It is important to consider domicile when instructed to administer estates or provide tax planning advice because the inheritance tax (“IHT”) position can differ depending on the spouse’s domicile, particularly in relation to gifts made between spouses during their lifetime or on death.
Domicile: the basics
Domicile is a concept that the courts use to determine which legal system applies to an individual where that individual has a connection with more than one jurisdiction. It is a complex legal concept and is not the same thing as “residency” or “nationality”; an individual can be resident in the UK for many years and yet be domiciled elsewhere.
Domicile can be acquired through: origin, dependency or choice. In addition, as from 6 April 2016:
• Individuals who are tax resident in the UK for at least 15 out of 20 tax years will become deemed domiciled in the UK for all tax purposes from their 16th tax year of residence (15 out of 20 rule).
• Individuals who were born in the UK with a UK domicile of origin but who acquire a domicile of choice elsewhere will be deemed domiciled in the UK for all tax purposes once they have been UK resident for at least one of the last two tax years.
• Deemed domiciled individuals will be subject to income tax, capital gains tax and IHT in the same way as UK-domiciled individuals, with limited exceptions.
Gifts where both parties are UK domiciled or both parties are non-UK domiciled
The starting point is that IHT is not payable on any gift made between spouses or civil partners during lifetime or on death, provided that:
• Both parties are domiciled in the UK for IHT purposes (that is, they are either domiciled or deemed domiciled in the UK); or
• Both parties are domiciled outside the UK for IHT purposes (that is, they are neither domiciled, nor deemed domiciled in the UK) (Section 18, IHTA 1984).
Gifts from UK domiciled spouse to non-UK domiciled spouse
If one spouse or civil partner is domiciled in the UK for IHT purposes and the other is not, there is an upper limit to the spouse exemption in relation to gifts made to the non-UK domiciled spouse.
• For transfers made before 6 April 2013, the limit is £55,000 overall, whether the gifts are made in lifetime or on death.
• For transfers made on or after 6 April 2013, a UK-domiciled individual can transfer up to the prevailing nil rate band to his non-UK domiciled spouse or civil partner free from IHT (currently £325,000).
The rationale for this is that when assets pass from a UK domiciled spouse to a non-UK domiciled spouse, they are potentially leaving the IHT “net” forever (because the non-UK domiciled spouse may not be subject to IHT on his or her death). By limiting the spouse exemption in these circumstances, the share of IHT of the UK-domiciled spouse is secured on the first spouse’s death.
Gifts to a UK domiciled spouse
The spouse exemption is available in full in relation to gifts made to the UK domiciled spouse.
Non-UK domiciled individuals who have a UK domiciled spouse or civil partner can elect to be treated as UK-domiciled for IHT purposes to take advantage of the unlimited spouse exemption.
The upshot is that the effect of domicile on inheritance tax can be significant and accordingly it is very important to address the issue of the spouse’s domicile early on when carrying out estate work or giving inheritance tax planning advice.
If you would like further advice on the issues raised in this articled then please do not hesitate to contact a member of our private client team.