The new look inheritance tax

The dust is still settling on the first Budget delivered by a woman, and my goodness what a Budget it was!? We are still yawning from the late night and still working our way through all the details and the over 100 pages of legislation.

Against that backdrop it is still worth revisiting the inheritance tax changes, as there was so much detail announced it was difficult to do even the headlines justice and keep the last blog to a length where even the keenest tax nerd wouldn’t have dropped off before they finished it.

On that note then, this blog still only gives our initial Inheritance Tax (IHT) overview, and there could still be more detail to be discovered over the next few days. Also, we should make clear that this blog looks only at the change to an IHT residence based system – the other changes announced, for example BPR and APR are outside the scope of this blog (but are still obviously relevant to many clients impacted by being brought within IHT for the first time – so look out for our wider coverage on those topics).?

Long term residence

Let’s start at the beginning, as Maria sang in The Sound of Music, a very good place to start. From 6 April 2025 inheritance tax in the UK will change fundamentally from a domicile based system to a system based on residence.? The policy document announced at the Budget introduced the concept of a “long-term resident” – an individual older than 20 who has been resident in the UK for 10 out of the 20 tax years before the one in which any transfer takes place. This is a major change from the original proposal that an individual would be subject to inheritance tax after just 10 consecutive years of residence. For this purpose, we are talking about tax years, with split years and years of treaty non-residence counting as full years of UK residence. For individuals who are 20 years old or younger, the test will be whether they have been resident in the UK for 50% of the tax years since their birth.

There were also changes to the ‘tail’ – i.e. the amount of time an individual will remain within the scope of UK inheritance tax once they become non-resident.? This will remain at 10 years for those who have been resident in the UK for 20 years or more, but for those who have been resident for between 10 and 13 years the tail will be much smaller, at 3 years.? This then increases by 1 year for every year of residence until it hits the maximum of 10 at 20 years.

The Treasury appear to have listened to concerns about those who have already left the UK being expected to be aware of such fundamental changes.? As a result for non-UK domiciled individuals and deemed domiciled individuals who are non-UK resident in 2025/26, the old 15/20 domicile rules will apply for determining long-term residence, provided they remain outside the UK.? Should they return to UK residence, they will then be subject to the new rules.

The statutory residence test will apply from 2013/14 to determine residence, but for earlier periods the old residence rules will apply, so there may be some dusting off of old records, and even old textbooks.

Individuals

For an individual, becoming a long-term resident will mean becoming subject to IHT on their worldwide assets owned outright.? However, a lifetime transfer of excluded property will remain outside of scope of IHT, even if the individual becomes long-term resident by the time of their death and within the 7 year “potentially exempt transfer” (PET) period.? By contrast, a lifetime gift of non-excluded property will remain chargeable at death rates if the transferor dies within 7 years, even if they have ceased to be long-term resident at the time of their death.

There will also be some changes to the spouse election to reflect the new rules.? From April 2025 the existing domicile election rules will be amended so that the spouse or civil partner of a long term resident can elect to be treated as though they were also long term resident. This election will last for 10 consecutive tax years.? It will still be possible to make a domicile election for periods before 6 April 2025 and there are transitional rules to cover elections which have already been made.

Trusts

In a nutshell, IHT will be charged on non-UK assets (alongside UK assets as is currently the case) in settlements at times when the settlor is a long term resident.? But you’d be disappointed if it was quite that simple, wouldn’t you?? So, there are a few more things to consider.

For relevant property trusts, whether or not non-UK assets are excluded property will no longer be fixed at the time the trust is established.? Instead, the excluded property status of those assets will depend on the long-term residence status of the settlor, meaning assets can move in and out of the excluded property status. ?A UK-dom settlor who is by extension not a long-term resident will be subject to an exit charge where assets become excluded property (up to a maximum of 6%) after 6 April 2025, following their change in status.? Similarly, where a long-term resident ceases to be a long-term resident, an exit charge will apply on the same basis. 10 year and exit charges for trusts will reflect on a pro-rated basis, the number of years that property has been excluded property in their calculations.

For qualifying interest in possession (QIIP) trusts, the excluded property status of the non-UK assets will depend on the long-term residence status of both the settlor and the IIP beneficiary.

Where the settlor of the trust has died, the excluded property status of the trust will depend on the long-term residence status of the settlor at death (subject to transitional provisions – see below).

Transitional provisions for trusts

The Treasury seem to have listened to feedback about some of the complications for trusts and have included some grandfathering for trusts already in existence.

Any excluded property which was comprised in a settlement before 30 October 2024 (Budget day) will not be subject to the gift with reservation (GROB) rules, meaning those assets will not be comprised in the Settlor’s estate where they retain an interest as a beneficiary, but they will be within the relevant property regime – this is a significant benefit as it protects these trusts from the potential for exposure to double tax.

For trusts where the settlor has already died, or where they die before 6 April 2025, the excluded property status of the trust will be based on the existing test – i.e. the domicile of the settlor when the trust was established and could mean indefinite excluded property status for the trust (and no ten year charges). Whilst this is a very valuable provision, it’s unlikley we will see any real life Hotblack Desiatos spending a year dead for tax purposes, and such extreme tax planning will remain within the pages of the Hitchhikers Guide to the Galaxy.

Where non-UK assets comprised in a QIIP were excluded property before 30 Oct 24 they will not be subject to charge when the QIIP comes to end or on death of beneficiary. However, it will not be possible to convert UK situs assets into non-UK assets for this purpose.

What is conspicuous by its absence is any of the hinted at transitional provisions to allow non-UK domiciled individuals to unwind trusts without a large tax charge – although perhaps the temporary repatriation facility (TRF) will go some way toward helping with this – see my previous blog [link] for more details on the TRF.

In conclusion, there is an awful lot to digest, even in the headlines, and anyone impacted by the changes will want to be working closely with their tax advisor over the coming months to properly understand the impact on their structure (and not just for inheritance tax) ahead of the rule changes in April.? On which note, we head back to considering the finer details and watch this space over the coming months for any surprises we discover in that process.

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