22 April 2012

International: Emigration

This is the second of two postings on the international aspects of my field of law. The first, which I posted earlier today, dealt with non-England-&-Wales people who arrive, or buy a home here. This posting deals with England-&-Wales people who leave, or buy a second home abroad.

When an English person buys a home overseas, his or her affairs can become a whole lot more complicated, and need to be dealt with carefully. Misconceptions about the situation abound, and this posting attempts to separate some of the myths from the reality.

The biggest misconception I come across regularly is the assumption by ex-pats either:
a.    that because they are English, their assets will pass on their death under English law; or
b.    that because their assets are in (say) France, their assets will pass on their death under French law.

Actually both assumptions are wrong and, if you think about it, they are inconsistent with one another as well. The important thing is not to make any rash assumptions, and to take advice on the actual situation. The real rule is, I’m afraid, rather more complicated than either of the above, and it is that:
a.    immovable assets (a term which more-or-less means the same as “real estate” – land and buildings) pass under the law of the jurisdiction where the asset is situated; but
b.    movable assets (any assets which are not immovable) pass under the law of the jurisdiction where the deceased is domiciled.

A further complication is that many other jurisdictions do not have the same rule. This can lead to an overlap (England and the other jurisdiction both claiming that their law applies) or a gap (England and the other jurisdiction both claiming that the other law applies).

Domicile is important for another reason also: the UK charges the worldwide estates of its domiciliaries to inheritance tax, but it only charges the UK-situated assets of non-domiciliaries to inheritance tax. With tax at a flat 40% on all assets over £325,000, this can make a huge difference.

That brings us to the very important question: what does domicile mean? In summary:
a.    Everybody has one, and only one, domicile at any one time.
b.    When you are born, your domicile is the domicile of your father at the time of your birth (except that illegitimate children take their mother’s domicile). This is called a domicile of origin.
c.    The domicile of origin is “sticky” – if at any time you do not have another domicile then your domicile of origin prevails. This can produce odd results (since it is possible in theory for your domicile of origin to be somewhere you have never been!) but can also produce unfortunate results, from a tax viewpoint, especially for those whose domicile of origin is English.
d.    You acquire a new domicile by making a jurisdiction your domicile of choice. To do so you have to be physically residing there and have the intention of remaining there permanently. This question of intention is one of objective fact: merely declaring “my domicile is so-and-so” (e.g. in your will) is not nearly good enough, although it can certainly help. Many people have had their domicile successfully challenged by their families or by the tax authorities. There are a large number of factors, called “badges of domicile”, which judges use to establish what your true domicile is.

Next, we come to the deemed domicile rules. These are rules that keep you in the UK’s inheritance tax net for longer than would otherwise be the case, by saying that if you were:
a.    tax resident in the UK for 17 of the last 20 tax years; or
b.    domiciled in the UK at any time in the last three years;
then you will be treated as if you were a UK domiciliary for inheritance tax purposes.

One common problem, in my experience, is that the deemed domicile rules are better known than the actual domicile rules by international clients (and sometimes by their advisers) – and perhaps this is because they are easier to understand and are far less woolly. It is therefore very important to avoid the misconception that the deemed domicile rules are the rules: they are not – they are just a limited extension to the rules and they apply for one purpose only, namely to catch some people in the inheritance tax net who would otherwise escape it. Take care to avoid that misconception: deemed domicile can only entangle you in the net, it cannot release you from it; deemed domicile does not apply to any of the other taxes, only inheritance tax; deemed domicile has no effect whatsoever on succession or family law.

Throughout this article, “England” means “England and Wales”. The law of England and the law of Wales are the same in this respect: they are one jurisdiction, so moving across that border has no more effect than moving from Hertfordshire to Hampshire. However, it is not always widely realised that Scotland and Northern Ireland are different jurisdictions: so this article does apply to an English person who moves to either of them – the only real difference being that he or she will have moved to a jurisdiction which also has UK inheritance tax.

