Under the current law, a person domiciled or most closely connected from a legal view point with the UK may only leave assets up to £55,000 above the applicable nil rate band allowance on their death to his or her non-UK domiciled spouse or civil partner free of UK Inheritance Tax. The £55,000 limited spousal exemption has not increased since 1982 and, no doubt has resulted in significant additional Inheritance Tax being paid over the years by families with a husband and wife (or vice versa or civil partner) domicile mismatch. This has an adverse effect on lifetime IHT planning for such couples as well.
On 11 December 2012 government published new draft legislation relating to a proposed new limit on the existing exemption. The new draft legislation will mean that from 6 April 2013 a UK domiciled person is free to leave significantly greater value assets to the non-UK domicile spouse or civil partner without incurring an adverse Inheritance Tax charge in the future.
The limited spousal exemption is to be increased to £325,000 and will be linked to the value for nil rate band going into the future. This does not quite remove the IHT disadvantage that such couples and their eventual choice of beneficiaries suffer, but it goes some way towards levelling the playing field between those with a domicile mismatch and those who have no such mismatch.
This is, however, not all a matter for celebration as the non-UK domiciled spouse or civil partner will have to elect to be treated as domiciled within the UK for UK Inheritance Tax purposes. The election can be made at any time up to two years from the date of death of the first spouse to die. It can be made during the joint lifetime of the couple.
It will not affect the electing spouse’s status for any other UK taxes but there is of course a UK Inheritance downside in that the person who elects to be treated as UK domiciled will, on the occasion of their death, have their world wide assets subject to UK Inheritance Tax rather than just their UK located assets subject to UK IHT.
There is the potential ‘escape route’ of deemed domicile i.e. that if the person (or more likely their personal representatives on their death) are able to show that the person had ceased to be UK resident for at least three consecutive full tax years preceding their death, then they may have achieved the best of both the non UK domicile IHT re non UK sited assets and an increased amount passing IHT tax free on the first to die’s death, where the UK domiciled spouse or civil partner dies first.
Whilst no such election can be made before 6 April 2013, (and often it might well be sensible for those affected by the change to wait and see what circumstances and rates prevail at the time of a UK domiciled spouse’s death), for those who could be affected by the change in the law, they could start a consideration as to whether this proposed change leads them to rethink their overall UK Inheritance Tax planning proposals or whether they will continue as they have to date.