Transfers of assets between UK domiciled spouses are always exempt for IHT purposes. However, where the donor spouse is UK domiciled and the donee is non-UK domiciled, a limited spousal exemption of £325k applies.
This exemption is linked to (but is in addition to) the IHT nil rate band and is a lifetime limit (i.e. it does not replenish after seven years). Any lifetime gifts over and above this threshold are potentially exempt transfers (‘PETs’) which will fall back into the donor’s death estate if not survived by seven years.
Where the limited spousal exemption is unutilised during lifetime, it will apply to relieve transfers made by the UK domiciled spouse on death. When coupled with the IHT nil rate band, assets worth £650k can be transferred without incurring an IHT charge. However, any value in excess of this (unless other specific IHT reliefs apply) will be taxable at 40% which could result in a significant IHT liability arising.
There are two types of election which can be made by the non-UK domiciled spouse. Both mean the non-domiciliary is treated as UK domiciled for IHT purposes. An election can be made:
Elections must be made in writing to HMRC and can be backdated for seven years from the date of the election. Typically, an election must be made within two years of death, although HM Revenue & Customs (HMRC) has discretion to extend this period.
If an election is made, the assets that can pass to the surviving spouse on death without a charge to IHT are unlimited. These elections are irrevocable for as long as the electing spouse remains UK resident. However, the election will cease automatically after four consecutive tax years of non-UK residence by the elector. Therefore, there is scope to escape IHT entirely on assets received.
Gary (65) is UK domiciled and is married to Carmen (61). Carmen has a domicile of origin in Spain and has been UK tax resident for nine years (she has not become deemed domiciled). She has also not acquired a domicile of choice in the UK.
Gary owns a home in the UK valued at £500k, cash deposits in UK bank accounts of £200k and a holiday home in Spain worth £300k. He has not made any lifetime gifts. Carmen owns a Spanish rental property and Spanish bank accounts.
Gary dies in September 2022 and leaves his entire estate to Carmen. The limited spousal exemption and Gary’s IHT nil rate band apply (totalling £650k), leaving £350k of value chargeable at 40%. Accordingly, his estate has an IHT liability of £140k.
Carmen elects to be treated as UK domiciled for IHT purposes, meaning Gary’s entire estate will pass to her free of tax. However, this also means that her worldwide estate now falls within the scope of UK IHT.
In November 2022, Carmen sells the UK property and closes the UK bank accounts, transferring the funds to her Spanish accounts, before moving back to Spain permanently. On 6 April 2027, the domicile election automatically lapses, and all Carmen’s assets (including those inherited) are outside the scope of UK IHT.
Forbes Dawson view
Where spouses have a domicile mismatch, the restricted spousal exemption can result in a significant, and usually unexpected, IHT liability arising if the UK domiciled spouse dies first. The elections may offer a solution to this.
However, it is always important to consider what overseas assets are held by the non-domiciled spouse as these will potentially be brought into the scope of UK IHT (as opposed to just the UK situs assets) by making an election.
There are very limited circumstances where a lifetime election would be beneficial. In the above example, if a PET from Gary to Carmen becomes chargeable on unexpected early death, a backdated election made after death should remove this liability. Conversely, a lifetime election by Carmen would bring her Spanish situs assets into the potential charge to UK IHT and if she had predeceased Gary, would have resulted in unnecessary UK IHT on these assets.
It is always advisable to undertake IHT planning as early as possible, but the above example just goes to show that even after death, it is not too late to undertake effective IHT planning in the right circumstances!
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