Any UK-based assets transferred between spouses domiciled in the UK is exempt from Inheritance Tax.
Spousal exemption is also applicable to non-UK domiciled spouses transferring assets to the UK, since such a transfer brings assets within the UK inheritance tax net.
Prior to 5th of April 2013, the maximum limit that a UK domiciled individual could transfer to a non-UK domiciled spouse or civil partner was £55,000. The limit was imposed to prevent assets from leaving the UK inheritance tax net. Gifts over that amount were considered as potentially exempt transfers and would only be exempt from IHT after seven years.
The exemption was also applicable upon death, so if the UK domiciled spouse left their estate to a non-UK domiciled spouse, the spouse exemption was available in addition to the nil-rate band. This meant that the first £325,000 transferred benefited from the nil rate band, and the next £55,000 was spouse exempt.
Changes to the limit
After the 5th of April, 2013, the IHT exempt amount was changed in order to be more fair for citizens across the EU. Since the introduction of the ‘2013 Finance Bill’, UK domiciled individuals can transfer to non-UK domiciled spouses or civil spouses, the same amounts as if they would be transferring in the UK, at the nil rate band (i.e. £325,000). What this means, is that a UK domiciled individual can now gift up to £650,000 to a non-UK domiciled spouse or civil partner, free of inheritance tax. This includes the nil rate band of £325,000 plus the spouse exemption of £325,000. However, this still doesn’t mean that EU domiciled spouses are treated the same as UK domiciled spouses.
Spouse exemption is still a lifetime exemption, meaning that any lifetime gifts exceeding £325,000 are potentially exempt transfers. If a spouse leaves the entirety of their estate to a non-UK domiciled spouse or civil partner, and they have not made any lifetime transfers, then any excess over £650,000 is liable for IHT.
The increase in the limit exempts around £108,000 worth from inheritance tax, however this does not drastically improve the situation for anyone with significantly higher wealth.
Electing to be considered as UK domiciled
A spouse or civil partner that is not normally domiciled in the UK, can now apply to be treated as UK domiciled for Inheritance Tax purposes.
There are two types of election, keep in mind that they are both irrevocable:
Lifetime election – valid from the date of election
Death election – valid from the date of death of the UK domiciled spouse
If it is a death election, it must be made within two years of the spouse’s death, and the death must have occurred after 5th of April 2013. If the election is successful, then any assets transferred from a UK domiciled spouse are exempt from inheritance tax.
It must be noted that, although making the election benefits the non UK domiciled spouse with unlimited transfers from the UK domiciled spouse, they also in effect elect their entire estate, including non-UK based assets to come under the UK inheritance tax scheme.
For the election to remain in force, the electing spouse must remain resident in the UK. This measure is to prevent the spouse from immediately retaking their non-UK domicile in order to avoid IHT on their non-UK assets. However, the election ceases to have an effect on non-UK assets after three or more consecutive tax years that the individual spends outside the UK.
If a valid death election is made, the beginning of the period determining residence is the date of the death of the UK domiciled spouse. This is useful to know for the surviving spouse if they wish to revert their original domicile and remove any IHT liabilities from their non-UK assets.
The changes to the cap will effect many mixed domicile couples in the UK and EU, in that they will have to pay less inheritance tax. However, it is worth carefully considering, whether an election would be beneficial in their circumstances. If most of the wealth is being held in the UK, then it might likely be a good idea. On the other hand, if most of the wealth is overseas and in possession of the non-UK domiciled spouse, then it is unlikely to be the right option. Various factors such as the couples age, life expectancy, amount and allocation of assets, and future plans have to be carefully weighed.