To elect or not to elect?

What does the new Finance Bill hold for non-UK domiciled spouses and civil partners? Hannah Herbert explains

There is not a great deal in the Finance Bill 2013 for married couples and civil partners to feel excited about. However, where only one member of the couple is UK-domiciled for inheritance tax (IHT) purposes there is a modicum of good news.

The cap on transfers from a UK-domiciled individual to their non-UK domiciled spouse or civil partner increased to 325,000 from 6 April 2013 and thereafter in line with the nil rate band. For the UK-domiciled spouse or civil partner it is now possible to elect to be treated as UK domiciled for inheritance tax purposes. This could be useful on the death of the UK-domiciled spouse or civil partner (particularly where the surviving spouse does not intend to be UK resident), or where the non-UK domiciled spouse or civil partner has comparatively fewer assets.

Married couples and civil partners affected will need to think carefully about whether to make the election because as ever there is a downside.

Prior to 6 April 2013, the maximum amount that could be transferred free of IHT from a UK-domiciled individual to their non-UK domiciled spouse or civil partner was 55,000. Transfers in excess of 55,000 required the UK-domiciled individual to use their nil rate band, and once that had been used up, to pay IHT. This cap on the spouse exemption has been fixed since 1984, so its real value has gradually eroded. The cap applied whether the transfer was made during lifetime or on death. There was some alleviation in respect of lifetime transfers as these were treated as potentially exempt transfers, however, the cap was capable of causing hardship on death, particularly where the death was unexpected.

Increased cap

The Finance Bill 2013 replaces the 55,000 cap on transfers to a non-UK domiciled spouse with a lifetime cap, set initially at 325,000 (new cap). The value of the new cap is not set in stone. The legislation refers to "the exemption limit at the time of the transfer" and HMRC's statement confirms that it will rise in line with the nil rate band. The new cap is a lifetime allowance, which will apply equally to lifetime transfers and on death.

We now know that the nil rate band is to be fixed until 2018, but the new cap appears to achieve the purpose of bringing the inheritance tax position of couples where one spouse or civil partner is domiciled abroad, more in line with the position of couples who are both UK domiciled. The measure is anticipated to have little impact on revenues, as HMRC predicts the change will affect a maximum of 19,000 estates left on death, which is less than 4 per cent of the total.

Even if the numbers are small, the new cap will make a real difference to couples affected, particularly where the death of the UK-domiciled spouse or civil partner was unexpected.

Option to elect

For the married couples and civil partners affected, the new cap is the default position (from 6 April 2013). There is, however, another option, also introduced by the bill, which allows the non-UK domiciled spouse or civil partner to elect to be treated as UK domiciled, for IHT purposes only. This is an interesting option, which will require both members of the couple to think carefully about the consequences of making such an election.

Making an election removes the cap on transfers to the non-UK domiciled spouse or civil partner, and enables the couple to benefit from the spouse exemption in the same way as those domiciled in the UK. The potential downside is that once an election is made, the worldwide assets of the non-UK domiciled spouse or civil partner are brought into the IHT regime so that, to the extent the nil rate band of the spouse or civil partner making the election has been used, transfers to any beneficiary other than the UK-domiciled spouse or civil partner will be liable to IHT.

HMRC requires written notice. If no election is being made, this will presumably be dealt with in the paperwork relating to the chargeable event taking place. If the non-domiciled spouse or civil partner intends to make the election there are time limits.

Once the Finance Bill 2013 has received royal assent (likely to be July), an election can be made at any time provided the marriage or civil partnership to which it relates, has been registered. For lifetime transfers, the last point at which an election can be made to take effect in relation to a lifetime transfer is the date of the transfer.

In relation to the death of the UK-domiciled spouse or civil partner, the last point at which an election can be made by the deceased's personal representatives is two years from the date of death. Provided the death occurred on or after 6 April 2013 the election can take effect from the point immediately prior to death. These provisions for writing back will be particularly useful where the death is unexpected.

Retrospective elections can be made in respect of chargeable events occurring between 6 April 2013 and royal assent, provided the marriage or civil partnership was registered by the date in respect of which the election is being made.

Capable of lapse

Once made, the election is irrevocable. However, if the person who made the election ceases to be resident in the UK for income tax purposes for three consecutive tax years from the point at which the election took effect, the election will cease. This could be of particular interest where the UK- domiciled spouse has died, and the non-UK domiciled spouse is not resident in the UK.

In these circumstances the election could be made in respect of the date of death, so that the deceased's assets could pass to the non-resident spouse uncapped. This could be a useful planning tool provided the surviving spouse does not intend to make transfers exceeding their own nil rate band within the three years following the date of death, when the election is deemed to have taken effect.

The election takes effect in relation to inheritance tax only, so that the income tax and capital gains tax position of the person making the election is unaffected. An election will also be ignored for the purposes of double taxation agreements.

Hannah Herbert is a case manager at Penningtons