Inheritance Tax and Living on the Island
06 Jul 2018
Written by Paul Hotchkiss
Inheritance tax and living on the Island
It is becoming more commonplace for individuals who live in the Isle of Man to own UK assets, which may include shares in UK companies. Individuals who hold UK assets should be aware that, upon death, their personal UK estate may be subject to UK Inheritance Tax (IHT) if it exceeds the IHT threshold which is presently £325,000. The rate of tax payable is currently 40%.
Investors should therefore consider simple strategies as an integral part of ownership of UK assets. As well as the location of their investments, it is equally important to consider not only their residence but also their domicile status - liability is not only applicable to new/recent residents but also to long-term residents and even to those born and bred on the Island.
Many people who live on the Island, especially those who have moved from the UK and overseas, incorrectly assume that their residence is all that is relevant for tax or, if they are aware of domicile, that they will simply acquire a new domicile for UK IHT purposes at some point. There is, of course, the assumption that simply living here for a long time achieves the objective of acquiring a new domicile which is not necessarily the case.
Simple strategies exist to reduce IHT
IHT can be reduced by buying the right type of UK exempt gilts which are exempt from IHT for non-UK residents or AIM stocks, authorised unit trusts and farmland which are usually exempt assets even for UK domiciliaries. However, most people will opt for an investment choice of stocks and shares. Such investments can be problematic for IHT purposes and the method of ownership is key. It is common for IOM residents (who are non-UK domiciled) to invest in such assets through an IOM company. The rationale being that the shares you own in the company are non-UK situs and outside the scope of IHT (therefore the situs of the shares the company itself owns becomes largely irrelevant). However, you may think you are investing via such a company when you are not depending on how your investment manager buys the assets…
UK registrars will not record the death of shareholders and the appointment of Executors/Administrators without production of a UK Grant of Probate unless the individual investments are relatively small. Registrars’ “Small Estates” requirements differ and the overall value of the UK estate would impact upon their requirements. The “Small Estates” facility would certainly not be available if the estate exceeded the IHT threshold. Furthermore, it is not possible to obtain a UK Grant of Probate without first complying with reporting and payment obligations for inheritance tax.
A relationship with a local stockbroker may result in your investing in a broad range of investments: shares, gilts, funds etc. Your stockbroker will provide you with a copy of their Terms of Business detailing their responsibilities and, if required, offer you facilities to hold shares electronically. Within their Terms of Business there is likely to be reference to the fact that the shares will be registered in their nominee company name, eg XYZ Nominees Limited (XYZ). This is usually done in order to achieve prompt settlement of both purchases and sales. Whilst the XYZ name will appear on the company share register and is therefore the “legal owner”, you will remain, at all times, the beneficial owner of the assets. Whilst holding the shares in a nominee name enables the broker to record your death without production of a UK Grant of Probate and continue to hold the shares on behalf of the Executors/Administrators of your estate, this arrangement must not lead you to think that IHT is irrelevant.
On your death
You may well think that, because your shares are registered in the name of XYZ, an IOM resident company, you do not own UK situated assets. However, the reality of the matter is that you are likely to be considered by Her Majesty’s Revenue and Customs (HMRC) to own the underlying UK shares which are simply registered in XYZ who are only acting in a nominee capacity. Therefore, even if you are lucky enough to be non-UK domiciled or to have shed your UK domicile of origin, you will still be deemed to hold UK assets for IHT purposes. We say ‘likely’ above because the position (as with most tax related matters) is not straightforward. The analysis centres on an old tax case called Re Clore, IRC v Stype Investments  in which it was broadly determined that the interest of a beneficial owner in property held by a nominee or bare trustee is where the underlying asset is located. Apologies for getting a little technical… In Re Clore, HMRC argued that Sir Charles Clore’s interest in a bare trust was located in the UK. There were two conflicting arguments presented before the court: (a) that he had rights under a contract for sale which was enforceable in the UK and (b) he had rights as a beneficiary against the trustee which was located in Jersey (where the trustee was resident). It was held that any contract was enforceable in England and therefore the interest was also in England. This is very important because in any instance it may be necessary to look to where the rights are enforceable in the context of any agreement which may be in place. However, whilst much depends on the nature of the nominee agreement, the problem is that, notwithstanding these possible nuances, HMRC’s practice is to look through the nomineeship to the person they regard as the real owner.
This contention is supported in leading texts: e.g. in McCutcheon on Inheritance Tax (5th Edition) at 32-75 it states:
“It is not uncommon to come across the position where a non-UK domiciled individual seeks to rely on the fact that UK situs property (often shares) is held through a nominee arrangement as the basis of protection from inheritance tax. Of course, it is no such thing. Holding assets through a nominee may (depending on the terms of the nomineeship) avoid the need to apply for probate but it will not take the assets outside the scope of inheritance tax nor avoid the obligation to submit an account of the assets for inheritance tax purposes because the nomineeship will not affect beneficial ownership of the asset.”
During your lifetime
Imagine that you are non-UK domiciled for all purposes and own a reasonable sized portfolio including UK shares and you wish to give them to your son or daughter, who also has an account with XYZ. That seems simple enough so you contact XYZ and instruct them to transfer the shares.
