No matter how much you hate inheritance tax or believe it to be unfair, there is little you can do to protect your loved ones from paying it on significant assets you pass down to them.
But a new tax loophole is opening up from April that could wipe out your obligations to the UK taxman altogether. The one condition you must abide by? You have to live outside the UK for at least ten years.
Yes, for most this would be a dramatic step to take simply to avoid tax. But there are already over five million Britons living abroad who could benefit, and many are tempted to retire elsewhere to enjoy warmer climes and often a better quality of life.
Hundreds of thousands of Britons already abroad may now find themselves exempt from paying UK inheritance tax without realising it – as this little-known loophole has largely gone under the radar.
Of course, such a big decision would take a great deal of planning – and anyone considering it would need expert advice and to consider their own personal circumstances.
Here, Wealth investigates why the rules are changing, how they will work – and what inheritance tax your loved ones may pay if you die abroad.
How are the rules changing, and how could I benefit?
Until now, British expats could spend all their time abroad, own property abroad, die abroad – and still their estate could be liable for inheritance tax in the UK.
That is because Britons living abroad could be considered resident outside of the UK but still domiciled in the UK.
An individual’s domicile is where their permanent home is considered to be and is much more nuanced than their residency. The rules to determine your domicile are complex and based on many factors, including where you were born and where you have your permanent home.
Many British expats working overseas but expecting to return to the UK in due course would be considered domiciled in the UK.
If you live permanently overseas but don’t have a fixed base in any one jurisdiction, you would remain UK domiciled. This can catch out many British expats who have lived overseas for years or even decades.
It is possible to change a UK-domiciled status by acquiring a ‘domicile of choice’ in another country, but this is a complicated process. You can live abroad for many years and still be considered UK domiciled – and so liable for UK inheritance tax.
However, from April the new system will replace ‘domicile’ with ‘residency’ and your liability to UK taxes will be assessed on your specific tax residency status.
That means that if you live abroad and have no assets in the UK, your estate will not attract inheritance tax on any foreign assets that you held – so long as you had been living outside the UK for at least ten years.
The change is part of the fallout from the abolition of so-called non-domiciled status that was confirmed in the Autumn Budget by Chancellor Rachel Reeves.
Non-domiciled status – or non-dom for short – relates to someone who lives in Britain but whose permanent tax residence is registered abroad. Those with the status do not have to pay UK taxes on their foreign earnings and assets. The unexpected beneficiaries of the scrapping of non-dom status are British people planning to retire overseas or already living abroad.
How much inheritance tax will I pay in the UK?
The rate of tax payable on your death is 40 per cent of the value of your estate – property, money and valuables – above £325,000 individually or £650,000 as a couple who are married or in a civil partnership.
On top of this, if you leave a property to a direct descendant such as a child or grandchild, you and your spouse can also each benefit from a £175,000 ‘main residence nil-rate band’. This means that a couple can give away a property up to the value of £1million free of inheritance tax.
If there’s a loophole, how will it work?
You can avoid paying IHT in Britain if you have claimed residency abroad – and been non-resident in the UK – for ten consecutive years. You will no longer be bound by where you are considered domiciled as this term will be scrapped and replaced with the universal term of ‘residency’.
However, any assets you have in the UK may still attract inheritance tax.
Wealth management group Evelyn’s partner and tax expert Ian Dyall says that unless people sell up completely and dispose of all their British property and investments before retiring abroad, they will still have to pay IHT, even if they do not return to the UK.
If you are already living abroad this time is simply included as part of the ten-year rule.
If you move abroad in the current tax year – before April – you will only be liable for IHT on your overseas assets and possessions for three years.
Does this mean I don’t pay if I retire abroad?
You will still be charged tax in the country where you reside. Chris Etherington, a partner at accountancy firm RSM International, says: ‘Remember, just because you won’t be paying UK inheritance tax does not mean you avoid paying death taxes in the country where you live.’
He adds that people may need to pay for costly specialist local advice, to ensure their financial affairs are in order.
Ian Dyall adds: ‘You may end up with the complexity and costs of having to comply with two different regimes. If people try to be too clever, they could end up having to pay for two sets of advisers.’
But what if I want to spend time in the UK?
You must not be resident in the UK for ten consecutive years. That doesn’t mean you can never visit, but you need to take care that you don’t spend so long that it appears you are resident here.
