts

Any IHT your estate pays is charged at a rate of 40% on gifts made in the three years prior to your death.

Gifts made three to seven years before you die are taxed on a sliding scale called ‘taper relief’. Gifts do not count towards the value of your estate after seven years has passed.

Here’s how the tax works out year-to-year:

Years between gift and death

Tax paid

Less than 3

40%

3 to 4

32%

4 to 5

24%

5 to 6

16%

6 to 7

8%

7 or more

0%

Source: HMRC

 

Making wills

Expats with assets in two or more countries should consider making a will in each. Many foreign courts are unlikely to follow UK wills or British inheritance laws when settling an estate.

 

IHT tax-free limits

Individuals have a £325,000 nil-rate band but can pass the unused allowance to a spouse or civil partner. This allows them to ‘double up’ on their nil-rate tax band to a maximum of £650,000.

On top of that, parents can also double up their main residence relief to leave a main home valued at up to £350,000 to close relatives without paying IHT, making a total pot of £1 million that is potentially exempt from tax by 2020.

Main residence relief stands at £125,000 in the 2018-19 tax year and rises to £175,000 for an individual in 2020.

Cash can be left if the main home is downsized or sold to pay care costs.

 

How we can help

It is important to review your estate planning as early as possible and continue to do so on a yearly basis. Our advisers will help you assess your tax liability and explore the options available for reducing it.

Tags: inheritance tax uk tax

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