Domicile

Domicile

Differently Domiciled

JAMES KESSLER QC suggests some United Kingdom income tax, capital gains tax and inheritance tax planning opportunities for married couples with different domiciles.

THIS ARTICLE CONSIDERS some tax problems and opportunities for a UK domiciled individual who is married to a foreign domiciled spouse. It is necessary to consider the various taxes separately.

Inheritance tax spouse exemption

IHTA 1984, s 18(1) normally provides complete exemption for inter-spouse transfers. S 18(2) imposes an important exception where:

The exemption is restricted to £55,000 only. Whilst it is generally true that a foreign domicile is a passport to tax saving, this is one circumstance in which a foreign domicile does represent a serious drawback. But note that this restriction does not apply the other way round; i.e. where the foreign domiciled individual makes a transfer to his UK domiciled spouse. (Nor should it apply in those circumstances because such a transfer brings assets broadly outside the realm of inheritance tax within its scope.) Also, the restriction does not apply where both spouses are not domiciled in the UK.

One simple solution to this problem may be to wait until the foreign domiciled spouse becomes deemed UK domiciled under s 267.

It is arguable that the restriction is in breach of EU law, where the transferee spouse is domiciled in another EU state. Holland v CIR [2003] STC (SCD) 43 is a startling test case in which a cohabitee contends that she should be entitled to the inheritance tax spouse exemption under human rights principles; discrimination between married and unmarried couples being in breach of Article 14 of the European Convention on Human Rights (Prohibition of discrimination). If ultimately successful — and the prospects of success seem greater than before given the comments of the Joint Committee on Human Rights on pre-owned assets (at www.parliament.the-stationery-office.co.uk/pa/jt200304/jtselect/jtrights/93/9305.htm) — the consequences for the tax system will be of volcanic proportions. It will need several further cases to determine the various human rights issues. What about a same sex couple? Their claim is arguably stronger since they cannot marry or obtain the tax advantages of marriage. The tax treatment of civil partnerships remains to be resolved and the Civil Partnerships Bill contains no provisions so that civil partners are regarded as unmarried for tax purposes. And what about a married man separated from his wife and living with another 'as man and wife'? Where will it stop?

Inter-spouse transfers which do not qualify for the spouse exemption will be potentially exempt transfers (PETs) unless some other exemption is in point. An inter-spouse gift may qualify for relief under IHTA 1984, s11(1):

This would normally apply, in particular, to the common case where an individual gives a half share in the family home to his spouse. The most basic requirement of 'maintenance' is to have a secure roof over one's head.

Since s 11 does not apply on death (at least in the Revenue's view), gifts within s 11 are an important 'last-minute' inheritance tax planning opportunity for an elderly or terminally ill UK domiciliary married to a foreign domiciliary.

Reservation of benefit on inter-spouse gift

The reservation of benefit rules do not generally apply to gifts from one spouse to another; see FA 1986, s 102(5)(a). However, where a UK domiciled individual makes a gift to a foreign domiciled spouse, so the spouse exemption is restricted to £55,000, a gift over that limit will be within the scope of the gift with reservation of benefit (GWR) rules, unless some other exemption is in point; for example, the family maintenance exemption which overrides the GWR rules.

One solution to this problem may be to sell assets at market value, so there is no disposal by way of gift, although there may be a stamp duty reserve tax or stamp duty land tax cost.

Remedial tax planning

There may be a need for remedial tax planning where there has been a GWR.

For example, where H has made a gift to W, and a reservation of benefit problem arises, the following solutions may be considered:

Inheritance tax planning

Various strategies suggest themselves when considering inheritance tax mitigation for couples with different domiciles.

Simple gift to foreign domiciled spouse

A simple and straightforward short and medium term strategy is:

The gift may be a PET, but that may not in practice be a serious concern. If the GWR rule applies, however, this effectively neutralises any tax saving. Indeed, it may make the position worse. This often makes simple gifts impractical. I describe this as short or medium term planning as it ceases to be effective if the spouse becomes deemed UK domiciled under IHTA 1984, s 267 (17 out of 20 years residence in the UK).

Gift and settlement

A more sophisticated inheritance tax strategy is:

In principle, the property in the settlement may be excluded property. This continues to be the case even if the donee spouse later becomes UK domiciled. Another advantage is that this should avoid the GWR rule. (For an (almost unbelievable) example of a botched execution of this idea, see Anker-Petersen v Christensen 2002 WTLR 313.)

This strategy only works if the settlor is the foreign domiciled spouse and not the UK domiciled spouse. One would need to consider whether the UK domiciled spouse might be a 'settlor' since the term 'settlor' includes a person who provides property for a settlement direct or indirectly. If there is a sufficient break between the two gifts, this should not be a problem. What is a sufficient break? The two steps must not form part of one arrangement; for the UK domiciled spouse to be the settlor there must at least be a conscious association between his gift and the creation of the settlement. (See Countess Fitzwilliam and others v CIR [1993] STC 502.)

Capital gains tax spouse exemption

TCGA 1992, s 58 provides (with immaterial exceptions) capital gains tax relief for inter-spouse transfers. This exemption applies regardless of the domicile of the spouses. It applies to sales at market value as well as gifts. N.B. Watch out for the consequences of the transfer for capital gains tax taper relief: see TCGA 1992, Sch A1 para 15.

Also, note that the relief does not apply to:

Whether this is consistent with the Human Rights Act 1998 may become clearer after Holland v CIR [2003] STC (SCD) 43.

Capital gains tax planning

Other capital gains tax planning points that are worth mentioning in the context of differently domiciled couples are as follows.

Asset yielding a gain

Suppose the UK domiciled spouse owns an asset which will give rise to a gain on a disposal. A simple and straightforward capital gains tax strategy is:

N.B. When undertaking such planning in this area, watch out for the implications of Furniss v Dawson!

Successive gifts

A more sophisticated capital gains tax strategy is as follows.

This offers the capital gains tax advantages discussed above, provided the UK domiciliary is not a settlor. If the object is capital gains tax planning and not long term inheritance tax planning, an alternative strategy here may be as follows.

There is no trust, so no issue of 'who is a settlor' arises. Take great care that the company can be proven to be non-resident!

Asset yielding a loss

The opposite point arises if the foreign domiciled spouse owns a foreign situate asset which will give rise to a loss. The loss on the disposal will not be allowable: see TCGA 1992, s 16(4). Accordingly:

The UK domiciled spouse should be in a position to realise an allowable loss.

Income tax planning

A simple and straightforward strategy is:

The inter-spouse gift, strictly, satisfies the transfer of asset conditions. The transferor would then fall within TA 1988, s 739 since he has 'power to enjoy' his wife's income. (See s 742(9)). However, Revenue Interpretation 201 provides relief.

The gift could also be a 'settlement' for the purposes of TA 1988, s 660A. However, s 660A(6) normally provides relief.

James Kessler is tax counsel in practice at 24 Old Buildings, Lincoln's Inn, e-mail: kessler@kessler.co.uk, website www.kessler.co.uk.

This article is drawn from chapter 30 of Taxation of Foreign Domiciliaries, third edition, price £125. Published by Key Haven Publications, tel: 020 7731 7700 or e-mail: administration@khpplc.com.

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