As announced in Budget 2012, the inheritance tax rules in relation to transfers from UK-domiciled to non-UK domiciled spouses (or civil partners) will change from 6 April 2013. On 11 December 2012, HMRC issued a technical note on the proposed changes – including draft legislation – and a consultation period now runs until 6 February 2013.
The new legislation includes two key provisions:
- An increase in the level of ‘spouse exemption’ available; and
- A means of ‘electing’ into a UK domiciled status
Increased ‘spouse exemption’
Currently, inheritance tax ‘spouse exemption’ is restricted to £55,000 in relation to a transfer from a UK domiciled individual to a spouse who is neither domiciled nor deemed domiciled in the UK.
Of the four possible permutations in relation to the domicile of a transferor and transferee spouse, this is the only one where the ‘spouse exemption’ does not apply at 100%, viz:
|Transferor||UK Dom||Non-UK Dom|
This £55,000 exemption has been fixed since 1982 (the Nil Rate Band at that time) and it is proposed that from 6 April 2013, it will increase to the then Nil Rate Band and that it would then be automatically linked to the Nil Rate Band from that point on.
The £55,000 exemption takes effect in addition to any Nil Rate Band available to the transferor so the maximum exemption available on a transfer from a UK domiciled individual to his a non-UK domiciled spouse going forward would, in effect, be double the Nil Rate Band.
This is a clearly a welcome change and it corrects an anomaly which has become more and more significant as the years have passed since 1982.
The ‘election’ option
Notwithstanding the increase, a non-UK domiciled individual receiving assets from a UK domiciled spouse remains in a disadvantaged position. The second change will allow such a non-UK domiciled spouse to avoid any disadvantage by electing to be treated as UK domiciled for inheritance tax purposes, thereby ensuring that spouse exemption is available at 100%.
The key points to note in relation to such an election are:
- The election will affect an individual’s domicile position only in relation to inheritance tax.
- The election will need to be made in writing but there will be no prescribed form.
- The election can be made at any time after marriage or registration of a civil partnerhip.
- Elections made while both couples are still alive will take effect from the election date.
- Elections can also be made within two year of the death of the UK domiciled spouse and such elections will be effective from the date of death.
To avoid a non-UK domiciled spouse simply revoking an election once spouse exemption has been obtained, elections will be irrevocable. However, the election will cease to have effect in relation to anyone who becomes resident outside the UK for three successive tax years. This broadly mirrors the position for a normal UK domiciled spouse who would have to leave the UK for three years to have a chance of losing his or her UK domicile.
The introduction of this election mechanism will provide a very useful method for non-UK domiciled individuals to avoid the UK inheritance tax which would otherwise have arisen on the death of their UK domiciled spouse.
Practitioners advising in relation to these rules should note the following additional points:
- The limited spouse exemption (i.e. now £55,000) takes effect before the potentially exempt transfer regime. Thus, one does not ‘wait and see’ whether the gift is survived by seven years – the exemption applies whenever a gift is made and once it has been used, it does not – unlike the Nil Rate Band – revive after seven years.
- Ordinarily, one would not need to consider the application of the inheritance tax ‘gift with reservation of benefit rules’ in relation to a gift between spouses. However, the exemption to the GWR rules is limited to extent of ‘spouse exemption’ available. To the extent therefore that ‘spouse exemption’ does not apply in relation to a gift, the GWR rules will be in point.
- The inheritance tax treaties which the UK has in place with The Netherlands, Sweden, Switzerland and the USA each modify the ‘spouse exemption’ restriction described here. The modifications differ from treaty to treaty and the relevant treaty should be referred to for the specific rules.