Hong Kong is a destination where UK professionals can find themselves working for many years, perhaps even settling there for life. Even though they may feel they have left the UK far behind, UK Inheritance Tax (IHT) may still have an impact on their wealth. That’s because domicile is not always the same thing as residence, when it comes to IHT.
In this briefing
Domicile is a term that is a fundamental part of the IHT legislation. UK IHT is charged on a UK domiciled individual’s worldwide assets – if you are non-UK domiciled, it is only charged on assets held in the UK. Yet domicile is not defined anywhere in that legislation. So we have to look at general and case law principles.
Everyone has a domicile of origin at birth. This will normally be the same as their father if their parents were married, their mother if not. Your domicile is broadly where you consider your home to be.
This can be replaced by a domicile of choice. One way of reducing the impact of IHT is to acquire a domicile of choice, somewhere new where you consider your home to be. However, the burden is on the individual to prove that they have established a domicile of choice, so it isn’t an easy option. And sometimes it’s only tested after someone dies.
Acquiring a new domicile can be easier said than done. In Civil Engineer v IRC (2002), C (an engineer) argued that he had established a domicile of choice in Hong Kong. He lived there for 29 years and therefore, he argued, the discretionary trusts he had set up in that period should not be subject to UK Inheritance Tax. His case failed as the Special
Commissioners could not find evidence that it was his intention to permanently settle in Hong Kong. He had also returned to the UK which in their view meant he reaffirmed his UK domicile of origin.
So what can someone do to establish a domicile of choice? The Special Commissioners, in the case of Gaines Cooper v HMRCC (2007), defined a domicile of choice as where someone had established their chief residence and their ‘home with the intention of establishing himself and his family there and ending his days in that country.’ The judgement gives a useful summary of the factors which connected him to England. He had a house and a business in the Seychelles and had even made arrangements for his ashes to be scattered there but:
So to establish a domicile of choice, it seems necessary to make a clean break with the UK. Supporting documentation can be invaluable – for example, letters to family and friends explaining plans, a cancellation notice of golf club membership. As a Hong Kong resident, someone may also want to apply for the status of Permanent Resident when eligible.
The strategies which can be used to break
links with the UK tie in nicely with sensible IHT planning. An individual will be deemed to have a UK domicile for at least three years after leaving the UK (and most likely for many years after that).
An individual could look at reducing assets, especially those held in the UK. To break links with the UK and reduce the value of assets in the UK, consider the scope to give away these assets. These could use UK IHT exemptions, such as the annual exemption of £3,000 per tax year or gifts in respect of a marriage.
It’s a good idea when gifting for IHT purposes to gift assets that are growing in value and retain assets that will depreciate. One of the great things about being non-UK resident is that there is no Capital Gains Tax (CGT) bill to pay on any growth. However, care needs to be taken that the person stays outside the UK for at least five complete tax years after the tax year of their departure. If they become UK resident within that time, they will be charged CGT on any gains on assets that they owned prior to departure and disposed of while they were non-resident (s.10A TCGA 1992).
Even if your client can demonstrate that they have established a domicile of choice in Hong Kong, they will still be liable to UK IHT on assets located in the UK. It can make sense to reduce the value of these assets to £325,000 (the nil rate band) or below, so that there is no liability for the non-UK domiciled client. The actual figure will depend on what nil rate band the client has available.
Steven and Martha emigrate to Hong Kong in July 2008. In March 2010 they give their buy- to-let property (bought in 2000) to their son, Matthew, as a wedding present. The property is now worth £250,000. They have made no previous lifetime gifts. There is a capital gain of £50,000 on the property.
IHT and CGT Consequences
In March 2010, Steven and Martha would still be UK domiciled for IHT purposes. So their gift will be a potentially exempt transfer. All future growth on the property is outside their estate from March 2010. The value for each of them was 1⁄2 market value (£125,000 each) less the exemption for a parent making a gift on marriage (£5,000 each - S.22 IHTA 1984), less the two annual exemptions (£6000
each – s.19 IHTA 1984). So if they survive seven years, each gift of £114,000 will be outside their estates. If one or both of them die within the seven year period, the gift will fall within the nil rate band, so no further tax would be due on death.
If Steven and Martha stay as non-UK residents until at least 2014/15 the gift will be completely free of UK CGT. However, their plan could change. Martha’s mother becomes ill in 2012/13 and the couple return to the UK to look after her. This triggers a CGT charge because they have been non-UK resident for less than five tax years after the tax year of their departure. They will each pay CGT on half of the gain (£25,000) less the CGT annual allowance in 2012/13 (£10,600). Steven is
a higher rate taxpayer and pays tax at 28% on the £14,400 net gain, while Martha has enough of the basic rate band remaining to pay tax at 18% on her share of the gain. If they had been able to stay as non-residents they could have saved £6,624 in tax.
Gifting to trusts can be an effective way to reduce the impact of IHT, and a way to evidence the breaking of links with the UK. Transfers of UK assets to a trust will be documented and if the settlor (person making the gift) is excluded from benefit, there is a clear break with the asset. This approach obviously relies on the settlor being ready to give up access to the asset.
Trusts can also offer a protective way of holding future investments, like a Hong Kong savings plan. This may safeguard them from a future IHT impact if a return to the UK is possible. These investments can also benefit from IHT exemptions for the regular premiums, such
as the exemption for expenditure from normal income (s.21 IHTA 1984).
Want to know more?
A guide is available from HM Revenue and Customs called “Residence, domicile and the remittance basis” (HMRC6) which has a lot more information on the topics covered here. You can find it at www.hmrc.gov.uk.
Any links to websites, other than those belonging to the Heng An Standard Life (Asia) Limited (“HASL”), are provided for general information purposes only. We accept no responsibility for the content of these websites, nor do we guarantee their availability.
Information provided in this briefing does not constitute any form of advice and HASL is not responsible for any advice given on the basis of this briefing. Any reference to legislation and tax is based on HASL's understanding of law and tax practice in Hong Kong and the UK at July 2012. These will be subject to change in the future. Tax rates and reliefs may be altered. The value of tax reliefs to the investor depends on their financial circumstances. No guarantees are given regarding the effectiveness of any arrangements entered into on the basis of these comments nor is HASL responsible for the completion of any tax returns on the basis of this briefing. We recommend that investors seek advice from professional advisers regarding their own personal circumstances.
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Disclaimer: The above information is for reference only and should not be construed as legal, tax or investment advice. You should seek professional advice regarding your tax circumstances and the types of savings and/ or investment that are suitable for you. Investing in investment-linked assurance scheme involves investment risks. Past performance is not indicative of future performance.