The Complexities of Cross Border Estate Planning

It is not uncommon today for many of our clients to have interests around the world. Whether it is a holiday home in Spain or France, shares in a US company or a bank account in the Channel Islands, each brings it own special issues. Without too much effort, a client’s estate planning can be complicated by the interaction of rules from another jurisdiction on any domestically focussed tax planning, which adds to the complication of administering an estate on death. Without the correct planning in place, there remains the spectre of an unexpected tax charge, which could ultimately result in of unrelieved double taxation.

The purpose of this article is to introduce some of the basic planning techniques used when dealing with such situations and which apply equally to each jurisdiction.

When dealing with multi-jurisdictionally planning, you need to start by considering the tax effects here in the UK. Most UK domestic inheritance tax planning is best explained by comparing the improvement in the tax exposure before and after the planning.

The same approach can be taken with multi-jurisdictional planning. There are a number of basic issues that need to be addressed, including available tax reliefs in the various jurisdictions and when tax charges are expected to crystallise. Of utmost importance is an understanding of the local jurisdiction.

Line up the tax events

The golden rule in dealing with cross border taxation is to ensure that the instances of taxation in both jurisdictions being levied occur simultaneously. Of equal importance is that there is either full relief in one jurisdiction or allowance of full credit.

The UK has entered into surprisingly few Gift and Estate Tax Treaties, under which one jurisdiction is willing to give up taxing rights over locally situated assets for individuals domiciled in another jurisdiction. For example, for UK domiciled individuals who own US situated assets there is full relief, limited to a number of assets, where federal estate tax is not charged as taxing rights are ceded to the UK. The most important exception to this is real estate situated in the jurisdiction and business interests. However, if your client is not deemed domiciled or deemed domiciled in the UK through long term UK residence, then they will not be able to avail themselves of the benefit of the Treaty.

 In the absence of a tax treaty, the alternative is to rely on unilateral relief. An example of where cross credit can go wrong is the disposal of real estate in France. If the property is a second home being gifted from parent to adult child, then in the UK this would not be regarded as an exempt transfer as it would trigger a UK capital gains tax charge (assuming there is not full principal private residence relief) and would only be regarded as exempt if the parent survived seven years. However, the transfer could trigger a French Gift Tax charge, which would not be allowed against any immediate charge to UK capital gains tax – a tax example of an apple and an orange.

Consider the local tax reliefs available in each jurisdiction

In the UK, if an individual survives seven years from the date of gift, then the gift will be exempt from inheritance tax; in comparison with some jurisdictions this is very generous. There is also a system which tapers the tax due if the gift is made more than three years before the date of death. There are a number of other exemptions, including the annual gift amount of £3,000 (per donor), the regular gifting out of income and the exemption for family maintenance. Gifts can be made without an inheritance tax consequence between spouses who are both UK domiciled or deemed domiciled, or from a non-UK domiciled spouse to a domiciled or deemed domiciled spouse. In the UK, the spouse exemption has been extended to partners in a civil partnership.

Other jurisdictions, for example the United States, operate a unified gift and estate tax. For federal purposes, an individual can gift up to US$13,000 per annum per donee, as well as up to US$133,000 to their non-US citizen spouse. Gifts between US citizen spouses can be made freely. If gifts are contemplated in excess of the exemptions, then these are deducted from the lifetime gifting allowance of US$1 million. Where the annual gifting allowance is utilised, then this is deducted from the US$3.5 million that can be gifted on death. As a result of the generous amount of US$3.5 million, there tends to be more of a drive to equalising estates between couples. At present, there is no US Federal Estate Tax on the statute books, though it will be revived from 1 January 2011 with lower exemptions and a higher rate imposed. It is assumed for the purposes of this article that any changes will revert back to their 2009 iteration.

Consider, however, a mixed domicile marriage, a fertile breeding ground for joined up tax planning: one spouse is US domiciled and the other is UK domiciled; both live in the UK but it is the US spouse with the bulk of the assets; what should one consider for planning for the death of the moneyed spouse?

With a domestic UK hat on, there is little issue on the assets being passed to the spouse. However, what happens above the US$3.5 million threshold when US federal estate tax steps in? A common solution is for the will to provide for a Qualifying Domestic Trust (QDOT), which acts to defer the tax charge until the death of the spouse. Under the terms of the QDOT, the surviving spouse must have a life interest in the assets of the Trust. This bears all of the hallmarks of the Immediate Post Death Interest defined in section 49A, IHTA 1984, which was introduced in the 2006 trust changes. On the death of the surviving spouse, tax events will be matched up and assuming that the surviving spouse has not displaced their UK domicile, he or she should be able to avail of the benefit of the 1978 Gift and Estate Tax Treaty.

Respect the local law

Each jurisdiction has a different approach to succession planning and death taxes. Civil law jurisdictions have a long established tradition of forced heirship, which fetter the right of the testator to dispose of their estate. In France, for example, it is common for children to inherit in place of the surviving spouse. Often, there are local solutions to the issue, such as the Société Civile Immobilière (SCI), though these may not necessarily fit in with the overall plan.

The imposition of a common law trust may not fit in with the local law. Returning to France again, the law was changed in 2008 to recognise trusts structures, though they have no fiscal advantages in inheritance tax. When dealing with new legislation it is important to see how it beds in and how the more complex cases are treated by the local courts. Foreign law can often be complex and as such local advice ought to be sought an early stage.

When considering local law, it is important to bear in mind that taxes can be levied at more than just a national level. In the US, State level estate taxes differ wildly. Some States lock into the federal rules, whilst others have decoupled themselves. One such example is Massachusetts, which levies State estate tax at 10 per cent above US$1million (of the death estate and certain gifts).

A converse argument is the creation of non-UK structures which may well offend UK rules. It is common for US citizens to create inter-vivos trusts to avoid probate on their death (these are often referred to as living wills or probate trusts), though for US tax purposes, they are regarded as a nothing. Following the changes in 2006, HM Revenue & Customs view such arrangements as fully constituted trusts as there has been a disposition by the settlor to the trustees for the purposes of section 43(2), IHTA 1984. So, what happens if your US client has returned to the US for a visit and whilst there met with their US lawyer who have created a living will for them into which all of their assets have been tipped, including the UK home? Have they created an immediate charge to UK inheritance tax at lifetime rates? Just to add insult to injury, the US will certainly not allow a credit for the UK inheritance tax charge. There is no definitive answer to this question beyond entering into debate with the Capital Taxes Office. Avoiding the issue altogether is the safest line.

The importance of bringing on board local expertise when there are assets in an overseas jurisdiction can not be underestimated. It may well be that any UK-centric plans are altered or that planning goes down a completely new avenue.

The Society of Estate Practitioners is an excellent source of advice on trust and estate practitioners working in other jurisdictions.

NB: The views expressed in this article are the author's own and do not necessarily represent the views of the firm.