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UK Inheritance Tax options for British Expats in Spain

Having moved to Spain you might think that you've escaped the clutches of HMRC and the UK inheritance tax system. Unfortunately, liability to UK inheritance tax is determined by domicile which is a complex and incredibly adhesive UK legal concept. This article explains options for British expats in Spain looking to reduce their UK inheritance tax obligation.

Written on 29 May 2019

You might think that having moved to Spain and escaped the British weather that you will have also escaped the clutches of HMRC and the UK tax system in its entirety.  Whilst this can be true when it comes to income taxes and savings & investment taxes there is one tax that can be nigh on impossible to shake off and that is UK Inheritance Tax.

Why is this you may ask, if I have left the UK then surely I am no longer liable to pay death duty in the UK? Unfortunately, liability to UK inheritance tax is determined by domicile which is a complex and incredibly adhesive UK legal concept.

You would think that having a permanent home in Spain would mean you are domiciled there but in practice you can remain UK domiciled even after living abroad for many years. Domicile is generally acquired at birth and whilst changing your domicile is possible there are no set rules governing this process which adds to the complication when trying to shed your UK domicile.

While this article is specifically considering British expats in Spain, it also contains relevance for British expats around the world.

Remember, you should never use the information contained in this article to make a decision, you must always seek independent advice regarding your financial planning, especially around the complex nature of inheritance tax planning.

Inheritance tax obligations in the UK and Spain

So what’s the issue?

Quite simply being UK domiciled means that your worldwide assets are subject to inheritance tax payable at 40% over the individual tax- free allowance of £325,000 (note there may also be a main residence allowance available).

Couple this with fact that Spain has its own version of death tax – called succession tax and payable by the beneficiary and not the estate of the deceased as in the UK, so not necessarily offset by any double taxation agreement - your accumulated wealth could soon be significantly diminished by the impact of these taxes.

This is why you need a plan and need to plan early.

Unfortunately none of us know when our time is up and the earlier you plan the more options that are available to you. Don’t think this is a tax exclusive to the fabulously wealthy – in 2017-18 inheritance tax receipts hit a record £5.2bn- and with escalating UK property prices even a modest home in many parts of the UK can swallow up the tax free allowance.

The importance of specialist, independent advice

Taking advice is essential- a good adviser with specialist cross border UK/Spain knowledge can help you assess your potential liability, understand your objectives for passing on your wealth and put in place an effective strategy that will help you mitigate this tax as well as Spanish succession tax– i.e. pass more to your loved ones and give less to the tax authorities.

 

Let’s have a look at some of the options that are available.

Options for minimising inheritance tax

Minimise your UK assets

First if you really don’t intend to go back to the UK at some stage in later life put some daylight between you and Great Britain. Sell your property, move your investments away (it’s more tax efficient for Spanish residents to do that anyway), and give up your season ticket at your favourite football club as well as your golf club membership. You need to demonstrate that you have left the UK for good and take away any ammunition that HMRC might have in terms of your intention to go back. If you can’t bear to do any of the above then the likelihood is that you will retain your UK domicile no matter how long you have lived in Spain.

The benefits of gifting

The second thing you can do is start giving away some assets to take advantage of the UK inheritance tax breaks available. You can give away a modest amount each year but any significant gifts will be potentially exempt transfers meaning that you will need to survive for seven years to take these out of your estate and gifts generally mean giving up ownership and entitlement to the asset.

Setting up trusts

The same goes for using trusts, you can create a trust but the liability exists for a further seven years and if you give away more than the value of the nil rate band there will be an immediate tax liability of 20% as an advance payment of UK inheritance tax.

There are two interesting trusts you could consider, namely Discounted Gift Trust and Gift and Loan Trust both of which can remove assets from your estate from the establishment date by utilising life insurance wrapper products but you need to be careful using Trusts when resident in Spain because Spain doesn’t recognize them and solving one tax problem can sometimes lead to another- expert advice is essential.

Life assurance

How about good old fashioned life assurance? A second death whole of life policy will do exactly what it says on the ”can” – it won’t eradicate your UK inheritance tax liability but will provide your beneficiaries with a lump sum to pay the bill provided the sum assured is adequate. Needs constantly reviewing and cost can be a major factor, after all the policy is going to pay out one day so trying to insure a 90 year old for a few million is going to be pretty expensive.  The other problem is that there is limited choice in terms of supplier, bizarrely most UK insurers don’t want to take on expats resident in Spain and the local market in Spain is not geared up to providing that type of protection. There is however a market and a good adviser can source this type of cover for you.

Inheritance tax and pensions

One interesting recent development is the idea of using your pension provision as a means of passing on wealth free of UK inheritance tax. The 2015 UK pension reforms included new rules abolishing the 55% “death tax” that applied to pension funds. Since then money can be passed tax free if the pension holder dies before age 75 and over age 75 recipients pay tax at their marginal rate. With careful planning even this can be managed to avoid tax completely.

Before 2015 the advice was always to run down pension schemes but now this is completely reversed and pension preservation provides an effective inheritance tax solution. This benefit also applies to ROPS (Recognised Overseas Pension Schemes) where the tax liability over the age of 75 can also be removed.

Of course many of you will say that you rely on your pension income to maintain your standard of living and this takes us back to the need for early planning and the benefit of speaking with an adviser who can take an holistic approach to your financial planning needs. By way of example drawing down income from a Spanish Compliant Bond and preserving a pension can have significant tax benefits both locally in Spain and in terms of  UK inheritance mitigation.

QNUPS

Talking of pensions leads to the jewel in the crown of inheritance tax mitigation: QNUPS (qualifying non-UK pension schemes). You can invest non -pensionable assets in a QNUPS retirement scheme, with no reporting requirements, that has the added and significant benefit of removing those assets from UK inheritance tax even if the plan holder were to return home.

But is that too good to be true?

This benefit was an unintentional consequence of legislation and there is talk every year that the UK Government might close this loophole, they probably haven’t looked at it so far because QNUPS benefits are not so well known. If you have capital that you don’t need to access in one lump sum QNUPS can be the perfect solution.

We go back to our earlier point that early planning is essential, QNUPS is first and foremost a pension scheme and needs to be set up as such – no good our 90 year old trying to establish a pension scheme HMRC will see it purely as inheritance tax evasion and withdraw the tax break when the Executors submit their accounts.

The importance of setting up a legally binding Will

Our final point is one that can often be overlooked. Make sure you have a will in place in both countries. Your Spanish will should be written under English law to avoid Spanish ‘forced heirship rules’ and your wills shouldn’t conflict with each other and should be reviewed regularly to ensure that they reflect your current intentions.

Always request independent advice

UK inheritance tax is a pernicious tax that can be avoided (or at least mitigated) in many circumstances but you need advice to stop your beneficiaries losing out and your wealth disappearing to the Treasury. Like a lot of financial problems there isn’t a one size fits all solution and you need to find a cross border expert who can listen to your requirements and provide you with the best solution to meet your individual needs.

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