Wednesday, 26 September 2012 12:52
Technical Update: Expat planning
In this edition of Technical Update we look at the implications of emigrating overseas on taxation and assets. Tim Thornton-Jones from Berkeley Law is a specialist in private client tax planning and has built up a significant practice advising the expat community of Monaco.
The article explores the long-term financial implications and what could go wrong that people should consider before making the move.
While they may expect to have language barriers or to feel homesick, they may not expect financial hurdles caused by complicated jurisdiction rulings. What works in the UK may no longer work in a foreign jurisdiction.
Particularly important are the rules on IHT, particularly for retirees who are emigrating, in the event that one dies while abroad. Contrary to popular opinion, IHT is dependent on domicile rather than residence meaning that IHT is payable on all worldwide assets, potentially causing a hefty bill for any family back in the UK.
There is an option to change your domicile of origin but you will have to prove to HMRC that you have no material ties to the UK, a difficult process which is often unsuccessful if challenged in court.
Further problems occur surrounding Wills, heirship rules and taxation treaties between countries. All these scenarios create a wealth of opportunities for Financial Planners to prove their worth before clients make the big move.
According to Government statistics, almost 3.5 million Britons live abroad – equivalent to over seven per cent of the population. Apparently, only Mexico has more expatriates. In terms of long term international migration, Australia is the top destination, followed by Spain, the USA, France, Germany, New Zealand, the UAE and Canada. Monaco alone is home to 3,500 British expats.
People emigrate for a myriad of reasons; their work may demand it, they may be lured by sunnier climes, a less taxing commute, a better work life balance and so on. More and more clients and potential clients of Financial Planners are retiring abroad, choosing to spend their retirement years in a country where the cost of living is cheaper, the standard of living is better and where the weather is sunnier.
Entrepreneurs and business owners in particular often opt to move to a tax- free jurisdiction prior to selling their businesses, in order to escape UK Capital Gains Tax and Income Tax on their future income. These people will often have family still residing in the UK – children and grandchildren – and they may well continue to own assets in the UK. The destinations of choice for this group of expats are France, Spain or Monaco.
Clients who move abroad to work may not already own substantial assets in the UK, usually having offloaded properties prior to moving. These may be more focused on accumulating wealth, often in a tax-free jurisdiction, before ultimately returning to the UK or emigrating for good.
One of the key issues for people leaving Britain is that they often focus too heavily on improving their standard of living and the effect of taxation during their lifetime, but fail to consider the full impact on their finances, particularly the situation arising on death. Financial Planners can assist in these situations, helping expat clients to avoid landing their families with an unexpectedly hefty Inheritance Tax (IHT) bill as well as planning for other unforeseen situations.
Whereas Income Tax and Capital Gains Tax is based on residence, IHT is based on domicile. Expat clients may assume they are not liable to UK IHT because they are no longer UK resident and many are surprised to discover that this is unlikely to be the case.
Domicile is a legal term – meaning you 'belong' to a certain country – often the place you regard as your homeland. Your country of domicile is normally the same as your nationality, irrespective of residency. Everyone is born with a domicile of origin, which will be taken from your father. To become domiciled in the country in which they reside, individuals need to prove to HMRC that they no longer have material connections with the UK, and that they are a permanent resident in that other country. Recent case law in the UK has demonstrated that it is very difficult to shed one's domicile of origin and replace it with a domicile of choice.
If your clients remain UK domiciled, then UK IHT is payable on all their worldwide assets including, for example, their retirement home in Monaco. Even if they are no longer UK domiciled, IHT will still be due on any assets situated within the UK.
Successful Estate Planning for expat clients will need to take account of the IHT (or equivalent death taxes) in both the UK and the country in which the client resides.
Unlike the UK, where for the most part, assets can be freely disposed of by Will, in other countries, the story can be quite different. Forced heirship rules are statutory in a number of countries, such as France, and they determine the proportion of a deceased's estate that has to pass to various membersofthefamily. The Gallic approach favours a higher proportion of the estate being left to children, with only a small proportion passing to a surviving spouse. For a widow, this could be a catastrophic turn of events, particularly if there was any familial disharmony. For example, the deceased may have had children with a first wife and the relationship with the step mother may well be strained or even non-existent. In this case, it would be very difficult for the widow to appeal to the better nature of her husband's offspring and this in turn could jeopardise her lifestyle.
