Non domiciled disadvantage
We hear much from the media about the rights and wrongs of the UK’s largely favourable historic system of taxation of individuals who are resident but not ‘domiciled’ in the UK (non doms). A less high profile problem for non doms is often overlooked: the inheritance ax (IHT) problems that face a couple if one spouse (or civil Partner) is a non dom, and the other is UK domiciled.
Mixed domicile couples can find themselves with a large and unexpected IHT bill if one spouse dies, or even in relation to property given by one to the other during their lifetimes.
For simplicity married couples and civil partners are referred to as ‘spouses’ here.
What is the problem?
It is common knowledge that the ‘spouse exemption’ means that a married couple can give assets to each other without triggering an IHT charge. Less well known is the fact that the full spouse exemption does not apply where assets pass from a UK dom spouse to a non dom spouse.
Without the benefit of the spouse exemption, in general only gifts up to a maximum of £650,000 (to cover both lifetime gifts and assets passing on death) will be tax free. Above that, IHT bites, on lifetime gifts as well as on death. With the IHT rate standing at 40%, a little mental arithmetic shows the potential for a large tax bill.
The problem only arises when assets are transferred by the UK dom spouse to the non-UK dom spouse. This is because a transfer in that direction potentially takes assets outside the UK tax net: they pass from a person who is UK dom and has to pay IHT on their worldwide estate to a person who is non dom and is not subject to IHT on assets they hold abroad.
If the transfer is from the non dom spouse to the UK dom spouse, this trap does not bite. It would, however, generally be unwise to make such transfers without good planning advice in advance, as the move may bring assets into the UK IHT net that could have been kept outside it.
Isn’t there an election that deals with the problem?
A non dom spouse can elect to be treated, for IHT purposes, as if they were UK dom, eliminating the mismatch.
This ‘solution’ can come with a very great tax cost: making the election would bring all the non dom’s own worldwide assets into the IHT net. If those are substantial, this could be an expensive mistake, and other approaches to coping with the tax problem may well be more satisfactory than the election.
If you would like a copy of our fuller briefing on mixed domicile marriages, please contact Judith Millar, Judith Morris, or the partner with whom you usually deal.