In the January edition of Private Client update Ailsa Moorhouse reported on the publication of draft legislation which increased the inheritance tax (IHT) exempt allowance for transfers made by UK domiciled individuals to non-UK domiciled spouses or civil partners from £55,000 to increase in line with the Nil Rate Band.  We can now confirm that the Finance Bill 2013 introduced a lifetime cap on transfers as expected, set initially at £325,000 (New Cap).  The Finance Bill 2013 also included the option for the non UK domiciled spouse or civil partner to elect to be treated as UK domiciled for inheritance tax purposes.  Hannah Herbert considers the circumstances in which a couple might consider making an election, and the consequences.

The New Cap

The New Cap is a lifetime allowance, which applies equally to lifetime transfers and on death.  It is to track the Nil Rate Band as expected, but this is now fixed until 2018.  The measure is anticipated to have little impact on revenues, as HMRC predicts the change will affect a maximum of 19,000 estates left on death, which is less than 4% of the total.  Even if the numbers are small, the New Cap will make a real difference to couples affected, particularly where the death of the UK domiciled spouse or civil partner was unexpected. 

New - option to elect to be treated as UK domiciled

For the married couples and civil partners affected, the New Cap is now the default position.  However there is another option, also introduced by the Finance Bill 2013, which will allows the non UK domiciled spouse or civil partner to elect to be treated as UK domiciled, for inheritance tax purposes only.  This is an interesting option which requires both members of the couple to think carefully about the consequences of making such an election.

Making the election - consequences

Making an election removes the cap on transfers to the non UK domiciled spouse or civil partner, and enables the couple to benefit from the spouse exemption in the same way as those domiciled in the UK.

The potential downside is that once an election is made, the worldwide assets of the non UK domiciled spouse or civil partner are brought into the inheritance tax regime so that, to the extent the Nil Rate Band of the spouse or civil partner making the election has been used, transfers to any beneficiary other than the UK domiciled spouse or civil partner will be liable to inheritance tax.

How to make an election

HMRC requires written notice as to whether the election is being made.  If no election is being made, this will presumably be dealt with in the paperwork relating to the chargeable event taking place.  If the non-domiciled spouse or civil partner intends to make the election the following time limits apply:

Timing of the election

Once the Finance Bill 2013 has received Royal Assent (likely to be July), an election can be made at any time provided the marriage or civil partnership to which it relates, has been registered.

For lifetime transfers the last point at which an election can be made to take effect in relation to a lifetime transfer is the date of the transfer. 

In relation to the death of the UK domiciled spouse or civil partner, the last point at which an election can be made by the deceased’s personal representatives is two years from the date of death.  Provided the death occurred on or after 6 April 2013 the election can take effect from the point immediately prior to death. These provisions for writing back will be particularly useful where the death is unexpected.

Retrospective elections can be made in respect of chargeable events occurring between 6 April 2013 and Royal Assent, provided the marriage or civil partnership was registered by the date in respect of which the election is being made.

Election - irrevocable but capable of lapse

Once made, the election is irrevocable however, if the person who made the election ceases to be resident in the UK for income tax purposes for three consecutive tax years from the point at which the election took effect, the election will cease to have effect.  This could be of particular interest where the UK domiciled spouse has died, and the non UK domiciled spouse is not resident in the UK.  In these circumstances the election could be made in respect of the date of death, so that the deceased’s assets could pass to the non-resident spouse uncapped.  This could be a useful planning tool provided the surviving spouse does not intend to make transfers exceeding their own Nil Rate Band within the three years following the date of death, when the election is deemed to have taken effect.

The election takes effect in relation to inheritance tax only, so that the income tax and capital gains tax position of the person making the election is unaffected.  An election will also be ignored for the purposes of Double Taxation Agreements.