The domicile election procedure, can be a great benefit in some cases, particularly following a death. In other cases however, adopting this disarmingly simple solution could be a very expensive mistake.
WHAT IS THE ELECTION?
The non-UK domiciled (non dom) partner in a mixed domicile marriage or civil partnership may elect to be treated, for IHT purposes only, as if they were domiciled in the UK. They will not be treated as UK domiciled (UK dom) for other taxes, or for matters such as matrimonial disputes, or who inherits property on death under the intestacy rules.
Making an election by choice is quite different from the deemed domicile which automatically arises where certain conditions are met. (See box on page 2.)
WHAT IS THE PROBLEM THAT THE ELECTION IS DESIGNED TO SOLVE?
In general there is full exemption from IHT for assets that pass, in lifetime or on death, between spouses / civil partners. (Spouses and civil partners are both referred to here as a `spouse', for brevity). This full exemption is not available, however, where the assets pass from a UK dom spouse to a non dom spouse.
It is only in this mixed case, and where the assets originate with the UK dom spouse, that the problem arises. Where both spouses are UK dom then assets can pass between them without an IHT charge, both in lifetime and on death. Where they are both non dom there is no IHT problem. As a result of this, spouses who have different domiciles are often not aware that their tax position is vulnerable. (See box on page 3.)
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WHAT IS DOMICILE?
Under the general law your domicile is basically the place you regard as your permanent home, maybe a country that you intend to return to although you do not in fact live there at the moment. This is a question of fact. As well as having tax significance, domicile status decides such matters as whether English law or a foreign law applies to matrimonial disputes, and also questions of who will benefit from property on a death. Someone born abroad with a foreign domicile will generally find it fairly easy to retain that foreign domicile for an extended period, unless they make a positive choice to acquire an English domicile.
WHAT IS DEEMED DOMICILE?
IHT has historically had its own particular gloss on the general rule of domicile. In particular, individuals who have been resident in the UK for an extended period are automatically treated for IHT purposes as domiciled here, whether or not they are actually domiciled under the general law. They are deemed to be domiciled in the UK, and this brings their worldwide assets into the IHT net. From 6 April 2017 a deemed domicile rule has applied for the first time for capital gains tax (CGT) and income tax purposes. Residence in the UK for 15 out of 20 tax years is the test, which also applies for IHT purposes. In practice a person may be resident in the UK for less than the 13 actual years before becoming deemed
domiciled for each of these taxes. Special rules apply to counting years for individuals who have been UK resident for a period, then non-resident, then resident again.
Deemed domicile operates quite differently from the domicile election. The IHT election does not affect a person's deemed domicile status under these rules for CGT, income tax or IHT purposes.
There is a further category of deemed domicile which was also introduced from 6 April 2017. An individual who is non dom but was born in the UK and has a UK domicile of origin (so called formerly domiciled residents) will become deemed domiciled in the UK from their second year of residence.
There is an allowance equal to the prevailing IHT nil rate band for assets passing from the UK dom spouse to the non dom spouse. The nil rate band (325,000 at present) is also available, provided it has not been used for other gifts. This currently gives a combined maximum value for relief between mixed dom spouses of 650,000.
The lack of a full spouse exemption means that, unless the estate is relatively modest in size, either the election or some forward planning is needed to avoid an IHT bill at 40%. Without some forward planning, the end result in some cases is that IHT is charged on both deaths, producing an effective rate of nearly 65%. This happens when the
surviving non dom spouse becomes UK dom at some time after the first death, perhaps because of children settling here, or when, after the first death, the surviving spouse acquires a deemed domicile as a result of the number of years they have been UK resident. (See box opposite.)
Assets are often transferred between spouses, and gifts are made, for reasons completely unconnected with tax indeed with no awareness that there might even be tax implications. For example, for non-tax reasons the UK dom spouse who already owns a house may want to put it into joint names; or major purchases may be made by one spouse or the other without thought of tax. The 325,000 non dom spouse exemption covers both lifetime gifts and those made on a death. If it is used up on lifetime gifts it will not be available for property passing on death. Gifts made during lifetime in excess of the exemption plus any unused nil
rate band are not exempt and may suffer an IHT charge.
