The Strange Case of Dr Watson’s ‘Deemed Domicile’

Watson’s return to UK

Dr Watson returned from India after seeing service in the second Anglo-Afgan war where he was wounded and then suffering enteric fever landed at Tilbury docks on 5 January 1881. No longer able to stay in India, his domicile of choice, Watson rents rooms at 221b Baker Street with a Sherlock Holmes. Dr Watson has various houses in India which is the custom there and he enjoys substantial dividends from Peninsular & Oriental Steam Navigation Company shares. The shares are quoted in London. Dr Watson has the ultimate intention of returning permanently to India, his domicile of choice, but has remained in the UK because of his illness and subsequent adventures with Holmes. He receives a strange letter on 26 April 1897 whilst at 221b Baker Street from Her Majesty’s Revenue and Customs (Queen Victoria) suggesting he is now to be categorised as ‘deemed domicile’. He passes the letter to Sherlock Holmes who states ‘Watson, I am minded to ignore this strange letter but something perturbs me about it!’

The Crime

Holmes deduces that if Dr Watson is considered ‘deemed domicile’ in the UK despite his claim for domicile of choice in India this would mean his Indian assets and Peninsular shares will be taxed on his death at 40%. Similarly if he returns to India and dies within 3 years of leaving the UK he will also be taxed on the value of those assets at the date of his demise. The clues Holmes has turned up are that Watson returned to the UK on 5 January 1881 and was classed as resident for income tax purposes from that date i.e. tax year 1880/81. This income tax treatment also affects inheritance tax too as the income tax residence rules impact on inheritance tax. So even though Watson arrived at Tilbury Docks on 5 January 1881 towards the end of the tax year i.e. 5 April 1881 he was classed as resident for income tax and also inheritance tax for the whole of the year 1880/81. As the years passed Watson did not know this until the strange letter was received on 26 April 1897 from Her Majesty’s Revenue and Customs (Queen Victoria) suggesting he is now likely to be categorised as ‘deemed domicile’. What perplexes Holmes is that the letter mentions Watson’s residence in UK as being 17 years out of the last 20 years of assessment. However, Watson arrived in the UK on 5 January 1881 and it is now 26 April 1897 some 16 years 4 months later not 17 years!

The clues

So how is it Dr Watson can be classed as deemed domicile in the UK when the legislation says 17 out of the last 20 years? Holmes researches the legislation:

267                                          Persons treated as domiciled in United Kingdom.

(1)                   A person not domiciled in the United Kingdom at any time (in this section referred to as “the relevant time”) shall be treated for the purposes of this Act as domiciled in the United Kingdom (and not elsewhere) at the relevant time if—

(a)                   he was domiciled in the United Kingdom within the three years immediately preceding the relevant time, or

(b)                   he was resident in the United Kingdom in not less than seventeen of the twenty years of assessment ending with the year of assessment in which the relevant time falls.

(2)                    Subsection (1) above shall not apply for the purposes of section 6(2) or (3) or 48(4) above and shall not affect the interpretation of any such provision as is mentioned in section 158(6) above.

Holmes deduces that the words ‘years of assessment’ means tax years i.e. 6 April to the following 5 April and not actual years spent in the UK which in Watson’s case is some 16 years 4 months. Hence, the deemed domicile and attaching tax consequences. Also, the word resident means that when Dr Watson joined Holmes at 221b Baker Street in January 1881 it was his intention to settle in London having signed a sub-lease to lodge with Holmes. This fact means that Watson was resident for income tax purposes from his date of arrival and thereby subject to inheritance domicile tax by implication for the whole of the 1880/81 tax year although he had been in India for most of the year. Holmes wonders if he has missed any salient points?

The conclusions

‘Deemed domicile’ in the UK for inheritance tax purposes can apply inheritance tax to anyone’s worldwide assets if they are resident in the UK for seventeen out of the last twenty tax years. Leaving the UK after 22 April in the tax year April may mean that UK residence applies for that year although this depends on certain connecting factors but in Dr Watson’s case his circumstances may preclude this as he has the maximum number of connecting factors meaning his ‘arriver’ status at Tilbury Docks and ‘leaver’ status at departure from UK at the end of his residence there is limited to less than 46 and 16 days respectively. Even if Watson was to return to India straight away then for income tax purposes he would be classed under the new residence rules as a ‘leaver’ and just 16 days in the UK would make him resident for income tax because of his connecting factors. Consequently he would be treated as resident for inheritance tax too! Holmes muses that had the boat bringing Dr Watson been delayed in Cape Town for six weeks due to storms, a common occurrence at that time, and his arrival had been on 26 February 1881 his first year of residence would have been 1881/82 and not 1880/81 because he had less than 46 days in the UK. Therefore Dr Watson’s continued presence and personal connections in the UK since his arrival do point to him being ‘deemed domicile’ from 26 April 1897.

