The path to equality

EU pressure has forced changes to the inheritance tax treatment of non-domiciled spouses. The current £55,000 cap on the spousal exemption for non-doms has been branded discriminatory. It is the latest challenge by the EU where a member state’s tax rules provide a home advantage. But the question remains – will the changes satisfy the EU lawmakers?

The Finance Bill changes offer non-dom spouses a choice rather than automatic equality. An increase to the limit and linking it to the prevailing nil-rate band or alternatively to elect to be treated as UK domiciled for IHT. Domicile is core to IHT. Someone who dies domiciled in the UK is subject to IHT on his or her worldwide estate. Non-doms are only subject to UK IHT on assets located in the UK. But once they have been UK resident for 17 out of 20 tax years, they become “deemed domicile” for IHT.

Domicile is not the same as nationality or residence. It is the country that you consider (or, more importantly, HMRC deems) to be your permanent home and where you would expect to return to. A statutory definition of residence will be introduced from April 2013. But there are no such plans to introduce a definition of domicile in the tax legislation. Instead we have to rely on previous case law.

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Gifts between spouses are normally totally exempt from IHT. But this unlimited exemption does not apply where the gift is from a UK domiciled individual to their non-domiciled husband or wife. Here gifts are subject to a lifetime cap of £55,000.

This limit dates back to 1982 and at the time was equal to the IHT nil-rate band. This was when the average house price was around £24,000 and ET was trying to phone home. Much has changed since then. The EU opened its borders and international mobility has increased. Marriage between couples with different domiciles is now much more common. Yet still the £55,000 threshold has remained frozen.

Increasing the limit to £325,000 and linking it back to the nil-rate band is a significant improvement, but it still does not match the unlimited exemption enjoyed by UK domiciled married couples.

For this to apply, the non-dom spouse will have to make a written election to be treated as UK domiciled for IHT. Similar to a deed of variation, this can be done up to two years after the death of their UK domiciled spouse. And their treatment as a UK domicile for IHT will not affect their ability to claim the remittance basis on their overseas income and gains.

The cost of an unlimited exemption is that the non-dom spouse’s worldwide assets are now within the UK IHT net. Many non-doms invest in assets that are excluded property for IHT. Offshore bonds have been popular investments for this reason and specific exemptions treat UK Oeics and unit trusts as excluded property. All these investments along with overseas property and bank accounts would subsequently be within scope if they elect to be treated as UK domiciled.

For example, Peter is UK domiciled and his Spanish wife, Francesca, is non-UK domiciled. Peter dies and leaves his £1m estate to Francesca, which breaks down as follows: