Excluded Property Trusts – It pays to plan early!

5th August 2014

Inheritance tax, or IHT as we advisers like to call it, is one of those taxes that elicits two types of responses when the conversation comes around with clients.

In camp one are the clients that say they don’t really care what happens when they die and point out the fact they never had anything when they came into this world, so why should they be bothered if their heirs, children or relatives have to pay away 40% of what they inherit to the tax man.

Then there is camp two that feels the tax man has had enough out of them during their working lives and would like to make plans now to potentially mitigate as much of the IHT burden on their heirs, children or relatives.

Whilst delivering a budget statement in the house of commons, Gordon Brown once famously dubbed IHT as a voluntary tax, as he saw it as a tax you can plan to mitigate against by arranging your financial affairs properly.

For UK Resident/Non Domiciliaries it can be difficult to know what to do or where to start, as they are more likely to be unfamiliar with the particular nuances of the British tax system. However, UK Resident/Non Doms have a major advantage when it comes to potential IHT mitigation.

The main advantage you have, is the use of excluded property trusts. As UK Resident/Non Doms need to have lived in the UK  for 17 years out of 20 before they become ‘deemed’ UK domiciled for IHT purposes, and therefore liable to IHT on your worldwide assets, so with a bit of early planning a whole lot of tax may potentially be mitigated.

An excluded property trust is used to place non-UK property or assets into. It will be free from UK inheritance tax even when your status changes in future (i.e. after you have lived in the UK 17 out of the last 20 tax years) and you become either deemed domicile or domicile in the UK at a later stage.

The following property is considered excluded:

    • Property that is situated outside of the UK
    • Cash and bank accounts located outside of the UK
    • Shares and other stock market securities registered outside of the UK
    • Offshore bonds

There are three main rules to follow to ensure that excluded trust investments will be outside of the UK inheritance tax net. Namely, when the trust is set up:

    1. An individual must not be treated as UK domiciled
    2. The trust must be free from UK based assets
    3. No further money or assets must be put into the trust when an individual becomes deemed UK domiciled or is treated as UK domiciled.

An excluded property trust is essentially a discretionary trust offering flexibility as to who is able to benefit from the trust (including the settlor) and the choice of beneficiaries. The settlor also automatically becomes one of the trustees and will have control over the trust fund investments.

How does the excluded property trust concept work in practice?

Lets consider Ivan, a successful entrepreneur who has just relocated into the UK with his wife and children. Now that he has opened a subsidiary of his business in the UK, he still has an estate worth £5 million in his native country, comprised of cash and stock market securities.

Ivan is looking to make the UK his long-term home and has just bought a family house in London. As London property is a ‘UK-situs’ asset, it cannot be placed into the excluded property trust. However, Ivan is looking to purchase a holiday home in France and, if he uses the funds for this purchase from a non-UK bank account, the French property becomes an eligible asset.

Ivan also transfers most of his non-UK sited assets into the trust and appoints a financial adviser to invest on his behalf for future benefit of his wife and children whom he names as beneficiaries. One of the recommendations that the financial adviser made was to consider an offshore bond.

An additional benefit of an offshore bond is that as it produces no income, trustees (including Ivan) would not need to complete a self-assessment return.

As Ivan is a UK Resident/Non Dom at the time the gift into trust is made, then no IHT reporting or IHT is due at that time. As the property is considered excluded property, exit charges and periodic changes are not applicable.

So when Ivan eventually passes away (hopefully well after his 17+ years stay in the UK), only his UK situs assets, such as his UK property will fall into the UK IHT net as the excluded property trust was set up while he was not deemed UK domicile.

This example illustrates the use of the trust in relation to UK inheritance tax. It does not take account of any local tax that may arise in other countries.