What happens at the stockbrokers is that the legal ownership of the shares will remain in XYZ Nominees Limited but XYZ will record the change in beneficial ownership. On the face of it nothing in substance changes. The problem is this: what you have done is in effect make transfers of UK situate shares and that is a potentially exempt transfer, which may have inheritance tax implications if you subsequently die within a 7-year period of making the gift.
The position is worse if the gift does not amount to a potentially exempt transfer: it may be a lifetime chargeable transfer, taxable at up to 20% of its value immediately! (More tax may be payable if you die within seven years, but it seems unkind to mention that.)
What about probate in the UK?
Probate cannot in practice be obtained in the UK without first having paid any IHT which is due.
If probate is not obtained there, for example because the stockbroker accepts instructions from executors appointed in the IOM without the need for a UK Grant of Probate, that does not extinguish the liability. Worse, the liability follows the assets so, if the executors do not deal with it, the liability will fall on your beneficiaries.
So IHT can be managed simply.
However, your IHT position can become a little out of control in circumstances where you need to go to the UK for any form of treatment or simply become UK resident for a period of time (eg by virtue of a secondment, family circumstances, business and similar). The reason for this is the legislative changes which arose in April 2017.
Changes in April 2017
You may have heard about the April 2017 ‘non-dom’ changes in the UK. The most talked about change has been that individuals who are not-domiciled in the UK (non-dom) will become deemed domiciled in the UK for all tax purposes once they have been resident in the UK for only 15 out of the last 20 years (instead of 17 as previously). The 17/20 rule only applied for inheritance tax (IHT) rather than for all taxes. What is perhaps not so widely known is that there are many other new rules being introduced alongside this change. These are far too many to cover in one article and so, in this article we have focused in on one potential pitfall which could detrimentally affect Manx residents in certain circumstances.
From April 2017 for certain Manx residents who fall into the following category may have to consider IHT a little more carefully; simple investment choice may not assist them.
(1) were UK born, with a UK domicile of origin;
(2) Have acquired an IOM domicile of choice; and
(3) who have to go to the UK for medical treatment, and who sadly die during or soon after their treatment.
These individuals may be brought within the scope of UK IHT, with the result that their entire worldwide estate (rather than just any UK situs assets they own) above the nil-rate band and after any exemptions, will be subjected to UK IHT. At the death rate of 40%, this could be a costly consequence, especially if unanticipated. There are quite a few people who may fall into this category given that our health service cannot necessarily cater for certain illnesses, so treatment in the UK may be required or be offered as the first choice.
A UK born and domiciled individual who lives on the Island permanently but returns to the UK to live will be deemed domiciled in the UK in their second year of UK tax residence. This seems harsh but under current rules this is the impact. To reduce the impact of this measure HMRC have allowed a short grace period for IHT, which is bestowed by virtue of an extra stem to the definition of a formerly domiciled resident (FDR) for IHT purposes. A FDR is someone who:
• was born in the UK;
• had a UK domicile of origin at birth;
• is resident in the UK in a tax year; and
• was resident in the UK for at least one of the two tax years immediately preceding that tax year (applies for IHT purposes only)
Surely these circumstances are exception and HMRC ought to be lenient?
HMRC do have an, ‘exceptional circumstances’ rule which is part of the SRT, where a maximum of 60 days in any tax year are disallowed as days presence for SRT purposes if they are spent in the UK due to exceptional circumstances, ie those spent in the UK beyond the individual’s control.
One might that think the requirement to have necessary treatment the UK NHS can offer would be regarded as meeting this definition; however, it is not clear that HMRC would agree with this. In relation to medical treatment HMRC’s guidance note states that “Choosing to come to the UK for medical treatment or to receive elective medical services such as dentistry, cosmetic surgery or therapies will not be regarded as exceptional circumstances”.
Arguably, in the case of the treatment of serious /life threatening conditions which is only available in the UK and not in the IOM, Manx residents have not chosen to come to the UK for medical treatment, but have had to, as the other stark ‘choice’ is less palatable. There is an, admittedly harsh, counter argument that HMRC might deploy, that the individuals did choose to come to the UK, as they choose to have the treatment itself (but with the alternative being perhaps the ending of their life then, even for HMRC, this seems a tough stance to take).
Ultimately the position is not clear. It does not seem equitable that at the time of one of life’s most stressful situations, individuals should have to worry about a potentially large tax liability, nor that such individual’s IHT position should be made worse simply because the Manx government is not able to provide treatment for all serious illnesses on the Island.
Can you insure against this risk?
There are many things a non-UK resident can do to ameliorate their IHT exposure as set out above: buy IHT-friendly assets (AIM stocks, exempt gilts, agricultural property etc). However, one often-overlooked possibility is to buy insurance which pays out enough on death to cover the potential IHT liability. The insurance company must not be established to pay the proceeds of the policy into the estate of the deceased as this would be self-defeating. Therefore, the insurance policy is often settled on trust for children so they have enough funding to settle any IHT liability. Anyone in a position where they may fall within the scope of IHT inadvertently may want to consider insurance and take appropriate advice. Of course, it is equally important to make sure the assets held are non-UK situated where possible and if at all possible make sure you do not become a UK tax resident.
If you are concerned about your UK residence position or the impact of these rules please contact us on 00 44 1624 872140 or firstname.lastname@example.org.