From 6 April 2025, Inheritance Tax (IHT) will move from a system based on domicile to one based on residence. ‘Long-term residents’ will be subject to IHT on their worldwide estate.
When is Inheritance Tax (IHT) charged?
An individual’s estate is subject to IHT at up to 40% on death, after the deduction of the available nil rate bands and any exemptions. The Chancellor yesterday confirmed that the IHT thresholds will not change until 2030. More details surrounding the changes made to the calculation of IHT and certain exemptions can be found here.
IHT can also be charged when assets are settled onto trust or are distributed from a trust, as well as on the 10-year anniversary of a trust’s creation.
What is a long-term resident?
From 6 April 2025, an individual is a long-term resident if they meet either of the below conditions in the year of the event (e.g. their death):
- If an individual has been UK resident for at least ten out the last 20 tax years prior to the year in question
- If an individual is under 20 years old, if they have been UK resident for at least 50% of tax years in their lifetime
These tests apply regardless of your common law domicile.
If an individual is a long-term resident, their worldwide income and gains are within the scope of UK IHT. If an individual is not a long-term resident, only their UK assets, including any interests in UK residential property, are within the scope of UK IHT.
Where spouses have ‘mixed’ long-term residence statuses, an election can be made by the spouse who is not a long-term resident to treat themselves as one.
Inheritance Tax (IHT):The ‘ten-year tail’
Under the standard long-term residence rule, when an individual becomes non-UK resident they are left with a ‘ten year tail’ whereby their worldwide assets remain in the scope of UK IHT for ten years after they cease to be UK resident. .
The government have in part acknowledged the difficulties of this position by allowing for a shortening of the number of years an individual remains exposed to UK IHT once they become non-UK resident (‘the tail’) as follows:
- UK resident for ten to 13 out of the previous 20 tax years – three tax years
- UK resident for 14 to 19 years out of the previous 20 tax years – four to nine tax years
- UK resident for 20 year out of the previous 20 years – 10 tax years
The end result is once you have been UK resident for 20 tax years, you will remain exposed to UK IHT for a further ten years once you become non-UK resident, bar those who fall within the transitional rules for 2025/26 as set out below.
The shortening of the tail is only relevant when we are considering an event in the period of non-UK residence. To reset the clock completely and then return to the UK, all individuals will need to become non-UK resident for a consecutive ten tax years. This aligns with the FIG regime, as set out by Alice Pearson.
Example 1
Mrs X has been UK resident since 2010/11. She will cease to be UK resident from 2026/27. How will the new rules apply to her?
As Mrs X was UK resident for 16 tax years and is now non-UK resident, the shortening provisions apply meaning she will cease to be a long-term resident from 2033/34 after six tax years.
Transitional rules
An individual who would otherwise be a long-term resident will be subject to a separate test if they are:
- legally domiciled outside of the UK on 30 October 2024 and
- they are non-UK resident for 2025/26 onwards.
In this case, the rules that applied to deemed domiciled individuals must be considered and effectively an individual must be i) deemed domiciled under the 15 out of 20 tax years test and, ii) UK resident in at least one of the four tax years prior to their death.
Example 2 – Non-UK domiciled
Mrs Y, who is legally domiciled outside of the UK, has been UK resident since 2013/14 and her last year of UK residency will be 2024/25. If Mrs Y dies in March 2029 what will her IHT position be?
As Mrs Y is legally domiciled outside of the UK as at 30 October 2024 and will be non-UK resident for 2025/26 onwards, the transitional rules apply. At the time of her death in 2028/29, Mr Z had not been UK resident for 15 out of 20 of the previous tax years. She will therefore only be subject to IHT on her UK assets.
Example 3 – deemed domiciled
Mr Z, who is legally domiciled outside the UK, has been UK resident since 2003/2004 and his last year of UK residency will be 2024/25. If Mr Z dies in March 2029, what will his IHT position be?
As Mr Z is legally domiciled outside the UK as at 30 October 2024 and will be non-UK resident for 2025/26 onwards, the transitional rules apply. At the time of his death in 2028/29, Mr Z had been UK resident for 15 out of 20 of the previous tax years, however, he had not been UK resident in any of the 4 previous tax years. Therefore, he will only be subject to IHT on his UK assets.
Gifts outside the UK
The government has also confirmed that where an individual who is neither domiciled nor deemed domiciled in the UK makes a gift off non-UK assets prior to becoming a long-term resident, the gift will not be subject to IHT where an individual dies within the seven-year window, even if they have become a long-term resident by that point. Therefore, this gives individuals who are not yet deemed domiciled a window of opportunity to make gifts overseas prior to the time they become a long-term resident.
Excluded Property Trusts
Under the current rules in place, where a settlor transfers non-UK assets to a trust at a time when they are non-UK domiciled, such assets are considered ‘excluded property’ and remain outside the scope of UK IHT even once the settlor becomes deemed domiciled in the UK.
As the government had all but confirmed would be the case, the definition of excluded property will be altered and whether a trust holds excluded property will now be determined by reference to whether there is a living settlor who is a long-term resident at the time of the relevant event. This means that trusts with a living settlor who is long-term resident will fall into the relevant property regime and be subject to ten-yearly charges and exit charges.
Owing to the ‘Gifts with Reservation’ rules, it would usually be the case that where a settlor or his spouse can continue to benefit from settled property, its value also remains in the personal estate of the settlor on their death, effectively creating a double IHT charge on assets falling within the relevant property regime. However, the government has confirmed that excluded property comprised in a trust as at 30 October 2024, will not be caught by this rule and hence the double IHT charge does not apply for these settlors even once the long-term residence rules come into play.
The winners
The long-term residence test is the same regardless of an individual’s domicile. This means ‘Brits Abroad’ stand to be the inadvertent winners from the new rules.
Those individuals who might previously have still been within the common law concept of domicile years after leaving the UK, will now fall outside the scope of IHT on their worldwide assets once they cease to meet the definition of a long-term resident. As UK assets, including any interest deriving from UK residential property, will always be in the IHT net, these assets will still need to be quantified and reported to HMRC. However, it does not seem that continuing to have connections to the UK, such as holding a British passport, will have any impact on the IHT position.
The change in rules also means that a gift of non-UK assets into trust by a settlor who has been non-UK resident for at least ten consecutive tax years will not trigger an immediate inheritance tax charge. However, care should be taken should the settlor intend to return to the UK during their lifetime.
What can I do pre-5 April 2025?
If you are currently neither legally domiciled nor deemed domiciled in the UK but will become a long-term resident from 6 April 2025, you could consider making a gift of non-UK assets outside the UK prior to the end of the tax year. This gift will remain outside the scope of IHT even if you pass away within seven years.
If you are currently a non-UK resident looking to move to the UK shortly, we would suggest you seek advice to determine the number of tax years you have been non-UK resident and consider whether your return could be delayed until ten complete tax years have elapsed.
Contact Mercer & Hole
As always, please contact a member of the Private Client Team at Mercer & Hole if you would like to discuss further, we are happy to help.
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