Clueless?

Holmes admits defeat and contacts his trusty old tax accountant Jon Golding and recounts Dr Watson’s situation to him. Golding mentions to Holmes that under s 267(2) above the UK’s deemed domicile rule is ignored where there is an overriding Double Tax Treaty relevant to estate taxes. This would preclude UK estate duty/inheritance tax being applied on Dr Watson’s overseas assets at the time of his death as long as he is domiciled in a country that has such an agreement. However, Watson’s Peninsular & Oriental Steam Navigation Company shares would still be taxed in the UK. Golding finds a rare edition of Article III of the UK/India 1956 (SI 1956 No 998) treaty on his bookshelf which says:

‘Duty shall not be imposed in Great Britain on the death of a person who was not domiciled at the time of his death in any part of Great Britain but was domiciled in some part of India on any property situate outside Great Britain…’

Golding also states that India repealed its Estate duty law and therefore no assets would be subject to estate taxes in India on Dr Watson’s death if he was to be domiciled there by choice.

As an aside Golding mentions that there are also such treaties with Italy, Pakistan and France. The UK/Italian Treaty of 1966 (SI 1968 No 304) also similarly states if the deceased was domiciled in Italy then such property not located in the UK will be exempt from UK inheritance tax. Holmes leaves his accountant’s office with this bit of useful information for future cases.

The accountant’s conclusion of this case is that should Dr Watson should return for to India immediately or in the future and resurrect his Indian domicile and then treaty relief would preclude the application of the deemed domicile rule. Holmes decides that Dr Watson’s services to him are more important than the potential saving in tax and says nothing!  

Apologies to Sir Arthur Conan Doyle.

Jon Golding ATT TEP former tax author is UK Tax and Trusts adviser with PI Ltd, Kuala Lumpur. Contact jongoldingtax@gmail.com Tel: +6012 287 1550 

Going Down Under?

Is a client seeking to set up a business in 'God's own country'? JON GOLDING provides some useful tips.

OVER 150,000 PEOPLE each year are estimated to emigrate abroad from the United Kingdom, many to set up business abroad rather than retire. John Howard, the Australian premier, is beginning his fourth term of office as leader supporting the contention that Australia is the new land of opportunity and an area for business growth. As one of the favoured destinations for immigrants, the Australian tax system is very similar to that of the UK, but there are a number of matters that need to be noted particularly where a business is being set up.

Contracts and work permits

A UK national requiring to work in Australia will require a visa, work permit and will have to adhere to the strict entry and exit requirements imposed by the Australian immigration authorities. A number of different categories apply to business visitors wishing to stay in Australia. The business visitor must only be engaged in work in Australia if the work is relevant to the conduct of the business, or performance of the tasks specified in the visa application. Any breach of conditions may lead to cancellation of the visa and possibly penalties. See www.immi.gov.au.

Choice of business vehicle

In Australia, possible choices of venture vehicle will be the proprietary company (pty) or the public company which is listed on the Australian Stock Exchange. However, alternatives to the company structure in Australia might be the partnership, sole tradership or the operation of a small business through a unit trust or discretionary trust.

Partnerships/joint ventures

A partnership in Australia is the relationship between persons carrying on a business in common with a view to profit. The partnership is formed by the parties executing the partnership agreement, although a formal agreement is not necessary because of the different partnership Acts existing in the various states of Australia. Depending on the state or territory in which the business is situated, it will apply its respective Partnership Act, e.g. Partnership Act 1892 (NSW), The Partnership Act 1891 (Queensland). This Act contains a number of statutory assumptions that apply to all general law partnerships and may not be relevant to the new partnership being set up (and may even be detrimental!). One of the assumptions is that the partners will all share in the profits equally and be taxed individually (see the Table below) but this may not be appropriate if one party has contributed a greater amount of start-up capital than the other partner(s). See Canny Gabriel Castle Jackson Advertising Pty Ltd v Volume Sales (Finance) Pty Ltd [1974] 131 CLR 321, 3 ALR 409.

