IHT: Non-domiciled spouses and civil partners

By | 9 April 2013

[Note – This article is based on the legislation published in Finance Bill 2013. At the time of writing (March 2013), the legislation is subject to possible amendment before Finance Bill 2013 receives Royal Assent.]

Individuals who are domiciled in the UK are liable to IHT on chargeable worldwide property. Non-UK domiciled individuals are also liable to IHT, but only on chargeable UK property. There is no statutory definition of ‘domicile’ for IHT purposes. Domicile is a concept of general law. However, in addition to the general law concerning domicile, there is also a ‘deemed domicile’ rule for IHT purposes (IHTA 1984, s 267). This rule broadly states that a person can be deemed to be domiciled in the UK if one of two alternative conditions is satisfied.

Deemed domicile

The first condition is often referred to as the ‘three-year rule’. It broadly states that a person is treated as domiciled in the UK if he or she was domiciled here at any time in the three years immediately preceding the time when the question of domicile needs to be decided.

The alternative condition is commonly known as the ’17 out of 20’ rule. This is broadly that a person will be deemed domiciled in the UK when he or she has been resident here for 17 out of the 20 tax years ending with the present one. In determining whether an individual is resident in the UK for these purposes, it is necessary to look at the income tax rules on residence, bearing in mind that there is also a new statutory residence test in Finance Bill 2013.

As mentioned, if either of these conditions is satisfied, a person is deemed to be domiciled in the UK for IHT purposes.

Spouse exemption

The IHT spouse or civil partner exemption is contained in IHTA 1984, s 18. The general rule is that transfers of value between spouses are exempt transfers to the extent that the property in question becomes comprised in the estate of the transferor’s spouse. The increase in the recipient spouse’s estate is normally exempt for IHT purposes. However, the legislation then goes on to restrict the spouse exemption, by stating that if the transferor spouse is domiciled in the UK but the recipient spouse is non-UK domiciled, the transfer is exempt only up to an upper limit, less the value of any previous transfers which have taken place.

Prior to changes in Finance Bill 2013, for many years this upper limit was £55,000. The reason why the restriction was set at £55,000 is that it had been in place since 9 March 1982, when the IHT nil rate band was also £55,000.

It is important to note that the restriction in the spouse exemption applies only if the recipient spouse is non-UK domiciled. So if both spouses are domiciled in the UK, or if both spouses are domiciled abroad, or if the spouse making the transfer is non-UK domiciled but the recipient spouse is domiciled in the UK, there is no restriction in the spouse exemption.

If a lifetime gift exceeds the restricted spouse exemption, the excess will generally be a potentially exempt transfer (PET).

Example 1

Frank is UK domiciled. On 1 January 2011, he made a lifetime gift of assets worth £200,000 to his non-UK domiciled wife, Greta. No previous gifts were made. The first £55,000 of this gift is exempt for IHT purposes under the spouse exemption. The balance of £145,000 is a PET.

Unfortunately, Frank died in January 2013. He left his estate worth £500,000 to a discretionary trust for his family. When calculating the IHT on Frank’s estate, his nil rate band of £325,000 is reduced by that part of his lifetime gift to Greta which was not covered by the spouse exemption, i.e. the PET of £145,000. Thus only £180,000 of the nil rate band remains to be offset against the estate on death of £500,000, leaving £320,000 liable to IHT at 40%, i.e. £128,000.

One effect of the restriction in the spouse exemption is that it becomes more difficult for a UK domiciled spouse to transfer unused nil rate band to his or her non-UK domiciled spouse. For deaths before 6 April 2013, if the amount left on death exceeds £55,000 plus the available nil rate band, there will be no unused nil rate band left to transfer.

HMRC’s inheritance tax manual at IHTM11033 includes two further examples. The first example, involving Mr and Mrs Allsop, is similar to the example of Frank and Greta above, except that the husband’s lifetime gift to the wife is made more than seven years before the husband’s death. What this example illustrates is that the restriction in the spouse exemption applies without time limit as far as lifetime gifts are concerned. They do not fall out of charge after seven years in the same way as PETs.
HMRC’s second example involves a married couple, Mr and Mrs Costa, who were both domiciled outside the UK when Mr Costa made a lifetime gift of £500,000 to Mrs Costa, so there was no restriction in the spouse exemption at that point. However, Mr Costa subsequently becomes domiciled in the UK and makes a further gift of £100,000 to Mrs Costa. This example points out that the restricted spouse exemption is not available on the later transfer because of the earlier lifetime gift, despite the fact that both spouses were originally domiciled outside the UK when the gift of £500,000 was made.

Lifetime and death elections

The Finance Bill 2013 legislation affecting the spouse exemption includes two main changes. The first change is that the spouse exemption upper limit for restriction purposes is increased from £55,000. The new upper limit is the nil rate band threshold at the time of the transfer. For example, if a gift is made from a UK domiciled individual to a non-UK domiciled spouse during the tax year 2013/14, the spouse exemption on that gift will be restricted to the nil rate band for that year, i.e. £325,000.

Returning to the above example of Frank and Greta, let us assume that Frank’s lifetime gift of £200,000 was made in 2013/14. Under the new rules, the gift would fall within the £325,000 upper limit, and would therefore be subject to the spouse exemption in full. This means that Frank’s nil rate band of £325,000 would be available on death. His estate of £500,000 would be reduced by a full nil rate band of £325,000, leaving £175,000 chargeable to IHT at 40%, i.e. £70,000.