This problem – that somewhere which you or I might think of as one country is actually divided into several jurisdictions – is quite common. Each state of the USA is a separate jurisdiction, for example. So is each canton of Switzerland. Canada and Australia are divided into a number of jurisdictions. This can affect the points analysed earlier in this article quite considerably. For example, moving to the USA and intending to stay there permanently, but not settling on a particular state, cannot give you a new domicile of choice.

International: Immigration

This is the first of two postings on the international aspects of my field of law. The second, which I'll post later today, deals with England-&-Wales people who leave, or buy a second home abroad. This posting deals with non-England-&-Wales people who arrive, or buy a home here.

I like to start writing about legal problems by presenting a common misconception. So often, someone’s problem is not the one they think they have, and the solution is not the one they thought they needed.

In this case, I want to start by discussing “domicile”, which is the connecting factor for English succession law. (A “connecting factor” is the thing which connects a person to a system of rules: for example, I am not subject to any of the laws of China because I have no connecting factor. As a “resident” of England I am subject to its income tax rules. If I were a “citizen” of the United States I would suffer federal estate tax on my death. If my “nationality” was Spanish I could leave my worldwide assets under a Spanish will. In each of the preceding sentences the item in quotation marks is the connecting factor.)

One common misconception, in my experience, is that overseas clients, and often their advisers, are aware of a set of English rules called the “deemed domicile rules” – and in particular the rule which says that you are treated as domiciled in England after 17 years of tax-residence – and therefore assume that it requires a long period of residence in England to become domiciled here: that you cannot become domiciled on day one.

This thinking is wrong. The deemed domicile rules exist only to catch some people in the tax net who would otherwise escape it. It is far more important to look at the actual domicile rules first. This is especially important because domicile, as well as being the connecting factor to England’s succession law, is also the connecting factor to our inheritance tax. (Stated very briefly, a non-domiciliary who dies only pays inheritance tax on assets situated in the UK, while a domiciliary who dies pays inheritance tax on the entire worldwide estate.)

You become domiciled through (i) physical presence here, with (ii) an intention to remain permanently. As you can see, those two criteria could be fulfilled the day you get off the plane.

It follows that if you are a potential long-term immigrant, there are two things to deal with, before arrival:

The first is to establish whether you will be domiciled in England from the outset. It is usually tax-advantageous not to be domiciled. If you are to be “non-dom”, to use the common abbreviation, where is your domicile? What ties are you maintaining with that domicile? What are your plans to leave England? What evidence have you got to prove these things? 

The second is to divest yourself of non-UK situated assets before you become domiciled, or deemed domiciled, in England. This process can involve making gifts within the family, but more usually involves the creation of trusts, offshore, of a kind which will retain their UK-tax-free status even if their settlor (the person who created them) becomes UK domiciled later.

Domicile is not the connecting factor for all purposes. Sometimes mere presence or activity in England brings you within the scope of some of our laws (just as I would become subject to the criminal laws of China if I visited, even if I was only a tourist). Unlike inheritance tax, the connecting factor for income tax is “residence”. Residence is far more easily established than domicile. Living and working here for six months can be enough to make you tax-resident, for example.

It is therefore possible to be resident but not domiciled (“res-non-dom”) and traditionally that has been considered a charmed tax status: the UK tax residence probably (although not necessarily) preventing the res-non-dom from being taxed as a resident of anywhere else, but non-UK assets (often themselves, ideally, situated in offshore tax havens) only being taxed on the “remittance basis” – in effect, only on the income actually brought into the UK.

Unfortunately, as a result of some changes in recent years, the remittance basis is now only available in three circumstances, and all other res-non-doms are taxed on the “arising basis” – that is, effectively, on all their worldwide income (just like an English person):
1. during the first (approx.) 7 years of residence;
2. where the unremitted foreign income is less than £2,000 a year; or
3. where the taxpayer pays a £30,000p.a. “Remittance Basis Charge”. Paying this charge is entirely optional, so the decision whether to pay it turns on the level of unremitted foreign income. If the tax on that would be more than £30,000 then the charge is worth paying, otherwise it is not.