Too often, problems only come to light when the UK dom spouse dies unexpectedly. The suvivor then finds that the inheritance which they had thought would be tax-free is in fact taxable, and that the tax position of lifetime gifts is an expensive nightmare to untangle.
HOW CAN THE ELECTION SOLVE THE PROBLEM?
The non dom spouse can elect to be treated as if they were UK domiciled, and so get the benefit of the full spouse exemption. The theory is that the problem then dissolves: there is no limit on the value of gifts that can be passed tax-free from the UK dom spouse to the non dom spouse.
ARE THERE OTHER ADVANTAGES?
Making the election would not prevent the non dom spouse from benefitting from the remittance basis of taxation for income and gains.
Availability of IHT spouse exemption Domicile of transferor UK
Domicile of transferee
325,000 (55,000 before 2013/14)
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...MAKING A DOMICILE ELECTION SHOULD NOT BE REGARDED AS A SIMPLE STEP TO SOLVE AN IHT PROBLEM...
SO WHAT IS THE DRAWBACK?
Although the election can be extremely useful in some cases, in others it could be equally harmful. This is because the election goes much wider than merely giving the non dom the benefit of the spouse exemption. It treats the non dom as if they were UK dom for all IHT purposes. The consequence is that all the non dom's worldwide assets come fully within the IHT net and past gifts made by them may need to be re-examined. The non-UK assets of a non dom are, generally speaking, exempt from IHT on death, and lifetime gifts can also be exempt provided they are correctly structured.
This means that if the non dom has significant assets overseas
they should think carefully before making an election and losing this very major advantage. In deciding whether to make the election, they need to balance the advantages and the disadvantages. Although it is possible to `reverse' the effect of the election, this requires four continuous full tax years of non residence.
WHAT ARE THE FACTORS TO BALANCE WHEN DECIDING WHETHER TO MAKE AN ELECTION?
Factors include: what is the relative wealth of
the spouses, including any expected or possible inheritances that they might receive in the future? where is that wealth located, in the UK or elsewhere?
what are the relative ages and health of the spouses?
how long do the spouses expect to remain in the UK?
are the couple's financial circumstances such that assets are in fact only likely to pass from the UK dom spouse to the non dom in the event of the death of the UK dom spouse? Or will transfers also occur in lifetime?
is the non dom spouse already deemed to be domiciled in the UK under existing IHT rules because they have been resident here for so long?
The answers to questions of this sort will help establish whether making the election will destroy existing or future tax advantages in circumstances where the likelihood of an IHT charge arising is in fact small. In such cases, the possible IHT charge might be better and more cheaply provided for in other ways, for example by insurance.
SHOULD I MAKE A DOMICILE ELECTION?
Making a domicile election should not be regarded as a simple step to solve an IHT problem, but a major decision which will be right for a proportion of cases, but certainly not for all. The IHT benefits of non dom status mean that deciding whether
it is right to make an election requires careful analysis of the specific situation, involving looking forward as well as at the immediate position.
...THE BENEFITS OF NON DOM STATUS MEAN THAT DECIDING WHETHER IT IS RIGHT TO MAKE AN ELECTION REQUIRES CAREFUL ANALYSIS OF THE SPECIFIC SITUATION...
The case where the election is in practice most likely to be useful is as tax planning `first aid' after an unexpected death the situation where no advance planning has been done to achieve the best outcome. As explained below, however, there are many reasons why this first aid can rarely be as effective as planning ahead.
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...THERE IS NO `ONE SIZE FITS ALL' ANSWER, AND CARRYING OUT PLANNING WILL ALWAYS PRODUCE A BETTER RESULT THAN LEAVING THINGS TO CHANCE...
It is not uncommon for people to delay the effort of estate planning on the basis that, in the event of an untimely death, a Deed of Variation can always be used if need be to rewrite the will (or intestacy) in a more taxefficient way. The possibility of making both a Deed of Variation and a post-death domicile election may now increase this temptation. This combination may be invaluable first aid but it is unlikely to be as effective as good pre-death planning. For example, if minor children are involved an effective Deed of Variation may be impossible; and dying without a will can create a distressing family situation where, for example, the surviving spouse does not even become outright owner of the family home.
