Beware of the dreaded inheritance tax and changes to it from April 2017!
Approximately 1.3 million Britons now live in Australia and Brexit may only increase this number! Many think that moving to Australia means they no longer need to worry about UK tax, but often they are not fully aware of the tax and in particular the inheritance tax (IHT), implications of moving here. Similar issues can arise for Australians owning UK assets, which have become more attractive because of the exchange rate and individuals working abroad. With information sharing between tax authorities now the norm, it is no longer possible to ignore this.
Your domicile status rather than residence status will usually determine your liability to IHT, as the UK imposes IHT at 40% on the value of your estate above your available nil rate band (currently £325,000, but with the potential to transfer this to your spouse if unused to have a combined £650,000 and possibly an additional £125,000 each (for 2018/19), for a main residence nil rate band). Transfers between spouses are exempt provided they have the same domicile status. However, transfers to a non UK domiciled spouse (for example, to an Australian spouse), from a UK domiciled spouse are only exempt up to £325,000 (in addition to your nil-rate band).
If you are British, but consider Australia to be your permanent or indefinite home, you may have acquired an Australian domicile of choice, although it will depend upon the facts. The difference is that if you still have a UK domicile you will potentially be liable to IHT on your worldwide estate and anything you transfer into a trust can be caught too (with a 20% IHT entry charge and ten year anniversary and exit charges of up to 6%). However, if you have acquired an Australian domicile of choice or have an Australian domicile of origin, you will only be liable to IHT on your UK estate and anything you transfer into a UK trust.
In November 2017, the UK made significant changes to IHT to affect Britons living in Australia or Australians owning UK residential property. These apply from 6 April 2017. The changes include:
- non-UK domiciled individuals are no longer able to shelter UK residential property from IHT by holding through an offshore entity such as an Australian trust. Ten year and exit charges will apply so trustees will have UK tax, record keeping and reporting obligations. Loans and collateral linked to UK residential property have also lost their IHT excluded property status
- individuals with a UK domicile of origin and who are born in the UK will be unable to take advantage of a subsequently acquired domicile of choice at any time they are a UK resident. After a one year grace period, any Australian trusts will become subject to ten year and exit charges and if the trust is settlor interested (which most Australian trusts are), income and gains arising will be taxable on the deemed settlor (the person who transferred the significant assets and not the same as the Australian $10 settlor) and the trust assets may be deemed to fall into the settlor’s estate on death. This will affect Britons who consider Australia to be their home but have decided to live in the UK due to family or other circumstances and
- Australians living in the UK who still have an Australian domicile of origin will become UK deemed domiciled for all UK tax after having been a resident for 15 out of the last 20 tax years of residence (instead of the current 17 of 20 years), so you may wish to create IHT and CGT effective ‘protected’ trusts before they are deemed domiciled.
A lack of knowledge is not a sufficient defence and penalties can be onerous if taxes go unpaid.
What to do about IHT?
Individuals with an IHT exposure should seek professional advice. Some common strategies include:
- preparing a domicile declaration as evidence of Australian domicile of choice for Britons living in Australia who consider Australia to be their permanent or indefinite home and who have lived here for at least three UK tax years (so are not UK deemed domiciled under the three year rule), although HMRC will still consider the facts (at the time of death), as domicile is a complex area of law and increasingly subject to challenge by HMRC
- IHT effective lifetime giving – each individual is able to make:
- £3,000 worth of gifts per year plus £250 to any number of individuals
- regular gifts out of surplus income (which varies according to circumstances)
- potentially exempt transfers (i.e. absolute gifts), which are exempt if you survive for seven years (with tapered rates applying if the gift was made more than three years but within seven years preceding death)
- encumbering property liable to IHT with debt, as IHT is due on the net value of an estate, but complex rules apply to this now, so again advice is recommended
- making gifts to UK charities in a Will (which are IHT exempt) and
- considering if any assets qualify for Business Property Relief or Agriculture Property Relief.
What else to do?
This note focusses on IHT, but individuals should also seek professional advice on:
- what happens to assets on death or incapacity? It is necessary to consider whether to have Wills and the equivalent of enduring powers of attorney (known as UK lasting power of attorney which deal with financial decisions in the event of loss of mental capacity, as the UK does not recognise Australian powers of attorney), in the UK and Australia, as succession to real estate is determined by the laws of the country in which it is situated whilst succession to other assets (known as movable property) is determined by an individual’s domicile at the date of their death. Although it is possible to have a grant of probate resealed in the UK, this makes the administration of an estate more complicated and lengthy. As Australia does not have IHT, it is usually preferable to have Wills in both countries (which must be carefully drafted to ensure that one does not accidentally revoke the other), since it is possible to be more flexible with Australian estate planning (for example by including asset protective and tax effective testamentary trusts in Australian Wills)
- UK capital gains tax, since after 6 April 2015 is charged on non-UK residents disposing of UK residential property. This was not the case before April 2015, so a pro-rata adjustment and valuations from April 2015 will be required on any sale. Changes to UK Principal Private Residence Relief were also made from 6 April 2014
- Australian capital gains tax, as if you have a simple Will leaving everything to your children outright and your children are living abroad at the time of your death, Australian capital gains tax may be triggered and act as an effective back door inheritance tax. This does not apply in relation to gifts to Australian resident beneficiaries and can also potentially be avoided for non-resident beneficiaries by having Wills with testamentary trusts in them and provisions to deal with this issue
- UK income tax obligations in respect of UK assets including the recent significant income tax (and stamp duty) changes relating to investment properties which make it less attractive for buy to let investors
- whether the UK Annual Tax on Enveloped Dwellings applies where an individual owns UK residential properties via a “non-natural person”, such as an Australian trust
- the Australian tax and compliance requirements of owning UK assets or having an interest in a UK trust or company. If these have not been disclosed to the ATO (for example because they were inherited from a parent), the individual should consider doing so through the ATO voluntary disclosure regime to avoid harsh penalties and
- if there is any possibility of a return to the UK or spending significant amounts of time in the UK, then tax advice should be taken in Australia and the UK well before any change in circumstances to avoid unforeseen tax liabilities being incurred and allow any restructure of wealth if appropriate.