UK Inheritance Tax: What Expats Need to Know

With the UK government cracking down on inheritance tax, many are wondering how they can best pass on their wealth. International Adviser’s article aims to demystify the situation, especially for those living abroad.

The Rise in Inheritance Tax and Penalties

Over the last year, there’s been a noticeable uptick in the UK government’s inheritance tax (IHT) collection. Between April to July this year, IHT receipts climbed by a significant £200m, reaching £2.6bn. Simultaneously, penalties for families who didn’t adhere to IHT regulations also increased by 33%, amounting to £2.28m.

How does Inheritance Tax work?

In layman terms, if someone passes away and leaves an estate, and if this estate owes any IHT, the amount needs to be settled before anything can be passed on to the heirs or beneficiaries.

There’s a bit of good news here, though. If the deceased’s estate is being transferred to their spouse, this transfer is exempt from IHT. However, other beneficiaries might have to pay a 40% tax on the inheritance, after deducting a tax-free allowance of £325,000. And, if the full £325,000 tax-free amount isn’t used when the first partner dies, the second partner can access up to a doubled allowance of £650,000 when they pass away.

Moreover, an additional relief of £175,000 can be availed on the primary residence if it’s passed on to the children. This amount doubles to £350,000 if not used after the first death. But for larger estates, specifically those valued over £2m, this relief starts to decrease and eventually vanishes for estates worth more than £2.35m.

UK Succession Law: Domicile vs. Residency

UK’s inheritance law doesn’t focus on where the deceased was a tax resident at the time of their passing. Instead, it looks at their ‘domicile’ status.

‘Domicile’ is a term used in the legal world that represents the place an individual views as their permanent home. Generally, a person’s domicile is the same as that of their parents (typically the father’s) at the time of their birth. While this might sound simple, it’s notoriously challenging to change one’s domicile. Even if a person leaves the UK and lives abroad for decades, their UK domicile can still remain.

This concept is crucial, especially when considering the difference in how various European countries handle inheritance. Many European countries, with their civil law systems, focus on the deceased’s ‘habitual residence’ when applying inheritance taxes and succession laws.

Now, here’s where things get even trickier: if a UK national with a UK domicile dies in an EU country, there could be legal conflicts. Both the UK and the EU member state might claim rights over how the deceased’s assets are distributed and taxed.

Double Tax Conventions: Preventing Twice the Trouble

To mitigate such cross-border inheritance conflicts, ‘double tax conventions’ exist. Their goal? To ensure that assets are not unfairly taxed by two countries. Typically, the country where the deceased was domiciled has the right to tax all properties, irrespective of their location. Meanwhile, the other country only taxes certain kinds of assets within its borders. And if any double taxation issues arise, there are set guidelines to determine which country provides tax credits.

However, not all European countries have clear-cut rules for determining the deceased’s domicile, which can create complications. If both countries decide to tax an asset, relief measures are available, but they might be limited, especially if the asset is situated in a third country.

The European Solution: Brussels IV

Recognising the complications around cross-border inheritances, the EU introduced the European Succession Regulations, or ‘Brussels IV’, in 2015. This legislation allows EU-based foreign nationals to decide whether they want the succession law of their residing EU country or their native country to apply upon their death.

Yet, Brussels IV isn’t a one-size-fits-all solution. Sometimes, it can lead to higher succession taxes. Fortunately, there are options to safeguard one’s assets and beneficiaries, such as:

  • Tweaking real estate conveyancing clauses
  • Modifying marital property agreements
  • Investing in specific financial products that offer better estate planning, additional allowances, or reduced estate tax rates.

In Conclusion

The landscape of inheritance tax and succession law, especially for UK expats, is undeniably intricate. Yet, with careful planning and a thorough understanding of both UK and EU regulations, it’s possible to ensure that one’s hard-earned assets are protected and passed on in the most beneficial manner.