Non-UK domiciles and the ‘residence nil rate band’: IHT changes coming in April
At first glance, the ‘residence nil rate band’ would seem to be of no obvious interest to individuals who are non-UK domiciles. But as Paul Thompson, technical manager for UK-based Canada Life, explains below, if their assets include a residence in the UK, they may well benefit from the additional nil rate band, being introduced with effect from 6 April…
The term “residence nil rate band” or RNRB, is arguably easy enough for most non-financial services industry people to ignore; and until recently, those who happened to be non-UK domiciled residents of the United Kingdom had even less reason than most to pay no attention to it at all. That’s because, like much tax legislation aimed at UK resident taxpayers, there wasn’t any chance that it would affect them unless they had been in the UK for 17 years or more.
Beginning next month, though, more non-dom individuals who have assets, which happen to include a residence, will potentially be subject to inheritance tax (IHT) – and therefore, for the first time, a possible reason to want to remember the letters RNRB. Because they may well benefit from a new nil rate band (NRB) to be introduced with effect from 6 April 2017.
Those in the business of advising such non-doms on tax matters, meanwhile, definitely will want to remember the acronym, and what it represents.
The 17-year rule
When a client is not domiciled in the UK, their assets outside the UK are not, of course, subject to IHT in the UK. The same is true if they reside in the UK and retain their status as non-UK domiciles – for a while. But once they have been resident in the UK for 17 or more tax years of the previous 20 tax years, they are “deemed to be domiciled” in the UK for the purposes of IHT, from their 17th tax year of residence.
That 17-out-of-20 rule is about to change, however. With effect from 6 April 2017, it is to be replaced by a 15-out-of-20 rule, which will apply to income and capital gains taxes, as well as IHT.
It should be noted that, under the new rule, the client’s deemed UK domicile status will apply from the 16th tax year of residence, not the 15th as might be supposed.
Be that as it may, both clients who are non-doms and clients who become deemed doms could well have a residence in the UK which could potentially benefit from the RNRB.
The amount of the RNRB will be £100,000 initially, although this will increase by £25,000 on each subsequent 6 April, until it reaches £175,000, after which it will be increased in line with the Consumer Price Index (CPI).
Both parties of a married couple (or civil partnership) will have their own entitlement and, just like the underlying nil rate band, any unused RNRB from the first death will be transferrable for use on the second death.
Note, in particular, that the date of the first death is irrelevant for these purposes. Even if the first death occurred, say, twenty years ago, when there was no RNRB, provided that the death of the survivor occurs on or after 6 April 2017, the unused RNRB from the first death can be transferred and used on the second death, potentially doubling the survivor’s entitlement.
So how can advantage be taken of this new, additional nil rate band? Firstly, the deceased must have a “residential property interest”. This is defined as:
“…an interest in a dwelling-house which has been the person’s residence at a time when the person’s estate included that, or any other, interest in the dwelling-house.”
Note the use of the words “has been.” An interest in a dwelling-house can be a residential property interest, even if the deceased was not actually living in it at the time of death.
There seems to be no minimum period during which the dwelling-house has to be the person’s residence but, presumably, there would need to be some evidence of residence, such as paying utility bills and having post delivered to the individual at the address, for example.
The ‘more-than-one-property scenario’
Given that the deceased does not have to be living in the dwelling-house at death, it is not difficult to imagine situations in which a client dies owning more than one residential property interest. In such circumstances, the deceased’s personal representatives will need to nominate which dwelling-house is to benefit from the RNRB.
It should also be noted that it does not matter where the dwelling-house is situated. It might be in the UK, but it does not have to be. However, the interest in the dwelling-house must have been part of the person’s estate on death.
For the purposes of IHT, a person’s estate does not include “excluded property”. That is, property situated outside the UK, where the person entitled to it is domiciled outside the UK.
Nevertheless, where a long-term UK resident becomes deemed UK domiciled, all of their property worldwide will be potentially subject to IHT, meaning that a residential property interest could be in a dwelling-house overseas.
In order to benefit from the RNRB, the interest in the dwelling-house must be inherited by one or more lineal descendants. This includes children, grandchildren, great-grandchildren and so on, as you might expect.
But it also includes those persons’ spouses or civil partners, as well as adopted children, step-children (whether adopted or not) and foster children.
It is important to realise that, if the interest in the dwelling-house is made subject to a discretionary will trust, this will not qualify for the RNRB, even if the beneficiaries of the will trust are restricted to lineal descendants.
The RNRB £2m limit
Unlike the basic nil rate band, the amount of the RNRB tapers away if the net value of the deceased’s estate on death, including the value of the interest in the dwelling-house, exceeds £2m.
In these circumstances, the RNRB will be reduced by £1 for every £2 of estate value in excess of £2m. This means that, if a client has an initial entitlement to a £175,000 RNRB, for example, it will be reduced to nil if the estate value is £2.35m or more.
If a widow or widower has an entitlement to a £350,000 RNRB, because of an unused RNRB transferred from the first death, it will be reduced to nil if the estate value is £2.7m or more.
There are a number of important considerations to bear in mind when applying this £2m limit. Firstly, it applies to the deceased’s estate, as defined above. Consequently, if the deceased is neither UK-domiciled nor deemed UK-domiciled, any assets situated abroad can be left out of account when determining whether the £2m limit has been breached.
Secondly, all exemptions and reliefs must be ignored when determining whether the £2m limit has been exceeded. Thus, even if assets are left to a surviving spouse or to charity, they have to be taken into account in full. If assets qualify for 100% or 50% agricultural or business property relief, they have to be added in to the value of the estate in full to determine whether the total exceeds £2m.
Thirdly, the £2m limit applies only to the net value of the estate immediately before death. Strangely, perhaps, it does not take into account any transfers of value made by the deceased within seven years of death.
This means that any assets that have been made subject to a discretionary trust during lifetime, for example, will not be taken into account in calculating whether the value of the estate exceeds £2m, even if the trust had been created by a chargeable lifetime transfer within seven years of death.
The same applies to potentially exempt transfers (PETs) made within seven years of death. Thus, a client with an estate of £3m, for example, would have no entitlement to RNRB, unless at any time before death they made a PET of £1m.
Clearly, the potential for the PET to become fully exempt would not be realised on death within seven years, but the full RNRB would then become available, potentially saving IHT of up to £140,000 in 2020/21.
If the dwelling-house is sold on or after 8 July 2015, the benefit of the RNRB is not lost, provided that an equivalent value of other assets passes to lineal descendants on death. This also applies to the difference in value where the dwelling-house is replaced by a smaller one before death.
One thing that is certain about the introduction of the RNRB is that it represents yet another reason individuals planning to enter into any form of estate planning should not risk attempting to do so without qualified and experienced professional advice. At Canada Life, we believe professional advisers should ensure that their clients are aware of this, so that they are able to avoid making costly mistakes.
Paul Thompson is technical manager for UK-based Canada Life. This article originally appeared in the March issue of International Investment.