IF THE ELECTION WOULD NOT BENEFIT ME, WHAT CAN I DO TO MITIGATE THE IHT PROBLEMS?
The tax problems of a mixed domicile marriage are sometimes seen as intractable, so that the election may seem attractive despite its possible disadvantages. The fact that mixed domiciled marriages can also be used to great IHT advantage needs to be weighed in the balance. Tailored to individual circumstances,
an offshore trust made by the non dom spouse can be wholly outside the IHT net, allowing assets to pass down a generation or more without IHT.
Care is needed, as unless proper structuring is employed an offshore trust may produce little or no tax benefit, and can create a messy situation to be disentangled. The window of opportunity to create an offshore trust will close once the non dom has completed an extended period of residence in the UK as then they will be deemed domiciled in the UK for IHT purposes. The non dom spouse should review the planning possibilities well before they reach 13 years' tax residence in the UK.
When it comes to tax planning for a mixed dom marriage there is no `one size fits all' approach. The situation can be transformed, however, by careful assessment of which assets should pass in which direction under the wills, in conjunction with personal pension planning and well organised lifetime arrangements.
PLANNING FOR LIKELY INHERITANCES, AND ASSET PROTECTION
When a non dom parent or relative of the non dom spouse
...THE CASE WHERE THE ELECTION IS IN PRACTICE MOST LIKELY TO BE USEFUL IS AS TAX PLANNING `FIRST AID' AFTER AN UNEXPECTED DEATH...
dies, any inheritance received by the non dom is too often added to the family's general finances. This may expose the inheritance to tax on the death of the UK dom spouse (or even to tax on the death of the spouse who is currently non dom but later becomes deemed domiciled). The inheritance may also be straightforwardly vulnerable to creditors which can matter, in particular, to some professionals and entrepreneurs.
If the parent of the non dom spouse had instead been invited to settle the property in an offshore trust, IHT would have
been avoided and an IHT-free resource established abroad for future generations. The asset protection profile might have been considerably improved also. The tax and other implications of such planning in the parent's home country must, of course, be considered.
FOREIGN LAW IMPLICATIONS
In every tax and family situation that crosses borders proper attention must be given to the implications of any tax planning in the non dom spouse's own home country (and any country where the parties are presently resident or with which they have significant connections).
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UK planning which seems apparently excellent can otherwise be found often when it is too late to have produced undesirable results elsewhere. The best possible balance between the different countries involved has to be struck.
Co-habitees, whatever their domicile status, do not benefit from the IHT spouse exemption at all. Tax is only one angle however: co-habitees, whether of different domiciles or not, need to take particular care that they carry out at least basic estate planning to achieve their practical wishes as to who should actually inherit their property: left to itself, the law of intestacy will almost invariably produce unpalatable results.
The scope for a non dom spouse to elect to have a UK domicile can be a useful way of easing the problems faced by couples who have only relatively modest assets, or where the non dom spouse has few assets of their own.
inherit, significant assets that they would wish to keep out of the IHT net, an election may well prove to be a dangerously beguiling trap. The same is true in cases where, for example, the couple have a limited time horizon for how long they intend to spend in the UK, or perhaps their ages are significantly different. A lifetime election will in future be only one (and often not the best) of a number of possible approaches to achieving the optimum tax outcome in a mixed domicile marriage or civil partnership. Indeed, there is only one rule that applies in all cases: each set of the circumstances is different, and carrying out planning for those particular circumstances will always produce a better result than leaving things to chance.
In cases where the non dom spouse has, or can expect to
This publication is not meant as a substitute for advice on particular issues and action should not be taken on the basis of the information in this document alone.
This firm is not authorised by the Financial Conduct Authority (the FCA). However, we are included on the register maintained by the FCA (www.register.fca.org.uk) so that we can offer a limited range of investment services (including insurance mediation activities) because we are authorised and regulated by the Solicitors Regulation Authority (the SRA). We can provide these services if they are an incidental part of the professional services we have been engaged to provide. Mechanisms for complaints and redress if something goes wrong are provided through the SRA and the Legal Ombudsman.
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