The United Kingdom’s taxation system is complex, particularly when it comes to inheritance tax (IHT). Many individuals assume that residency status alone determines liability for inheritance tax, but this is not the case. The critical factor in HMRC’s assessment is often domicile, which can have a significant effect on the tax duties of an individual or their estate. Knowing the difference between residency and domicile, and how they apply under UK law, is crucial for effective estate planning.
Residency is a term that frequently arises in discussions about taxation and legal obligations. It refers to the country where an individual lives for most of the year and is determined annually based on specific criteria.
The Statutory Residence Test
The UK government assesses residency using the Statutory Residence Test (SRT). Introduced in 2013, this test considers several factors such as the number of days spent in the UK, connections to the country, and work commitments. Broadly speaking, an individual is deemed a UK resident if they spend 183 days or more in the country in a tax year. However, even those who spend fewer than 183 days may be considered residents based on other ties, such as property ownership, family connections, and employment.
Residency status is critical for determining liability for income tax and capital gains tax. However, when it comes to inheritance tax, residency alone does not determine tax liability. Instead, HMRC relies more heavily on an individual’s domicile status.
Domicile is a more enduring legal concept than residency. It generally refers to the country a person considers their permanent home or where they have strong connections. Unlike residency, which can change from year to year, domicile is more difficult to alter.
Types of Domicile
There are three main types of domicile under UK law:
1. Domicile of Origin – This is acquired at birth, usually from one’s father if parents were married, or from one’s mother if they were not. Even if an individual moves to another country, their domicile of origin remains unless they formally acquire another domicile.
2. Domicile of Choice – If an individual moves to a new country with the intention to remain there permanently or indefinitely, they may acquire a domicile of choice. To establish this, they must sever ties with their previous domicile and demonstrate a long-term commitment to the new country.
3. Domicile of Dependence – This applies mainly to minors and individuals legally dependent on someone else. Their domicile follows that of the person who has legal responsibility for them.
For taxation purposes, an individual’s domicile status has significant consequences, particularly in relation to inheritance tax. The UK’s tax system treats domiciliaries and non-domiciliaries differently, which can impact estate planning and tax liabilities upon death.
Inheritance tax is levied on an estate when someone dies, with a standard rate of 40% applied to assets exceeding the tax-free threshold of £325,000. However, how and where IHT is applied depends heavily on an individual’s domicile status.
A person domiciled in the UK is liable for inheritance tax on their worldwide assets. This means that whether they own property, maintain bank accounts, or hold investments in the UK or abroad, their entire estate is subject to UK inheritance tax.
For example, a British citizen domiciled in the UK who has accounts and properties in France, the United States, and Australia will have those foreign assets included in their UK IHT assessment. In some cases, double taxation relief may be available if the foreign country also levies inheritance tax, but this depends on existing tax treaties between the UK and that nation.
Non-domiciled individuals (often referred to as “non-doms”) only pay UK inheritance tax on assets situated in the UK. Their assets located outside the UK are generally exempt from IHT, meaning they may benefit from significant tax savings if their wealth is largely held abroad.
For instance, if an Australian domiciled individual has UK investments but retains most of their assets in Australia, only the UK-based portion of their estate will be considered for inheritance tax. However, the moment they acquire a UK domicile, their worldwide assets fall under UK inheritance tax rules.
Non-doms often use offshore trusts and other legal strategies to shield foreign assets from UK inheritance tax liability. However, tax laws regarding non-domiciled individuals have undergone significant changes over recent years, particularly concerning those with long-term UK ties.
To prevent individuals from indefinitely avoiding UK inheritance tax, the government introduced ‘deemed domicile’ rules. As of April 2017, non-domiciled individuals who have been UK tax residents for 15 out of the last 20 tax years are considered deemed domiciled. This means they lose their non-dom status for IHT purposes and become liable for UK tax on their worldwide assets.
The rule targets long-term UK residents who might otherwise retain offshore wealth to avoid inheritance tax. Deemed domicile status remains one of the most significant considerations for expatriates and non-doms aiming to manage their UK tax exposure.
While domicile plays the primary role in determining IHT liability, residency may still influence tax planning and exposure. For example, if an individual moves abroad but remains a UK domicile or becomes deemed domiciled, their worldwide estate remains taxable in the UK.
Residency also interacts with inheritance tax when considering international tax treaties. Some countries, such as France and the United States, have agreements with the UK to ensure that individuals do not pay inheritance tax in both jurisdictions on the same assets. These tax treaties vary widely, so expatriates must understand how UK residency affects foreign tax liabilities.
Individuals concerned about inheritance tax exposure should explore legal ways to manage their obligations. Several measures exist within UK tax law to help reduce or mitigate IHT:
1. Reassess Domicile and Residency – Those who have permanently moved abroad may consider severing UK domicile ties and adopting a foreign domicile to ensure their non-UK assets remain outside UK IHT calculations. However, this is a complex process requiring solid evidence of intent and legal permanence.
2. Utilise Gifting Rules – The UK allows individuals to make certain tax-free gifts. If a person survives for seven years after making a gift, it falls outside their estate for IHT purposes. Annual gifting allowances and exemptions for gifts to spouses, charities, or family members can minimise tax exposure.
3. Trust Structures for Non-Doms – Non-doms often use offshore trusts to protect non-UK assets from inheritance tax. However, HMRC has introduced stricter rules regarding trust taxation, so professional legal advice is crucial.
4. Consider the Spousal Exemption – Assets passed between UK-domiciled spouses are exempt from inheritance tax, but transfers from a UK-domiciled spouse to a non-domiciled spouse are subject to limitations. Understanding these nuances can help families structure estate plans efficiently.
5. Business and Agricultural Relief – Those with qualifying businesses or agricultural assets may benefit from tax reliefs that reduce the overall inheritance tax burden. These reliefs often require careful estate planning to ensure eligibility.
As inheritance tax laws continue to evolve, seeking professional advice is imperative for those with cross-border assets or ambiguous domicile status. HMRC scrutinises domicile claims closely, particularly for individuals who live abroad but continue to maintain property, investments, and family ties in the UK. Proactively managing residency and domicile issues can significantly reduce potential tax liabilities and ensure that wealth transitions to future generations as efficiently as possible.
Understanding the distinction between residency and domicile goes beyond simple tax law—it is a crucial element of financial planning. Whether UK-domiciled, non-domiciled, or deemed domiciled, individuals must ensure their affairs are structured appropriately to optimise their tax position while complying with evolving inheritance tax rules.
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