The amount of IHT or equivalent death taxes in countries that have forced heirship often depends on the degree of relationship between the deceased and the beneficiary. There are moves afoot to enable EU citizens to be able to elect to apply the law of their nationality to disposals of their assets by Will, but it is unlikely that this will be in force for several years. It is, therefore, absolutely essential when advising expats to consider their ability to dispose of their assets freely by Will and the likely tax consequences. This may well lead to a review of the manner in which foreign assets are held, for example, via a company rather than direct ownership, or via an insurance policy.
Account also needs to be taken of any Double Taxation Treaties that exist between the UK and the country in which an expat client resides. In most cases, there is a set-off between any local death taxes and UK IHT (that is, one ends up paying overall the higher rate of tax, but the asset is not taxed twice). However, to assist a UK-domiciled expat wishing to mitigate UK IHT on their UK situated assets, there are a number of things that can be done. The first is to make full use of the "Surviving Spouse Exemption." However, this exemption only exists in full, where the surviving spouse is also UK domiciled. As previously stated, even if an expat is successful in shedding their UK domicile, their assets situated in the UK will remain liable to UK IHT. If that expat's spouse has also become non-UK domiciled, then the Surviving Spouse Exemption will be restricted. If, as frequently happens, the surviving spouse (who was previously UK domiciled) returns to the UK following the death, this immediately revives their UK domicile, leading to UK IHT becoming payable on the worldwide assets of the surviving spouse on his/her subsequent death.
Secondly, and only if circumstances allow, use should be made of PETs (Potentially Exempt Transfers). A problem which often occurs in this situation for UK residents is that PETs also give rise to a deemed disposal for CGT purposes. This, of course, does not apply to expats provided they remain non-UK resident for at least five tax years after the date of the gift.
Lastly, use should be made of other relevant or appropriate IHT reliefs such as Business Property Relief (BPR) or Agricultural Property Relief (APR). BPR gives 100% relief from IHT for investments in unquoted trading companies once those investments have been held for two years. "Unquoted'', for these purposes, includes companies whose shares are quoted on AIM. The definition of 'trading' excludes activities such as property development and investment companies. However, a company that qualifies for BPR can be incorporated anywhere in the World. There are no limits to the amount that may be invested, nor any minimum percentages of share ownership. It is perfectly possible, therefore, for an expat to invest in his, or his family's, unquoted trading company and claim BPR after two years.
APR also gives 100 per cent relief from IHT for the "agricultural value of land and buildings used for agriculture." The minimum period of ownership is two years in the case of in-hand land, and seven years in the case of let land. Agricultural land and buildings anywhere in the EU, as opposed to worldwide, are capable of qualifying. Rather than investing directly into BPR companies or APR land and buildings, it is possible to invest via a collective investment scheme if that suits the particular circumstances of the client.
Whichever way such an investment is made, it is again essential to ensure that what may work from a UK tax perspective also works within the jurisdiction in which your expat client resides. When clients – particularly those in their retirement – decide to leave the UK in search of a better lifestyle elsewhere, they may be keenly aware that it will not necessarily be an easy path ahead.
Many will anticipate administrative and bureaucratic hurdles they'll have to leap and cultural dissonance they may face. They might fret about language acquisition and the fundamental issue of integrating into a community – they might not want to be dismissed as "les rosbifs." They know they will be homesick and miss family, friends and neighbours and can mitigate this by using Skype, organising regular trips back and having a steady stream of visitors. But when it comes to their finances, they are less likely to give full consideration to all the issues they face.
Hence, as their Financial Planner, it is essential to help such clients to consider the long- term financial implications and what could go wrong if one or other of them die. Early planning is absolutely essential for people thinking of moving abroad and local knowledge is key – ultimately, different rules and regulations in various jurisdictions might influence which country they want to move to. It's important to ensure that whatever works from a UK perspective also works in the local jurisdiction. And it is vital to keep any planning flexible enough to be altered or adjusted to reflect changes in personal circumstances or taxation.
A life in the sun is appealing for many. However, reminding them of the dangers and planning for all eventualities will mean that your clients are less likely to fall into any financial traps and ensure that when setting sail to a new life, there will be calm waters ahead.