In this, part 2 of our series exploring the changes being introduced for non-doms from 6 April 2025, we’re focusing on Inheritance tax (IHT).
WHAT’S CHANGING?
Under the current rules, individuals who have a UK domicile, or who are deemed domiciled, are in the scope of IHT on their worldwide assets, subject to specific exclusions and exemptions.
Individuals who are not domiciled or deemed domiciled in the UK are not liable to IHT on assets which are defined as “excluded property”. In the main, this refers to assets which are situated outside the UK, with the exclusion of interests in offshore entities through which UK residential property is held and the inclusion of some UK situs assets, such as holdings in authorised unit trusts (AUTs) and open-ended investment companies (OEICs).
Individuals who do not have a UK domicile under common law will become deemed domiciled once they have been tax resident in the UK for 15 out of the previous 20 tax years. Deemed domiciled individuals who permanently leave the UK and became non-UK resident for tax purposes remain in the scope of IHT on their worldwide assets for three further tax years, referred to as the three year “tail”.
Trusts which are created by non-doms individuals, referred to as excluded property trusts, can, in certain circumstances allow for assets with excluded property status to remain outside of the scope of IHT even once the settlor has become deemed domiciled.
Where individuals have a UK domicile status under common law, it’s not easy for them to replace that with a domicile of choice in another jurisdiction. The onus of proof that domicile has changed sits with the individual and requires them to effectively cut all ties from the country in which their domicile lies, and also demonstrate that they have established a domicile elsewhere and intend to remain there indefinitely.
HMRC will no longer provide a ruling on an individual’s domicile. This leaves the position open to an enquiry following the reporting of transactions where domicile status has an impact, which would quite often be on death, leaving uncertainty for the taxpayer, and their family, of the IHT liability connected to their estate.
From 6 April 2025, the domicile of an individual will no longer be relevant for IHT purposes and the above rules will come to an end.
THE NEW RULES
A new residency-based test will apply to determine the scope of IHT. From 6 April 2025, an individual will be in the scope of IHT on their worldwide assets if they are long-term residents, meaning that they have been resident in the UK for at least 10 out of the 20 tax years, preceding the tax year of the chargeable event, being a chargeable lifetime transfer or death. Individuals who do not satisfy this test will not be subject to IHT on excluded property, as defined above.
These rules are modified for individuals who are under 18, with the relevant test of long-term residence being whether they have been resident in the UK for at least 50% of the tax years since they were born.
For the purpose of these tests, tax years where an individual has qualified for split year treatment or has been treaty resident will be counted as a year of residence.
There has also been changes to the length of time that a taxpayer remains in the scope of IHT on worldwide assets, i.e. the “tail”. For individuals who have been in the UK for between 10 and 13 consecutive years prior to their departure, their tail is three years. The tail then increases by a year for every additional year of residence, i.e., four years for 14 years of UK residence, five years for 15 years of UK residence and so on, up to a maximum of 10 years for those who have been in the UK for 20 consecutive tax years.
These rules apply equally to individuals who have a UK domicile under common law, now providing them with certainty on their IHT position if they leave the UK long-term. Any UK domiciled individuals who have already been non-UK resident for at least 10 tax years will immediately fall outside of the scope of IHT on assets representing excluded property from 6 April 2025.
TRANSITIONAL RULES
There will be transitional rules for individuals who have been living in the UK pre-6 April 2025 and are either non-domiciled under common law or deemed domiciled and who are also non-resident in 2025/26:
- For any non-domiciled individuals who have not become deemed domiciled by 5 April 2025, i.e., because they have not been resident for 15 out of 20 tax years, there will be no IHT tail.
- For any individuals who are deemed domiciled but will lose that status by 6 April 2025, i.e., because their three-year tail came to an end on 5 April 2025 or earlier, there will be no extension to their three-year tail, irrelevant of the length of their UK residence period.
- For those individuals who are deemed domiciled at 6 April 2025, they will be subject to the existing rules and will have a three year IHT tail regardless of the number of years that they had been UK tax resident prior to their departure. For example, if an individual with deemed domicile left the UK, and became non-UK resident for tax purposes, on 6 April 2023 they will have an IHT tail until 5 April 2026.
It should be noted that, if individuals qualifying for the above rules return to the UK and regain a UK tax residence status post 6 April 2026 any subsequent departure will then come within the new rules, in terms of determining the length of the IHT tail.
These transitional rules will not apply to individuals who are UK domiciled under common law on 30 October 2024 and the new long-term residence test will apply to them from 6 April 2025. Therefore, if these individuals leave the UK and become non-UK resident the length of the IHT tail depends on how many years they have been resident for out of the prior 20 tax years, as explained above.
TRANSFERS OF ASSETS MADE IN LIFETIME
When an individual transfers assets in their lifetime, that transfer will be a potentially exempt transfer (PET) or a chargeable lifetime transfer (CLT) depending on the recipient of the asset.
PETs or CLTs which are made in the seven years prior to death will fall into the estate on death. If the asset transferred is classed as excluded property at the date of transfer (i.e. because it was a transfer of a qualifying non-UK asset and the individual was not a long term resident at that date under the new rules) that value will remain excluded from IHT on death, irrelevant of whether the individual’s residence status had changed by the time of death.
SPOUSE EXEMPTIONS
Under the current rules, a restriction applies to the spouse exemption of an individual who is UK domiciled or deemed domiciled, if their spouse is not UK domiciled or deemed domiciled.
The restricted spouse exemption in this situation is £325,000 unless the spouse makes an election to be treated as deemed domiciled. The election applies until the individual has been non UK resident for four consecutive years.