UK residency is assessed on how many days you spend in the UK and the ‘connecting factors’ to the UK that you retain. Connecting factors include the availability of UK housing, if you have a spouse remaining in the UK and whether you have been a UK resident in the past three years.
You can typically spend up to 90 days a year in the UK and remain non-resident here, if you have, say, only two connecting factors. However, if you break the relevant days’ threshold by even one day, the ten years start all over again.
Experts say that those considering moving abroad and claiming non-residence in the UK should keep back at least three weeks of the 90 days for family emergencies and other unexpected events.
Robert Salter, a tax director at accountancy and business adviser Blick Rothenberg, says: ‘Remember, if you live in Britain at any point and become UK tax resident in that tax year per our domestic law you will break the rule – and the clock starts again.’
Of course there are myriad considerations beyond the tax implications. Robert Salter points out that many will find the rule too restrictive if it curbs their ability to see grandchildren on a regular basis.
Will I pay death tax in a foreign country?
If you escape UK inheritance tax by leaving the country, you may still be liable for tax within the country where you have moved.
Alex Ruffel, partner at law firm Irwin Mitchell, says: ‘Every country has its own tax regime which you have to consider, so think very carefully about where you want to go.
‘Otherwise, you may have jumped out of the frying pan and into the fire. You could end up being exposed to various local taxes, like an annual wealth tax, not just on death like IHT, that will leave you worse off.’
Will tax be due if I die within ten years?
The rules are clear – as a default, if you die within the ten-year period the UK taxman can be expected to come after your estate for the full IHT owed.
However, tax expert Robert Salter admits the tax situation could get ‘messy’ depending on where you live.
He says: ‘It is unlikely you will be doubly taxed – paying death tax twice, both in the country in which you live overseas as well as in the UK, as the UK would typically allow ‘tax credit relief’ on the IHT you have paid overseas.
But expect the UK taxman to chase you for the extra tax due in the UK. This means if you pay the equivalent of 30 per cent death tax abroad, the UK taxman can chase you for the other ten per cent.
What other taxes should I consider?
You will have to think about all of the local taxes, from income tax to what you pay for any healthcare you need.
Furthermore, remember that while you may pay lower inheritance tax as a resident of another country, you may be liable to other taxes that erode the amount of wealth you can pass on, such as wealth taxes.
Some countries also have ‘gift taxes’, which means that if you gift a certain amount during your lifetime you may incur a tax bill.
In contrast, all gifts made in the UK are free from inheritance tax so long as you survive for a further seven years after making them.
Chris Etherington, a partner at accountancy firm RSM International, also warns that you will need to consider what impact moving abroad will have on any trusts that you have already put in place.
There are some countries that do not recognise them, which could spark legal complications.
Trusts are a popular method of reducing inheritance tax in the UK. They are a legal arrangement that allows cash, investments or property to exist outside of your estate so that legally they no longer belong to you. That means that when you die their value normally won’t count towards your inheritance tax liability.
Chris Etherington says: ‘You may think that because you have set up a trust, you have taken care of everything. Not so, as countries like Spain do not recognise trusts.’
Also, remember that while you’ll retain any UK state pension entitlement you’ve accrued, in some countries such as Dubai and Australia, the value of your payments is frozen at the point at which you move.
How do the rules over death taxes work in other countries?
Dan Harris of UK firm Stone King LLP says: ‘In almost every other jurisdiction apart from the UK it is the inheritor who pays the tax and the allowances and rates vary, depending on how close the beneficiary is to the deceased in terms of bloodline.
‘Stepchildren can sometimes be charged as much as 60 per cent tax, whereas gifts to children can pass tax-free, which can be tough on blended families. Likewise, gifts to charities can pay 60 per cent, and foreign assets placed in trust can be taxed up to 60 per cent.’
Harris adds that most countries don’t allow you the freedom to give your property to whomever you wish. Instead ‘forced heirship’ rules mean that most of your estate has to pass to pre-determined parties.
In Spain, inheritance tax rates vary depending on the value of the inheritance that the beneficiaries will receive and your relationship to them. The basic rates are set by central government, but each of the autonomous regions can reduce the rates and some are set as low as zero per cent. There is no automatic spousal exemption.
In France, there is a 100 per cent exemption for any assets passing between spouses. Otherwise, inheritance tax rates range between five and 60 per cent, depending on the value of the estate.
In Australia, though there is no inheritance tax on death, capital gains tax is payable instead.
