This article explains the importance of using excluded property trust in the UK inheritance tax planning for non-UK domiciles living or planning to live in the UK.
One area that has seen distinct change and increased planning opportunity is the area of effecting non-UK domiciles that are resident in the UK or about to become resident in the UK. Forthcoming changes will reduce the number of years of residency before someone is deemed domicile highlighting the importance of swift planning in this area. For more information on the changes read our article ‘Abolishing permanency of non-dom status’.
‘Excluded property’ is a term used within IHT legislation to describe assets which are exempt from the scope of the IHT legislation.
Property situated outside the UK can be considered excluded property if the owner is domiciled outside of the UK. For example, a French townhouse owned by a Dutch domicile would be considered excluded property.
Where property is held within a settlement (settled property) and that settled property is outside the UK, the property would be regarded as excluded property providing the settlor was not UK domicile at the time the settlement was made.
An excluded property trust is designed for individuals who are not domiciled in the UK and who want to protect their assets from IHT.
For settled property to benefit from the excluded property rules, two conditions need to be met. The first condition requires that the settlor must not be considered domicile or deemed domicile in the UK.
Therefore, in order to fulfil the first condition it is necessary for the settlor to be a non-UK domicile. So for example, Stefan was born in Sweden and has always lived in Sweden. He is intending to work in the UK for a number of years. On entry to the UK, Stefan would be regarded as a non-UK domicile individual. It is worth being aware that for a non-UK domiciled individual, this settlement provides no IHT benefits. However, where the settlor becomes UK domicile or UK deemed domicile in the future, any such settled property will remain free from IHT.
The second condition requires that the assets of the settlor must be situated outside the UK. So for example, Pierre effects an offshore bond with an Isle of Man provider. As the bond is situated outside the UK then this would satisfy the second criteria.
Excluded property trusts – the features
An excluded property trust can be any type of trust, absolute, interest in possession or discretionary. However, in most cases, a settlor would use a discretionary trust. The main reasons for this are due to flexibility this type of trust provides. The settlor is able to be a beneficiary under this trust, without the gift with reservations applying. Even when the settlor becomes UK domicile for IHT purposes he is still able to benefit under the trust because the legislation only requires the settlor to be UK domiciled “at the time the settlement is made.”
Also, as the settlor is non-UK domicile at the time the gift into trust is made, and therefore has no IHT liabilities, then no IHT reporting or IHT is due at that time. Providing the property remains within the definition of excluded property, exit charges and periodic changes are not applicable.
Excluded property in practice
If we consider an example: Indonesian chef Ramelan was born, lived and worked in Jakarta for many years. After making a name for himself in Jarkarta, he is offered a job as head chef at one of London’s top restaurants. Ramelan moves to London.
One evening Ramelan meets Rose, a UK domicile and after a whirlwind courtship Ramelan proposes.
After his success in his home country, Ramelan has assets within his Indonesian bank account with a value of approximately £1 million. After reading in the newspaper that non-UK domiciled individuals are affected by new legislation, Ramelan seeks specialised financial advice.
As Ramelan has not decided in which country – Britain or Indonesia - he will reside for the long-term future, his financial adviser suggests that he take out an offshore bond using money from his capital account and place it within an excluded property trust. This means if Ramelan does become UK domiciled in the future, the property that was placed within the excluded property trust will not be subject to IHT.
A year later Ramelan marries Rose and they decide to make their home in the UK. Several years later, Ramelan is regarded as UK deemed domicile and although he’s eligible to pay some IHT, the bond within the excluded property trust would not be subject to IHT.
On retirement, Ramelan and Rose decide to buy a property in the English countryside and would like to use the excluded property trust fund to help fund the purchase. Ramelan can either take the proceeds out of the trust as a beneficiary or the trustees could purchase the property. At this point the trust will lose its status as an excluded property trust, as the asset of the trust i.e. the house in the country is now situated within the UK.
The changes to the remittance basis remind us of the need for care to be taken regarding original source of money. For more details of the remittance basis, please refer to our article 'Remittance to the UK - a taxing decision.'
Generally, the procedure operated by a UK resident would be to have two bank accounts - a capital only account and an income only account.
You would expect the premium for the offshore bonds to be funded from the capital account to avoid any complication that may arise due to the remittance and of course any withdrawals made on the bond should also go into that account.
There are strong tax benefits of using an excluded property trust, however a client's circumstances will play a large role in determining if this trust arrangement is a suitable solution. Demonstrating a level of knowledge will present excellent financial planning opportunities for some clients and underlines the importance of seeking comprehensive financial advice.