Were you born in the UK or own UK assets? Inheritance tax and succession planning tips

By James Whiley and Isabella Urso

Were you born in the United Kingdom (UK) or own assets in the UK? Without proper UK tax planning advice, you could end up paying more than necessary in UK inheritance tax (IHT).

What is UK inheritance tax and when does it apply?

IHT can apply to UK citizens (even if they have moved to Australia) and Australian citizens who have made the UK their permanent home or own UK assets at their death.

The UK imposes IHT at 40% on the value of an individual’s worldwide estate above their available nil band rate (£325,000, but with the potential to transfer this to a married spouse, if unused, to have a combined £650,000 and possible additional £175,000 each for a main residence nil rate band in 2024, noting these amounts are subject to change each year).

Transfers between spouses are exempt, provided they have the same domicile status. However, transfers to a non-UK-domiciled spouse (for example, an Australian spouse) are only exempt up to £325,000 unless the non-domiciled spouse elects to be treated as UK domiciled.

An individual’s worldwide estate can capture anything transferred into a trust with a 20% IHT entry charge and 10-year anniversary and exit charges of up to 6%.

Domicile status

The UK currently imposes IHT according to domicile status rather than residence status.

There is no single definition of ‘domicile’.

You are born with a domicile of origin. A domicile of origin is generally established according to where you were born and follows the domicile of your father at the time of your birth if your parents were married.

You can acquire a domicile of choice (which is state-based in Australia) if you were born with a UK domicile of origin and you consider Australia to be your permanent or indefinite home, although it depends on the facts.

In practice, an individual from the UK is born with a UK domicile of origin but can move to New South Wales permanently and indefinitely and acquire a domicile of choice in New South Wales.

If an individual still has a UK domicile of origin at their death, they will potentially be liable to IHT on their worldwide estate. However, if they have acquired an Australian domicile of choice or have an Australian domicile of origin, they will only be liable to IHT on their UK estate and anything transferred into a UK trust.

Following the most recent UK Budget, it’s anticipated that there will be a dramatic change to IHT, with the proposed abolition of the century long ‘domicile’ based system in favour of a ‘residence’ based system.

The new rules mean that the UK will impose IHT on the value of an individual’s worldwide estate if they are resident in the UK for 10 years, with a 10-year tail keeping individuals within the IHT net after leaving the UK. The IHT liability on assets in trust will depend on whether a settlor meets the 10-year residence criteria or is within the 10-year tail at the time the assets are settled.

The new rules provide certainty for individuals who have already left the UK or are planning to leave the UK, but mean that individuals may be kept within the IHT net for a longer period of time than under the domicile-based system.

The current IHT treatment will remain the same for any non-UK property that is settled on trust by non-UK domiciled settlors before 6 April 2025. Provided trust assets continue to meet excluded property criteria under the current legislation, and subject to any future anti-avoidance provisions, there will be no IHT on such assets. This provides significant succession planning opportunities.

The UK Budget also anticipates significant changes affecting Australians living in the UK, which we have not detailed in this update, but are relevant to individuals moving to or currently living in the UK.

While the current government has given a date of 2025 for the changes to IHT, the consultation process hasn’t begun and there is likely to be a change of government before 2025.

We will be monitoring the developments of the proposal closely.

How can I address my exposure to IHT?

Careful planning is required. Some common strategies for individuals with an IHT exposure include:

• if an individual with a UK domicile of origin acquires a domicile of choice in Australia and has lived in Australia for at least three UK tax years (so they are not UK deemed domiciled under the three-year rule), a statutory declaration of domicile can be prepared as evidence of their Australian domicile of choice. Domicile is a complex area of law and it depends on the facts.

Statutory declarations of domicile remain relevant to succession law in the UK and Australia, even if the proposed changes to the current domicile-based system are made.

• lifetime gifting of:
  • £3,000 worth of gifts per year plus £250 to any number of individuals;
  • regular gifts out of income (which varies according to circumstances);
  • potentially exempt transfers (ie absolute gifts), which are exempt if the individual survives for seven years (with tapered rates applying in between);
• encumbering property liable to IHT with debt, as IHT is due on the net value of an estate, but complex rules apply to this;
• making gifts to UK charities in a Will (which are IHT exempt);
• considering if any properties qualify for Business Property Relief or Agriculture Property Relief; and
• establishing an excluded property trust before 5 April 2025 to hold non-UK assets to shelter them from IHT and for succession planning purposes for non-UK domiciled individuals given the proposed changes in the UK Budget.

What else should I consider?

This article primarily discusses IHT, but individuals should also seek professional advice on:

• whether to have Wills and the equivalent of enduring powers of attorney, which deal with financial decisions in case of mental incapacity, in both the UK and Australia. Although the UK and Australia will recognise Wills prepared in either country, it is important to have the equivalent of an enduring power of attorney in the UK (known as a lasting power of attorney) as Australian enduring powers of attorney (state-based in Australia) will not be recognised in the UK and vice versa.

The succession of real estate follows the laws of the country or state where it’s located, while succession to other assets (movable property) is determined by an individual’s domicile (state-based in Australia) at the date of death.

Due to lengthy administrative delays in probate proceedings, it’s typically advisable to have Wills in both countries, carefully drafted to prevent accidentally revoking each other. This allows for more flexibility in Australian estate planning, such as incorporating asset protective and tax-effective testamentary trusts into Australian Wills and makes the administration of an estate quicker and less complicated;

• Australian capital gains tax, as if you have a simple Will leaving everything to your children outright and your children are living abroad at the time of your death, Australian capital gains tax may be triggered and act as an effective back door inheritance tax. This does not apply in relation to gifts to Australian resident beneficiaries and can also potentially be avoided for non-resident beneficiaries by having Wills with testamentary trusts in them and provisions to deal with this issue;
• the Australian tax and compliance requirements of owning UK assets or having an interest in a UK trust or company. If these have not been disclosed to the ATO (for example, because they were inherited from a parent), the individual should consider doing so through the ATO voluntary disclosure regime to avoid harsh penalties; and
• if there is any possibility of a return to the UK or spending significant amounts of time in the UK, then tax advice should be obtained in Australia and the UK well before any change in circumstances to avoid unforeseen tax liabilities being incurred and allow the restructure of wealth if appropriate.