A new world for Inheritance Tax
Detail in the residence-based regime may catch some unawares
Detail in the residence-based regime may catch some unawares
An inheritance tax (IHT) regime based on residence rather than domicile was announced by the previous Government in its Spring Budget of March 2024. One year and 30 days later, the new regime will be effective from 6 April 2025. Its detail has been decided upon by the current Government (different from the one which announced it) without the consultation originally promised. At the time of writing Finance Bill 2024-25, which contains that detail, is in its final form and is pending Royal Assent.
In some ways the residence-based regime will be simpler and clearer cut than the rules based on domicile with which many are familiar. Since April 2013, residence has been prescribed by the detailed rules of the Statutory Residence Test (SRT). In contrast, the law around domicile is governed by voluminous case law and is very fact specific, with some recent cases being found in favour of the taxpayer and others in favour of HMRC. The new regime will remove the subjectivity of domicile and provide more certainty for all. There are, however, a number of aspects buried in the legislative detail which may catch some unawares.
At its simplest, the residence-based concept is straightforward enough. Anyone who is a ‘long-term UK resident’ (LTUKR) will be subject to IHT on their worldwide assets on death or on the making of certain lifetime gifts. Anyone who is not a LTUKR will only be subject to IHT on their UK assets; their non-UK assets (except for those whose value represents the value of UK residential property, which are deemed UK assets for IHT) will be outside the scope of IHT.
At first glance, the rules around whether someone is a LTUKR are clear-cut. If you have been UK tax resident for 10 or more of the last 20 tax years, you will be a LTUKR. However, as is so often the case, the devil is in the detail… For example, the transitional rules for individuals who were not domiciled at law in the UK on 30 October 2024 (the day of the current Government’s first Budget), mean that someone who may have been in the UK for some time but leaves the UK and is non-UK resident in 2025/26 (which may not actually require having physically left the country by 5 April 2025 provided one is non-resident under the SRT), could be outside of the worldwide scope of IHT by 6 April 2028. Whereas if that individual deferred their departure by some 12 months and became non-resident in 2026/27, they would not cease to be a LTUKR until 6 April 2036. Their additional year of UK residence effectively lengthens their ‘IHT tail’ by seven years to 10 years.
And then there are the rules for trusts. Since the introduction of IHT, whether non-UK assets held in trust are within the scope of IHT or not has been determined by the domicile status of the trust’s settlor at the time they settled the trust. Since 2017/18, domicile for IHT (along with income tax and capital gains tax) has included deemed domicile. Long-term resident but non-UK domiciled individuals would commonly establish so called ‘excluded property trusts’ before their 16th year of UK tax residence, locking in the general rule that non-UK assets in the trust would thereafter be outside the scope of IHT.
In the new world from 6 April 2025, a trust will be an ‘excluded property trust’ as and when its settlor, if still living, is not a LTUKR. For certain trusts the LTUKR status of the life tenant beneficiary will also come into play. This will result in complexities and sometimes onerous requirements for trustees. Some trusts will see an IHT ‘exit charge’ arise as early as 6 April 2025 when the new law comes into effect. Trustees of others will need to consider how they will track and audit the UK tax residence status of the settlor, as well possibly as the life tenant. Ideally the trustees will be forewarned of the potential for the settlor ceasing to be a LTUKR so they can plan appropriately for how they might fund any IHT exit charge that will arise as a result. And for trusts with settlors potentially within the LTUKR transitional provisions, whether or not an IHT exit charge arises at all could turn on whether or not the settlor is UK tax resident in 2025/26. Hopefully someone will make the settlor duly aware…
A final thought for consideration is that trustees need to be alert to the potentially valuable transitional rules for certain gifts with reservation of benefit and ‘qualifying interest in possession’ trusts. Making decisions without awareness of these rules could result in actions which are not necessarily in the best interests of the trust’s beneficiaries.