Inheritance Tax Is Akin To Grave Robbery

Key points * Inheritance tax is akin to grave robbery. * If abolished, does inheritance tax have to be replaced? * The ability to obtain multiple use of the nil-rate band. * Rising property prices will increase the numbers affected by inheritance tax. * The economic benefits of abolition.
WHEN I READ 'Rufus's law', by Richard Curtis (Taxation, 29 March 2007, page 345), I looked at my goldfish swimming in his little round bowl with Mrs Goldie and wondered what he would make of the Daily Express headline on scrapping inheritance tax. Unlike Rufus, who can chase caribou in Canada providing he remembers his dog passport, Goldie cannot really go anywhere and only has his little bowl to look out of at the never changing scenery! What would he think if he and Mrs Goldie passed on and left their only real possession, the round bowl, to the little Goldies and the bowl had to be sold to pay taxes? I showed him Rufus's law through the glass of the bowl and he was, like me, horrified at what he saw and started to blow bubbles furiously, but fortunately after ten seconds he had forgotten and was back to his calm self, swimming anti-clockwise around his little home. I am sure that Goldie would support The Daily Express in its campaign like the majority of the readership. Rufus obviously forgets the day he went to doggy training school and, as a new dog, made friends with Jack the Russell whom the other dogs all hated. Rufus initially could not understand why they hated his new friend, but after Jack had nipped his long legs many times he realised that the majority were right all along … Jack was a pain in the heels! Clearly, if 120,000 Express readers support the idea of abolishing inheritance tax they cannot all be wrong, as Rufus learnt in the dog training school all those years ago, but obviously has conveniently forgotten.

First, catch your worm

The Daily Express petition argues that 'By raising a 40% levy on earned assets, it is also effectively double taxation. It frequently piles financial misery and distress on families already suffering the pain of bereavement; that is nothing less than grave robbery'. Slightly emotive, but nonetheless accurate in many cases. On a death there are a number of forms to fill out and this is usually done by an acting solicitor who takes the emotional burden away from the families concerned. Most families see little of the paperwork at this difficult time and are protected to a great extent from day to day financial reminders of the deceased's demise. But then, when it is all over, they get a tax bill from HMRC which in many cases means they have to sell the family home they have inherited. Not only that, the family may have to find additional funding in the form of a loan (with interest) to pay the tax before the property can be sold. I think the analogy with grave robbing is actually quite generous! It's akin to the old days of Burke and Hare; but remember, even if the body was discovered on the anatomist's mortuary slab, the bodysnatchers could not be charged with any crime as a body was not property! I am starting to become emotive now and must address the points raised in the original article with a necessary detachment.

Is there a need to replace IHT?

Richard in his article suggests that if inheritance tax is abolished 'what will we replace it with?' Well I would say that many countries such as Hong Kong, Australia and New Zealand that have no estate duty taxes seem to find that the lack of such a tax has not hindered the economy or provision of services and infrastructure to their burgeoning economies. Hong Kong has more billionaires per percentage of population (according to Forbes Magazine, 18 billionaires per population of seven million) than any other country and chooses not to impose estate duty levies. Why is this? Because the powers that be know it would be counter productive in terms of inward investment and attracting high net worth individuals to remain there. The obverse of this is now being mirrored in the UK with emigration from these shores to Australia increasing as reported in The Times on 19 April. Those individuals now leaving will not be able to escape their inheritance tax burden unless they successfully change their domicile, but it does mean a lot of wealth is leaving the country and this is likely to continue. If inheritance tax was abolished, those high net worth non-UK individuals who are reticent about staying in the UK longer than seventeen years could make a greater financial commitment to the UK which in turn would boost the economy and the Treasury would receive, I believe, far more than the £3.2 billion lost in inheritance tax revenues. Those UK individuals leaving these shores would no longer be forced to look for loopholes and offshore havens to secrete their wealth. So the answer in pure economic terms is that one does not have to replace an abolished tax with a replacement, or have Hong Kong got it all wrong? I think not!

Mrs Goldie and IHT

The second point in the article mentions the eponymous Mrs Parkinson who inherits her father's flat worth £285,000 on which inheritance tax has to be paid and she is 'furious at being penalised' because of the hike in south-east property prices. Richard quite rightly states that after the nil rate band has been taken into account the actual effective rate is a mere 4%! I warmed to his suggestion of taking out insurance to pay the ultimate inheritance tax bill. However in most cases, because of age and life expectancy, the premiums would have been potentially exorbitant and in this particular case where would he, a pensioner, find the annual premiums?
Some would say that this was not the best case study for the Daily Express to report. I disagree; it is typical and defines the inequity in this tax. There are many cases like Mrs P who inherit a property which has a paper valuation on which tax is imposed notwithstanding IHTA 1984, s 191. But these types of estate are at a disadvantage because, in contrast to estates of higher value with liquid funds, they are unable to utilise the nil rate band every seven years to pass on assets to the children entirely free of inheritance tax. Instead they get one nil rate band and pay tax on the balance at an iniquitous rate of 40%. In this case you can look at the problem from inside the goldfish bowl or from outside and it looks totally different. Richard looking into my goldfish bowl sees only a 4% rate of tax, but Mrs Goldie looking out (Mr Goldie having expired and been flushed away quietly one night so as not to upset the children) does not. Similarly Mrs Parkinson does not see her nil rate band as a particular individual benefit as everyone gets it (and some others benefit from it more than once!). What she and many others see is tax at 40% on the balance, however small, and this is the whole point. It's similar to Rufus, the dog with everything including mange, possibly, racing against a Dachshund and Richard proudly saying it was a fair race because they started from the same spot. I won't bang on about tapered relief or a higher nil rate band because at the end of the day there should be no inheritance tax and therefore no such inequities.