Under the new rules, the same restriction will apply to the spouse exemption, in respect of transfers made by long term resident individuals to a spouse who is not a long-term resident. The ability for the spouse to elect for long-term residence status will be available and the election will last until the individual has been non-UK resident for 10 consecutive tax years.
Elections made prior to 30 October 2024 will remain in place, with the spouse making the election being treated as deemed domiciled until 5 April 2025, and then treated as a long-term resident from 6 April 2025, until they have been non-UK tax resident for four consecutive tax years.
Elections made on or after 30 October 2024 and before 6 April 2025, will be subject to the new rules from 6 April 2025.
CHANGES FOR OFFSHORE SETTLEMENTS
From 6 April 2025, the domicile status of the settlor at the date of settlement will no longer determine whether assets held in trust are excluded property or not. The status will be fluid and will hinge on the residence status of the settlor, such that when the settlor is long term resident, under the rules outlined above, the trust property will be subject to IHT irrelevant of the situs of the asset.
These changes could mean that existing trusts that were created by a UK domiciled individual who has since become long term non-resident may qualify to be treated as an excluded property trust. And, conversely, trusts that were created by non-UK domiciled individuals could cease to qualify as an excluded property trust when the settlor becomes a long term resident in the UK. The transitional arrangements which are outlined above for individuals will apply equally when determining a settlor’s status.
Where the settlor has died, the treatment of that trust will be permanently fixed for all subsequent events based on the status of the settlor at death. The rules vary depending on when the settlor died:
- If the settlor died before 6 April 2025 and was non-domiciled when assets were settled into trust, the trust will qualify as an excluded property trust for the remainder of its life.
- If the settlor died on or after 6 April 2025 and was not a long-term resident at the date of death, the trust will qualify as an excluded property trust for the remainder of its life.
QUALIFYING INTEREST IN POSSESSION TRUSTS
With regards to settlements in which a beneficiary has a qualifying interest in possession (QIIP) for IHT purposes, from 6 April 2025, for non-UK situs property comprised within such settlements to be regarded as excluded property, neither the settlor nor the beneficiary with the QIIP can be long-term resident on the date of the IHT chargeable event.
Where non-UK assets were comprised in a QIIP settlement and were excluded property immediately before 30 October 2024, they will not be subject to charge when the QIIP comes to an end or on the death of the QIIP beneficiary.
UK assets comprised in the settlement will not benefit from this treatment even if they are later sold and become non-UK situs.
After the existing QIIP ends and for QIIP settlements made on or after 30 October 2024, the settlement will be subject to the new long-term residence rules.
RELEVANT PROPERTY SETTLEMENTS
The settlor’s residence status will need to be reviewed on each occasion of charge related to a trust. For a relevant property trust this would include a settlement of assets into trust, the ten-year anniversary of a trust and the distribution of capital assets from a trust.
From 6 April 2025, an exit charge will arise each time a settlor loses their long-term residence status on all non-UK assets which are converted into excluded property as a result of that change of status.
This means that an exit charge will arise on 6 April 2025 on any trusts which have a UK domiciled settlor who is not long-term resident in the UK. The charge will be in respect of assets which become excluded property due to the changes in the rules. As long as the settlor remains long term non resident that excluded property will then be excluded from an IHT charge on future events.
Calculations of IHT on future ten-year anniversaries will reflect any changes in the status of assets throughout that ten-year period, i.e., the effective rate will be reduced to reflect the period during which assets qualified as excluded property.
GIFTS WITH RESERVATION OF BENEFIT (GWROB)
A GWROB exists when an individual makes a gift and continues to be able to benefit from the property which has been given away. Where that benefit continues to be present at the date of death, the property which was gifted is deemed to be part of the transferor’s estate for IHT purposes.
These rules apply whether the gift is to another individual or into a settlement. If the benefit ceases during lifetime, the individual will be deemed to have made a PET or a CLT at that date, which triggers the commencement of the seven-year rule.
Currently, the GWROB rules do not apply where the property gifted is excluded property, i.e., a gift or a settlement of a non-UK asset at a time when the individual is not UK domiciled or deemed domiciled.
From 6 April 2025, the changes which have been outlined above will feed into the GWROB rules and it will be the long-term residence status of an individual:
- on their death, where the benefit remains in place at death; or
- at the time that a reservation of benefit ceases
Which determines whether non-UK assets will be defined as excluded property or not. The status of the transferor at the original date of the gift or settlement will be irrelevant.
TRANSITIONAL ARRANGEMENTS FOR EXISTING GWROB IN TRUST ASSETS
Where assets held in a settlement had excluded property status at 30 October 2024, these will not be subject to the GWROB rules, irrelevant of the future residence status of the settlor.
It should be noted that this exclusion cannot apply to any UK assets held in the same trust, even if those assets are subsequently converted into non-UK assets. Additional settlements into the trust post 30 October 2024 will also be subject to the new rules.
This exclusion is purely in relation to a charge on the death of the settlor or on the settlor ceasing to have a benefit, as outlined above. It does not prevent the trust itself from falling into the new rules explained in the prior section.
NEED ADVICE ON THE CHANGES?
The above highlights the main changes to the inheritance tax regime for non-domiciled individuals, however, these changes are far-reaching and will also have an impact on UK domiciled individuals who have left the UK, both in relation to their own position and any trusts that they have created.
If you think you or a trust that you are connected to may be impacted by the new rules, seek personalised advice on your position as soon as you can before 6 April 2025.
The Budget also announced changes to IHT for pensions and assets qualifying for agricultural property relief and business property relief. Whilst not covered in this article, those changes may also have an impact on your exposure to IHT and we can assist with a full review of your position.
