With the UK government taking in record amounts of inheritance tax (IHT) and associated penalties, how will your domicile affect your tax position? Can you escape inheritance tax and pass on your estate as you wish?

Inheritance tax (IHT) receipts by the UK government from April to July 2023 were £2.6 billion – up £200 million.

Fines imposed on families who had broken IHT rules increased by a third to £2.28 million.

Liability to Inheritance Tax sits with the estate itself and must be paid before settlements to beneficiaries. An estate passing to a spouse is exempt from IHT, but the rest is potentially liable at 40%, less a tax-free amount of £325,000. For a married couple, any of the £325,000 is unutilised on the first death, there will be up to £650,000 of allowances available on the second.  

A further £175,000 of relief is available on the main home if it is passed to children, or £350,000 if this is not utilised on the first death. While overall, there is up to £1 million of allowances, the main home relief tapers away for estates worth over £2 million, reducing to nil at £2.35 million.

The application of UK succession law is based upon the domicile status of the deceased, not where they were tax resident at the time of death.

Domicile is a common law concept, and a person is domiciled in the UK if they belong here and regard it as their home. At the outset, this follows the parents’ (commonly the father’s) domicile at birth (the ‘domicile of origin’). This can be changed by moving somewhere else, making it their permanent home, renouncing the UK as their native land, and adopting a ‘domicile of choice’.

“This sounds much easier than it really is in real life,” said Jason Porter of specialist expat financial planning firm Blevins Franks. “In fact, a UK domicile of origin is very sticky, and can remain in place even if you have been absent from the UK for many decades.

“The majority of EU countries have a civil law legal system, where succession law and inheritance taxes are applied on the basis of the deceased’s habitual residence status.

“The incompatibility between the two rules could see the estate of a UK national who dies while living in an EU member state an area of cross-border legal conflict, with both the UK and the EU state claiming the asset must pass to their heirs according to their succession law, as well as arguing they have the taxing rights.”

The aim of a double tax convention is to allow the country in which the deceased was domiciled to tax all property wherever it is, and for the other country to tax only specified types of property, mainly real estate, in its territory. If double taxation arises, there are rules for deciding which country gives credit for the other’s tax.

For the majority of European countries there is no template to fall back on to establish which country is the deceased’s domicile. As no national succession law automatically takes priority, there is no basis as to who has the taxing rights. If both choose to tax the asset, double tax relief should still be available, but this may be restricted if the asset is located in a third country.

The succession law of each member state varies somewhat, but the majority follow the Napoleonic code to some degree and include provision for ‘protected heirs’. In many cases, children sit in a superior position to the spouse, enabling them to inherit 50% to 75% of the deceased parent’s estate. They may also have the power to remove the surviving spouse from what was the marital home after a fixed period.

In 2015, the EU attempted to try and find a solution with its new European Succession Regulations. Also known as ‘Brussels IV’, the new law covers cross-border inheritances and allows foreign nationals living in the EU to choose whether the succession law of that EU member state or their national succession law should apply on their death.  

“Brussels IV is not the perfect solution,” said Jason Porter. “In some cases, it can result in more succession tax becoming due. There also remains several options you can choose from to protect your spouse, including inserting clauses in the conveyancing of real estate, amending the marital property regime around the ownership of other investments and assets, and looking at certain financial products which may provide flexibility in estate planning, additional allowances, or reduced rates of estate tax.”