A final point about connecting factors is that they can lead to clashes with the laws of other nations. Let’s go back to our example of the Spanish national who can leave his worldwide estate by a Spanish will because in Spain “nationality” is the connecting factor. Suppose this man owns a house and a bank account in England. Do they pass under the Spanish will? Not necessarily. In England, “situs” (i.e. “where is the asset situated?”) is the connecting factor when it comes to land and buildings. So, Spanish and English law are already in conflict. As for the bank account, the connecting factor is “domicile”, which for all we know could be Spain or England or some third country. This generates another important “action point” for the client moving to the UK: to take advice on succession and estate planning, and to get wills (and trusts, if needed) in place in all relevant jurisdictions.

15 April 2012

Barmaid Syndrome - More Technical Solutions

This is my third and final post in a series on the subject of "Barmaid Syndrome" – the fear a woman has that, after her death, her husband will re-marry, then die leaving everything to the new wife and nothing to the children. In my last post I considered some simpler solutions: (1) trusting the survivor and (2) paying the children upfront. Now, it's time to touch upon some more technically complex solutions.

Solution 3: Mutual Wills. Although what I'm about to say isn't strictly correct, the easiest way to understand Mutual Wills is to think of them as if they were a contract between two people, usually husband and wife, that once one of them has died, the survivor will leave his or her will intact. I don’t like mutual wills at all. Come to me asking for one and I will try to talk you out of it. They are inflexible, they don’t take account of the way things may change in the future, and they encourage court battles after you have gone. They are definitely the last choice solution. Having said that, Mutual Wills suit some families’ needs: and even if he grumbles your solicitor will be able to prepare them for you.

Solution 4: Life Interest. This is a type of trust that can go into your will, or you can set it up in your lifetime. Its terms are that the survivor (known as the life tenant) has the benefit of the estate while he or she lives, but after his or her death it belongs to the remaindermen, who are usually the children.

Be aware of the downside: the survivor only has an income interest – he or she can occupy real estate, or receive the interest/dividends from investments. He or she cannot touch the capital, or the proceeds of sale of real estate. Those are protected for the remaindermen. It follows that you have to be able to afford a life interest. If you impose one, then your spouse finds himself or herself short of money, there is a real risk that your estate will be challenged through the courts.

A final point is that if you go to a solicitor asking for a life interest trust, she will almost certainly suggest that you have something more complicated (such as a flexible discretionary trust, or a flexible IPDI, or both) instead. I won’t go into all the technicalities here, but you should check that you are achieving the same overall effect.

8 April 2012

Inheritance Tax Strategy 1 - Don't Worry About It

No, I’m serious. Don’t worry about it.

If you just carry on with your life and do nothing about it, inheritance tax will not be payable until after you have died.

If you are a married couple, and you intend to leave everything to the survivor when the first of you dies, then no inheritance tax will be payable until both of you have died.

If your estate is large enough for inheritance tax to be payable, the people who you leave it to can still expect a substantial inheritance.

Inheritance tax really is somebody else’s problem.

Go ahead, enjoy yourself, don’t worry about it!

1 April 2012

Ten Reasons Not To Give Your Home Away: 9 and 10 - Care Fees Problems

Perhaps more important than the two remaining problems is this thought: planning to protect your home from the burden of care fees is, in effect, planning to live in state-funded care for the rest of your life if you become ill. And the quality of that care is not necessarily very high. People of modest wealth may have no choice about this - but people of means should be thinking of ways to fund high-quality care, not planning to avoid it.

9.     The Deprivation Rule. The rules which assess how much a person must pay for their care say that the local authority have to include among your assets any assets which you have given away with the intention of avoiding the social services charge.

10.  Insolvency. Supposing you do go into social services care, and they assess you to pay more than you can actually afford to pay (i.e. because you have given your home away). Then you would in effect be bankrupt. And there is nothing to stop social services from actually bankrupting you. The advantage from their viewpoint is the ability to go back and set aside any gifts made in two years (or sometimes five years) before the bankruptcy, giving them a direct action against your children or the property itself.

A final thought is to consider what other assets you have. If your income or other capital exceed the local authority's contribution thresholds then you will have to pay for any care in full, anyway. A gift of your home in those circumstances might have exposed you to all the risks mentioned in my two previous postings, for no benefit whatsoever.