Budget: The new look inheritance tax

The scope of inheritance tax (IHT) in the UK is fundamentally changing from a domicile-based system to a system based on residence. From 6 April 2025, the test for whether non-UK assets owned by individuals and trustees are within the scope of IHT will be whether the individual, or very broadly for trusts the individual settlor of the trust, is a ‘long-term resident’. The changes will not affect the taxation of UK situs assets (including indirectly owned UK residential property), which will remain within the scope of IHT, regardless of the individual’s residence status.

The policy document published at the Budget introduced the concept of a ‘long-term resident’ – an individual older than 20 who has been resident in the UK for 10 out of the 20 tax years before the one in which any transfer takes place. This is a major change from the original proposal in the Spring Budget, that an individual would be subject to inheritance tax after just 10 consecutive years of residence.

For this purpose, split years and years of treaty non-residence will count as full years of UK residence. For individuals who are 20 years old or younger, the test will be whether they have been resident in the UK for 50 percent of the tax years since their birth.

The statutory residence test will apply from 2013-14 to determine residence, but for earlier periods the old residence rules will apply, so there may be some dusting off of old records, and even old textbooks.

There were also changes to the ‘tail’ – i.e. the amount of time an individual will remain within the scope of UK inheritance tax once they become non-UK resident. 

This will remain at 10 years for those who have been resident in the UK for 20 years or more, but for those who have only been UK resident for between 10 and 13 years, the tail will be much smaller, at three years. This then increases by one year for every year of residence until it hits the maximum of 10 at 20 years. The effect is that, after 10 years of UK residence, the longer an individual has been UK resident, the longer the ‘tail’.

The Government appears to have listened to concerns about those who have already left the UK being expected to be aware of such fundamental changes. As a result, transitional rules are in place for individuals who have been UK resident but are non-UK resident in 2025/26. Deemed domiciled individuals will essentially be subject to the current three-year IHT tail. However, for non-UK domiciled individuals who would not have been deemed domiciled under the old rules (the 15/20 rule), no three-year rule should apply. In both cases, this applies provided they remain outside the UK. However, if they return to UK residence, then the new rules will apply.

These rules apply equally to UK domiciled individuals living abroad, with no connecting factors keeping such UK nationals within the scope of IHT for non-UK assets. Consequently, UK nationals living overseas will now have certainty that their non-UK assets will fall outside the scope of UK IHT once they have been non-UK resident for 10 tax years. 

For an individual, becoming a long-term resident will mean becoming subject to IHT on their worldwide assets owned outright. 

However, a lifetime transfer of excluded property (an asset excluded from the charge to IHT, for example non-UK assets) will remain outside the scope of IHT, even if the individual becomes a long-term UK resident by the time of their death and within the seven year ‘potentially exempt transfer’ (PET) period. By contrast, a lifetime gift of non-excluded property, will remain chargeable at death rates if the transferor dies within seven years, even if they have ceased to be long-term UK resident at the time of their death.

There will also be some changes to the spouse domicile election to reflect the new rules. From April 2025 the existing domicile election rules will be amended so that the spouse or civil partner of a long-term resident can elect to be treated as though they were also long-term resident. This election will last for 10 consecutive tax years. It will still be possible to make a domicile election for periods before 6 April 2025 and there are transitional rules to cover elections which have already been made.

From an initial review of published documents, it would appear that where double tax treaties that use the legal concept of domicile are in place, the domicile status of an individual will continue to be important.

For relevant property trusts, i.e. trusts subject to periodic 10 year and exit (upon distribution of trust assets) IHT charges, in a nutshell, IHT will be charged on non-UK assets (alongside UK assets as is currently the case) in settlements at times when the settlor is a long-term resident. But there are a few more things to consider.

For relevant property trusts, whether or not non-UK assets are excluded property will no longer be fixed at the time the trust is established. Instead, the excluded property status of those assets will depend on the long-term residence status of the settlor, meaning assets can move in and out of the excluded property status. 

For example, a UK-domiciled settlor who has left the UK and as time passes becomes not a long-term resident will be subject to an exit charge where assets become excluded property (up to a maximum of 6 percent) after 6 April 2025, following their change in status. Similarly, where a long-term resident settlor ceases to be a long-term resident, an exit charge will apply on the same basis. 10 year and exit charges for trusts will reflect on a pro-rated basis, the number of years that property has been excluded property in their calculations.

For qualifying interest in possession (QIIP) trusts, the excluded property status of the non-UK assets will depend on the long-term residence status of both the settlor and the IIP beneficiary.

Where the settlor of the trust has died, the excluded property status of the trust will depend on the long-term residence status of the settlor at death (subject to transitional provisions – see below).

From 6 April 2025, if the settlor is a long-term UK resident, the value of all the assets of an offshore trust will be subject to periodic ten-year and exit IHT charges, thereby bringing non-UK assets (which were previously excluded property) within the charge to IHT.

The Government seems to have listened to feedback about some of the complications for existing offshore trusts and has included some grandfathering provisions.

Any excluded property which was comprised in a trust before 30 October 2024 (Budget Day) will not be subject to the gift with reservation of benefit (GROB) rules, meaning those assets will not be comprised in the settlor’s estate where they retain an interest as a beneficiary, but they will be within the relevant property regime (periodic 10 year and exit charges) – this is a significant benefit as it protects these trusts from the potential for exposure to double tax.

For trusts where the settlor has already died, or where they die before 6 April 2025, the excluded property status of the trust will be based on the existing test – i.e. the domicile of the settlor when the trust was established, and could mean indefinite excluded property status for the trust (and no 10-year or exit charges). Whilst this is a very valuable provision, it’s unlikely we will see any real life Hotblack Desiatos spending a year dead for tax purposes, and such extreme tax planning will remain within the pages of the Hitchhikers Guide to the Galaxy.

Where non-UK assets comprised in a QIIP were excluded property before 30 October 2024 they will not be subject to charge when the QIIP comes to an end or on death of a beneficiary.

However, for both relevant property trusts and QIIP grandfathering provisions it will not be possible to convert UK situs assets into non-UK assets and achieve excluded property status.

What is conspicuous by its absence is any of the hinted at transitional provisions to allow non-UK domiciled individuals to unwind trusts without a large tax charge – although perhaps the temporary repatriation facility (TRF) will go some way toward helping with this – our article Budget: Non-dom reforms are going ahead from April 2025 explores this in more detail.

These fundamental changes to the underlying framework of IHT could, amongst other things, bring more taxpayers within the scope of UK IHT and therefore make IHT Business Property Relief (BPR) and Agricultural Property Relief (APR) more important and relevant than ever. However, in future these reliefs will not be as beneficial as they would otherwise have been. For further information about the significant reforms to BPR and APR see our article Budget: Major Changes to Inheritance Tax Reliefs, which explores the new 50 percent restriction to these valuable reliefs.

In conclusion, there is an awful lot to digest, even in the headlines, and anyone impacted by the changes will want to be working closely with their tax adviser over the coming months to properly understand the impact on their structure (and not just for inheritance tax) ahead of the rule changes in April 2025.

For further information please contact:

• Gavin Shaw
• Edward Brown