Inheritance Tax, or IHT, is a complicated topic with many different factors, clauses and conditions to bear in mind. This complexity means that, unlike other British tax categories, IHT differs in how it applies to each estate.
The Chase Buchanan team has created this article to summarise the basics of how IHT works and how the tax levy can change substantially in different sets of circumstances.
- 1 Who is Liable for UK Inheritance Tax?
- 2 Who Is Classed as a UK Domicile?
- 3 What Does Being a UK Domicile Mean for IHT?
- 4 Which Assets are Liable for British Inheritance Tax Charges?
- 5 Am I Liable for Inheritance Tax as an Expat Living Abroad?
- 6 What is UK Inheritance Tax?
- 7 Are There Allowances Against IHT Charges?
- 8 What are the Issues with IHT Allowances?
- 9 How Do Spousal Exemptions Work With IHT?
- 10 Can I Claim the Spouse Exemption and the Nil Band Threshold?
- 11 How much is IHT Worth to HMRC in the UK?
- 12 Is Inheritance Tax Voluntary?
- 13 Do UK Residents who are Non-Domiciles Pay IHT?
- 14 Is it Possible to Lose My Status as a UK Domicile?
- 15 Are There Advantages to Becoming a Portuguese Domicile?
- 16 How Quickly Can I Gain Portuguese Domicile Status?
- 17 Do I Need to be a Non-UK Domicile to Avoid IHT Charges?
Who is Liable for UK Inheritance Tax?
Any British domicile is liable to pay their calculated IHT charge, regardless of whether they still live in the UK or are an expat resident abroad.
Who Is Classed as a UK Domicile?
Most people are domiciles of their home country. The rule of thumb is that if your father worked, lived and was permanently resident in the UK, you are a UK domicile. The system bases your domiciliary status on your father, and usually, this remains static for the rest of your life.
Your place of birth is irrelevant, so even if you were born overseas, but your father was a UK domicile, your status remains the same.
In some cases, permanent overseas residents have become a domicile of that country by choice. Still, it remains possible to live away from the UK for many years and remain a domicile.
What Does Being a UK Domicile Mean for IHT?
Being a UK domicile means that, wherever you live, and for however long, you are liable for British IHT on all assets within your estate at your death.
You are also liable for IHT on transfers of wealth or assets made during your life.
Which Assets are Liable for British Inheritance Tax Charges?
IHT is charged on your worldwide assets. That includes anything you own in any country. For example, if you own a property in Portugal, it is part of your estate and is liable for the tax.
Am I Liable for Inheritance Tax as an Expat Living Abroad?
You are indeed. Regardless of where you live and whether that’s in Europe or further afield, you are liable for IHT if you are a UK domicile.
What is UK Inheritance Tax?
Currently, the tax is charged at a rate of 40% on estates worth over £325,000. As an illustration, if you have accounts, savings and assets worth £625,000, your beneficiaries would be liable for a tax of £120,000 on your estate.
Are There Allowances Against IHT Charges?
There is an allowance of £325,000, under which IHT is not chargeable. Any estates valued below this threshold are not liable for any inheritance tax at all.
Couples have an allowance per person, so the combined total below which no tax is chargeable is £650,000 between them.
That allowance can increase up to £1 million, depending on whether the couple has previously owned a UK residential property.
What are the Issues with IHT Allowances?
One of the biggest challenges is that the threshold (or nil band) has remained static since 2009.
Given the substantial change in property valuations over those years, the nil band is now far less effective than it was when first introduced.
Therefore, IHT is often considered a stealth tax. A property worth, say £300,000 in Portugal or the UK is very likely to now be worth well above the £325,000 threshold given appreciation over 12 years. So, many people who would have been exempt from IHT in 2009 are very likely liable now.
How Do Spousal Exemptions Work With IHT?
The spouse exemption means that couples are permitted to transfer assets between themselves, whether while alive or on the death of one person, without the value of that transfer being liable for inheritance tax.
There is no limit to this exemption.
Can I Claim the Spouse Exemption and the Nil Band Threshold?
Yes, you can, and this applies to each partner within a couple. On the death of the first partner, if you were to claim the spouse exemption and assets thereafter (if any remained) fell into the nil band category, there would be no inheritance tax to pay.
However, when the surviving partner passes away, their estate will be liable without exemption. Therefore, the heirs to the estate would be required to pay IHT on the assets combined value.
How much is IHT Worth to HMRC in the UK?
Inheritance tax creates a substantial amount of income for the UK tax office. In the 2020/21-tax year, HMRC collected in excess of £5 billion.
Is Inheritance Tax Voluntary?
It is; IHT does not have to be paid. The key is to structure your assets through long-term planning with an experienced financial advisor.
By doing so, you ensure that your estate remains to the benefit of your heirs and beneficiaries and does not end up as a liability paid to the tax office.
Do UK Residents who are Non-Domiciles Pay IHT?
Provided their assets are held in the UK and exceed the £325,000 nil band threshold, yes, non-domiciliary residents are liable.
Is it Possible to Lose My Status as a UK Domicile?
You can change your domicile status, but the process isn’t straightforward.
If you were to leave the UK and live in another country as a tax-resident for at least six years and have also lived in that country for at least six of the last 20 years, you might be able to acquire domiciliary status in your new country of residence.
Typically, to lose your UK domiciliary status, you will need to:
- Sever all UK ties, without any assets, properties, businesses, clubs or frequent visits.
- Demonstrate intent to remain a permanent resident in your new host country.
It is strongly advisable to seek expert advice if you are considering changing your domiciliary status to ensure you understand the process.
Are There Advantages to Becoming a Portuguese Domicile?
There are indeed; Portuguese domiciles do not pay any inheritance tax making this a compelling option for many people.
How Quickly Can I Gain Portuguese Domicile Status?
The process can take several years and depends on your circumstances.
If you choose to apply for domiciliary status, this is called your ‘domicile of choice’. It is vital to go through the proper channels to ensure you have applied correctly.
Do I Need to be a Non-UK Domicile to Avoid IHT Charges?
No, this isn’t essential and is just one of many options. It is also not wise to rely on being a non-UK domicile as your only strategy to mitigate the impact of IHT charges on your heirs.
Your domicile of choice status can take many years to acquire and yet can be lost if you:
- Return to the UK.
- Relocate to another country.
- Re-establish any of those ties with the UK.
In order to avoid IHT, your domicile of choice status needs to be valid at the time of your death or when you make a lifetime transfer of your assets. Therefore, if you run the risk of relying on this status and then lose it, you may not have any other structures in place and might not have sufficient time to re-apply for a new domicile of choice.
The only way to control your exposure to IHT, and that of your heirs, is to create a comprehensive tax-efficient strategy tailored to your specific assets, residency and domiciliary status.