International Love: Mixed Domicile Spouses and Inheritance Tax

With the twin hurdles of Brexit and Covid-19, one could be forgiven for thinking that international travel, let alone relationships, are sadly a thing of the past.

However, HMRC perhaps takes a longer view on such things, and a relatively recent (in inheritance tax terms) change to tax legislation on mixed domicile spouses (and civil partners) is worth examining, as it may affect more people than one might think.

As is widely known, Section 18 of the Inheritance Tax Act 1984 (IHTA 1984) contains a total exemption from inheritance tax (IHT) for transfers (by Will or lifetime gift) between spouses and civil partners. However, this exemption is limited where a UK-domiciled person makes a transfer of value to a non-domiciled spouse or civil partner. It is important to note here that one can be both resident in the United Kingdom while “non-domiciled”, domicile being based on more than just residency, and, at its simplest, the concept of domicile can relate as much to one’s country of origin as location.

The reason for a limited spouse exemption is to avoid a potential loss of revenue where a UK domiciled individual makes a gift to a non-UK domiciled spouse. The UK domiciled individual is liable to IHT on their worldwide assets. The spouse, however, only on assets that are in the UK, so once in their hands, they are excluded property and outside the IHT net.

Therefore, for gifts made on or after 6 April 2013, the spouse exemption is limited to the “nil-rate band” or tax-free allowance applicable at the time of the gift, currently £325,000.

Consequently, where a UK domiciled donor makes a gift of £900,000 to his non-domiciled spouse in his Will, the first £325,000 will be tax-free (via the nil rate band), then a further £325,000 will be tax-free under the limited spousal exemption, but the balance of £250,000 will be subject to inheritance tax at 40%, leaving a tax bill of £100,000.

Given the exponential rise in house prices over the last generation, if the matrimonial home forms a sizable part of the estate, the bill due could result in real hardship for the surviving spouse.

Moreover, due to a quirk in the legislation, unlike with lifetime gifts to children, which fall out of one’s estate as “potentially exempt transfers” (PETS) every seven years, lifetime gifts to such spouses do not fall away, instead, they reduce the limited spousal exemption to nil, running the risk that the transfer on death will suffer a greater tax charge.

Given the manifest unfairness of the above, fortunately, Finance Act 2013 introduced a process by which, after 6 April 2013, a non-UK domiciled spouse of a person domiciled in the UK can elect to be treated for IHT purposes as being domiciled in the UK.

Broadly, they can do this either by a ‘lifetime election’ so long as they have a spouse or civil partner who was domiciled in the United Kingdom, or, where a non-UK domiciled person has died, his personal representatives may make a death election on his behalf. Such an election must be made by sending notice in writing to HMRC, with prescribed information and within set time limits, depending on the circumstances. An election (whether a lifetime or death election) cannot be revoked.

If, however, the person who made the election is not resident in the UK for the purposes of income tax for a period of the following four tax years, the election will then automatically cease. Making an election will not be suitable in every circumstance, particularly if the surviving spouse has significant overseas assets which would otherwise remain outside of UK IHT and he or she intends to relocate to their country of origin following the death of their wife, husband or civil partner.

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