Estate planning strategies will largely be determined by the domicile and jurisdiction of the donor and their assets. Advisers must therefore familiarise themselves with the different legal and tax systems in place
The term "estate planning" has two principal meanings. The first is succession planning, which ensures your estate passes smoothly to your chosen heirs, and controls who gets what and when. The second is tax planning, which ensures what actually passes to your heirs is protected as best as possible from estate duties. Normally, the two go hand in hand. The objective of any estate planning strategy is to ensure that capital passes to the right people at the right time, and as much of it as possible is preserved for the recipients stated.
The main consideration that will affect an estate planning strategy is the domicile of the parties concerned. Who gets what, and how much tax is payable, can depend on the domicile of the donor or the domicile of the donee, or both, depending on the jurisdiction. Another important issue will be where the estate"s assets are situated. Under both meanings, distribution of a person"s estate will be more complicated if there is more than one jurisdiction involved, either because assets are based in different jurisdictions, and/or the beneficiaries and donor are in different jurisdictions.
For example, suppose an English national resides in France, and leaves a Belgian property to his son who lives in Spain. In this example, four jurisdictions will wish to claim inheritance tax (IHT). Furthermore, if the deceased has other children, the son may be forced to share the property with his siblings, should they make a claim under Belgian forced heirship laws.
This is an extreme example, but illustrates how estate planning in an international context can be a minefield. The adviser needs to be aware of how different legal systems approach succession and taxes, including:
• Are there any forced heirship rules, or can an individual dispose of his estate in any way he wishes?
• Are taxes levied on the estate of the deceased, or on the amount received by the donee (or both)?
• Does the jurisdiction recognise the concept of trusts?
• Are there treaties between the jurisdictions, either in terms of succession law, or double tax relief?
The concept of domicile itself can have a different meaning depending on the jurisdiction. In many jurisdictions, the concept is based on the concept of habitual residence, for example, it is a physical presence test. An individual need only live in France for more than 183 days a year for their worldwide estate to potentially become liable to French estate duty and succession law. Conversely, however, they should only worry about French estate duty on French situs property if they leave France to live elsewhere.
Other countries may have a modified physical presence test, which includes added tests that can bind former residents to the jurisdiction for a period of time after leaving. For example, if a Dutch national leaves the Netherlands and dies within 10 years he will still be deemed domiciled in the Netherlands for estate duty if he was still a Dutch national on death. There are similar rules in Ireland and Sweden.
Then, of course, there are domicile rules that bring the worldwide estate of individuals into the tax net unless active steps are taken to shake the domicile. The best known one of these is a UK domicile of origin, which, as a wealth of case law has shown, can be very difficult to shake, even if the individual concerned spends most of his life outside the UK. The flip side of this system means it is possible for an individual to be born in the UK, live there all their life and be domiciled elsewhere - possibly even in a country never visited.
Similar rules used to apply in Ireland, but in December 1999, the Irish moved to a residence-based test system whereby an Irish domicile of origin will only stick for IHT purposes for the first five years of non- residence. Conversely, a foreign national will be subject to Irish IHT on worldwide assets after being resident for more than five years (but not for income or capital gains tax purposes).
The table (below) illustrates the different approaches a selection of EU countries take to succession law and IHT.
Trust or Not?
Once an individual"s domicile is established, the next question should be what is the best form of estate planning? Should a trust be used or not?
For planning in the UK, trusts can be the most effective, both for domiciled and non-domiciled individuals. Trusts can be drafted in many formats with varying degrees of effectiveness for UK IHT.
A flexible power of appointment trust, for example, is a simple means of creating a potentially exempt transfer for IHT, without immediately giving the donee access to the capital. This gives the donor control over who receives the trust capital and when they receive it - very useful where beneficiaries are young or too immature to handle substantial inheritances.
Carve-out trusts can be used to reduce the estate for inheritance tax purposes, but at the same time retain access to the capital without breaching the gift with reservation rules. These come in many variants, but a particularly effective form is the Discounted Gift Trust, which can take the whole fund out of the estate if the settlor survives for at least seven years, while providing an income during the settlor"s lifetime. Furthermore, should the settlor die within the seven-year period, the inclusion amount in their estate can be substantially reduced, which means there is an immediate IHT saving when the trust is created.
In relation to non-UK domiciled individuals resident in the UK, settling foreign property on trust will create an excluded property trust, keeping the assets out of the UK IHT net, even if the settlor subsequently becomes deemed UK-domiciled for IHT purposes.
Life policies are a very effective asset to hold within the above trust structures, as they do not produce income, which makes the trust more tax efficient and trust administration slicker. Extraction of capital can be done tax efficiently by either using the 5% withdrawal allowance or by assigning individual polices out to beneficiaries.
Trusts are also widely used estate and succession planning tools in other common law jurisdictions, but they are not as common in civil law jurisdictions, and can even cause problems. Italy and the Netherlands are the only two civil law jurisdictions to have ratified the Hague Convention on the Law Applicable to Trusts, but other European jurisdictions are coming across them as individuals become more mobile in Europe.
In many European countries, the transfer of assets will result in an immediate gift tax liability, the amount payable being dependent on the relationship between the donor and the donee. Usually, the highest rates of tax will be payable where the donor and donee are unrelated, and the lowest rates will be payable where the donor and donee are parent and child. Therefore, the transfer of property into and out of a trust can result in the highest amounts of tax because there is no blood relationship between the trustee and the beneficiary/settlor.
Also, the trust may not be recognised at all if its terms are drawn in a way that goes against the succession laws of the settlor"s country of domicile, for example, a case in Belgium confirmed that a trust cannot be used to dispossess legally protected heirs. Several jurisdictions, such as the Isle of Man and Jersey, have laws that state if property is subject to a trust under that law, then the trust cannot be set aside under the law of another jurisdiction. While this may be effective where the only trust property is movable property, it would be inadvisable to rely on such vehicles in relation to immovable property situated in States that have forced heirship rules.
That is not to say that civil law jurisdictions have not devised methods of transferring assets in a way that gives the donor control over who receives what and when, or in a way that keeps estate duty at a minimum. For example, certain jurisdictions" marital property regimes allow forms of ownership between husband and wife that ensure the surviving spouse will inherit the whole estate on the first death. There are also special purpose vehicles in certain civil law jurisdictions, such as foundations, which can act in many ways like a trust. In relation to real property, corporate vehicles can be effective as the transfer on death involves movable property in the form of corporate shares rather than immovable property. Care is needed in certain jurisdictions, for example, France and Spain where punitive tax can be levied on real estate owned by certain non-resident companies.
The term "estate planning" has two meanings. The first is succession planning, to ensure your estate passes smoothly to chosen heirs, the second is tax planning.
The main consideration that affects estate planning strategy is the domicile of the parties concerned. Who gets what and how much tax is payable can depend on the domicile of the donor, the domicile of the donee or both.
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