In the second of our Short guide to series, which will examine different trusts and how they can be used in financial planning, Paul Kennedy offers guidance on IHT and excluded property trusts for non-UK domiciles
When people speak of War and Peace, they usually talk about the book's size (around 1,500 pages). I am afraid publications on offshore and foreign tax planning are equally voluminous. All of this can scare people away, but within this maze are some very simple inheritance tax (IHT) planning strategies.
At its basic level, the excluded property trust (ETP), is a case in point. The trust is for the non-UK-domiciled only. Do not set one up or buy a 'second-hand' one if you are UK domiciled.
You should be aware of the basic IHT rules for the non-domiciled; in short, the non-domiciliary avoids IHT by keeping investment outside the UK with a few UK exceptions - these non-UK assets are what are known as 'excluded property'. Unfortunately, this simple strategy is not sufficient for many non-domiciled residents, for the following reasons:
The individual may acquire a deemed UK domicile, which happens if they are resident in the UK for 17 out of 20 years, where they become subject to IHT on world-wide assets.
The individual may acquire an actual UK domicile, where again, they become subject to IHT on world-wide assets.
The individual may wish to give or bequeath assets to family members or others, who are or may become UK domiciled, where the assets would be included within their estates.
So, the simple strategy of investing outside the UK may not be sufficient to save IHT but fortunately for the non-domiciliary, the EPT enables these problems to be avoided.
Settled property is subject to its own rules. It is excluded property if the settlor was not UK domiciled at the time of making the settlement and the property is not situated in the UK again, with a few UK exceptions. Note the trustees do not have to be non-UK-resident.
Provided these two conditions are fulfilled, any subsequent changes in domicile are immaterial. This means even if the settlor should acquire UK domicile or be deemed domiciled, the trust assets still maintain their status as excluded property and remain outside the charge to IHT. The rule also applies, regardless of the domicile of the beneficiaries, meaning that while the investments remain in the trust they are not included within the estate of a potential UK-domiciled beneficiary, as they would be if gifted or bequeathed outright.
Excluded property is outside the IHT regime for periodic and exit charges, accordingly it is usual to use a discretionary trust to confer maximum flexibility. Crucially, the settlor is always defined as a potential beneficiary, meaning they can benefit from the whole trust at any time during their life.
While, there have been some recent trembles concerning the application of the gift with reservation rules, HM Revenue & Customs (HMRC) accepts they do not apply to a simple excluded property trust. Similarly, pre-owned assets are excluded for this type of settlement.
However, in practical terms it is important to establish a person is not UK domiciled before the trust is established. Where they are UK resident this may have already been tested in respect of income tax, but make certain that any HMRC ruling is current. In the reverse situation, where a UK domiciliary migrates you cannot get a hypothetical ruling. One solution is to wait at least three years and then test the situation by placing non-UK assets of just more than the IHT nil rate band into the discretionary trust.
Finally, be aware there are some more complex rules, so do not mess around with the trust. Creating life interests, adding UK property, adding property when domiciled or removing the settlor's interest can plummet the trust into rules that I could only explain if I had another 1,499 pages.
Joined as head of strategy, multi asset, in June
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