The second change is a completely new provision. This is an election to be treated as domiciled in the UK for IHT purposes. There are two alternative conditions for the election to apply. The first condition applies to an election during the person’s lifetime. This condition is that he or she is not domiciled in the UK when the election is made, but that his or her spouse is domiciled in the UK at that time.
As indicated above, the effect of the election is that the person who makes it is generally treated as domiciled in the UK for IHT purposes. What this means in practice is that his or her spouse can make exempt transfers without the spouse exemption upper limit applying. The person making the election will continue to be liable to IHT on their UK situs assets, as they would be if they remained non-UK domiciled. However, the downside of making the election is that their non-UK situs assets will become liable to IHT. In other words, he or she will be liable to IHT on their worldwide estate, in the same way as a person who has always been domiciled in the UK.

As mentioned above, there are two alternative conditions for the election to apply. The second condition relates to an election following death. This condition is broadly that the person’s spouse or civil partner died on or after 6 April 2013 and was UK domiciled at the time of death, and that the other spouse or civil partner was not domiciled in the UK at that time. What the election means in practice is that on the death of a UK domiciled individual, the non-UK domiciled surviving spouse may elect to be treated as domiciled in the UK for IHT purposes. This will allow legacies from the deceased spouse to benefit from the IHT exemption without restriction. It also means, of course, that the recipient spouse would subsequently be liable to IHT irrespective of the location of their assets.

Example 2

Henry is domiciled in the UK, and his wife Ingrid is non-UK domiciled. Henry dies in August 2013. In his will, Henry leaves his entire estate to Ingrid. Henry’s estate comprises UK assets worth £625,000, and non-UK assets worth £425,000.

If no death election is made, Henry’s estate will be liable to IHT of £160,000, which is calculated as follows: his total estate is worth £1,050,000, but the first £325,000 passing to Ingrid is subject to the IHT spouse exemption. That leaves £725,000, the first £325,000 of which is subject to the nil rate band, and the balance of £400,000 is liable to IHT at 40%, i.e. £160,000.

If Ingrid makes a valid election to be treated as UK domiciled, there is no IHT payable on Henry’s death because the spouse exemption applies without restriction to the assets passing to Ingrid. As far as Ingrid is concerned, the effect of making the election to be treated as UK domiciled is that, in addition to UK assets which would be subject to IHT regardless of her domicile status, Ingrid will also be generally liable to IHT on her non-UK situs assets, subject to her IHT nil rate band, if available.

In determining whether or not an individual is eligible to make the election, it will be necessary to look at their domicile status without taking into account the ‘deemed’ domicile provisions in IHTA 1984, s 267. With regard to the election itself, it will need to be made to HMRC in writing, and HMRC have indicated that there will be no specific form for making the election. A lifetime election generally takes effect from the date of making it, and a death election from immediately before the death of the spouse or civil partner. However, an earlier date may be specified in the notice (not earlier than 6 April 2013) of up to seven years, if the couple were married or civil partners and the spouse or civil partner was domiciled in the UK throughout a ‘relevant period’ (i.e. broadly from the earlier date specified in the election). A death election must be made within two years of the death, although HMRC may allow a longer period at its discretion.  

Once a lifetime or death election has been made, it cannot be revoked. This is because, using Ingrid as an example, she would otherwise be able to make the election and save IHT of £160,000 on Henry’s death, but revoke the election later so that the non-UK assets worth £425,000 passing from Henry would not be subject to IHT in Ingrid’s estate due to her non-UK domiciled status.


However, the Finance Bill 2013 legislation provides a possible escape route whereby an election can cease to have effect. This is broadly where the person making the election later becomes resident outside the UK for income tax purposes for four consecutive tax years. In that case, the election will cease to have effect following the end of the fourth full tax year of non-residence. The purpose of this provision is to ensure that an individual who makes the election but leaves the UK does not remain forever liable to IHT on their overseas assets. However, care will be needed to ensure that the individual is not subsequently domiciled in the UK at that point, either under the general law of domicile, or under the ‘deemed’ domicile provision for IHT purposes in IHTA 1984, s 267. Otherwise, the individual may still be liable to IHT on their worldwide estate, even though the election has ceased to have effect.

Nevertheless, this ‘non-residence’ rule would seem to offer some flexibility for IHT purposes, where an individual intends leaving the UK following the death of their UK domiciled spouse. Taking the two changes together, i.e. the increase in upper limit of the spouse exemption, and the election to be treated as UK domiciled for IHT purposes, it will generally be necessary to ‘do the sums’ and take into account the assets and personal circumstances of the spouses or civil partners in determining whether it is beneficial to make the election. It will probably seem very attractive for (say) a non-domiciled widow faced with a 40% IHT charge on her late husband’s estate to make the election, in order to benefit from an unrestricted spouse exemption. However, it must be remembered that the whole of her estate will then be brought into IHT (subject to the ‘three tax year’ rule mentioned earlier), so this generally makes the IHT on her husband’s estate more of a deferral than a saving, unless some lifetime planning is undertaken by the surviving spouse.

Finally, even before these changes were originally proposed, there was serious doubt as to whether the restricted spouse exemption was compatible with EU law, on the basis that it discriminated against non-UK domiciled spouses. Some concern will still remain on this discrimination point even after the changes become law, although it may be that the provision for the domicile election to cease having effect after four successive tax years of non-residence has been introduced to ease some of those concerns.  

The above article is reproduced from ‘Practice Update’ (April/May 2013), a tax Newsletter produced by Mark McLaughlin Associates Ltd. To download current and past editions of Practice Update, see the Newsletters section.