Demographic profiling

The Daily Express readership in Richard's article seems to be a fairly broad representation of the UK populus and is probably more typical than any other daily paper conducting a representative poll on such a matter. I would think that, say, the Financial Times would have A and B classification almost entirely through its readership and the Daily Sport might be D and E both of which would be unrepresentative. A majority of the Daily Express readership may not currently have an inheritance tax problem, but with property prices rising as they are, the problem won't stay away too much longer. Soon they will be inheriting properties that are increasing at double digit percentages in value and this increase will be added to their increasing double digit property values, swelling the estate to take it well into the 40% band. The readership cannot be criticised for being perceptive of the looming liabilities likely to be faced. Why should their beneficiaries not pay inheritance tax on their property value at the end of the day especially as they have lived in the property free from capital gains tax? The answer is simple … one man's profit is another man's loss. As property prices increase, the purchasers of those properties have to take out bigger and bigger loans to fund the purchase. The loan which will invariably be a repayment loan has interest to be paid back and this interest is being funded out of income which could have been spent on other things that attract VAT.
If I was in the Treasury I would rather have 17.5% now rather than the hope of 40% in goodness knows how many years' time. The Daily Express readership with its fixation on property price increases has latently showed a fundamental business flaw with the logic of imposing inheritance tax in an increasing property market. A lot of Hong Kong's wealth is based on real estate value increases, but you will not see estate taxes imposed because they would rather have jam today rather than the expectation of honey tomorrow … but then their business acumen has never been questioned! I return to Richard's article and his quotation from Cicero — 'who benefits'. Well, in the circumstances of inheritance tax, Oscar Wilde's quotation written on his wallpaper would be more appropriate 'It is killing me, one of us has to go'.

Epilogue

All old American TV series included the 'epilogue' at the end which rounded up the episode. Incidentally, the US does have estate taxes, but I won't mention the state of their economy. My epilogue is that the abolitionists are looking from the fish bowl outside and can see the inequity of inheritance tax and its manipulation of market forces whereas those non-abolitionists are looking into the bowl and don't even consider that implication. The law of physics says that light is refracted when it hits water, so fish can see you coming before you get to the bank of the river. I think it is the same here; we, those of us in the bowl, will never see eye to eye with those outside the bowl. So inheritance tax will probably stay and the words of Oscar Wilde on his death bed — 'I am dying, as I have lived, beyond my means' — will apply to most of us in the end.

Jon Golding ATT TEP former tax author is UK Tax and Trusts adviser with PI Ltd, Kuala Lumpur. Contact jongoldingtax@gmail.com Tel: +6012 287 1550

Wherever I Lay My Hat!

‘Home is where I rest my hat’ is the view of many people. Unfortunately it is also the view of UK’s HM Revenue & Customs (HMRC). So why should we be concerned?
If you leave the UK to work or retire in abroad and purchase or rent a property in the foreign country but keep a UK property then tax problems could arise. In many cases a property in the UK is kept which we either return to, or rent out, potentially leaving an income tax or capital gains tax (CGT) liability. The immediate response of your acquaintance in the bar will be ‘No worries mate, you’re UK non-resident’. Unfortunately, bar advice can be financially detrimental to your wealth.
If you rent out your UK property your tenant or letting agent should deduct income tax at 20%. You may be able to claim some of this tax back later but this depends on your circumstances. Non-UK residence is not a reason for not paying tax on UK rental income. If your tax affairs were up to date when you left UK you might be able to have the rent paid without this hassle but a complex form NRL 1 must be completed. Still, your mate in the bar will say ‘HMRC will never find out, so no worries’. Unfortunately HMRC will find out because they obtain details of letting income under their exhaustive powers and then charge you interest and a penalty.
What if you don’t rent out your UK property but stay there occasionally for short periods? You have two places you hang your hat; your property abroad and the one in the UK. Well, HMRC say if you have more than one property you must elect which is your main residence for UK CGT purposes otherwise you could be taxed at up to 28% on any gain on disposal. If you fail to do this then HMRC will elect for you. This may well be your property abroad so when you come to sell the UK property CGT could be payable!
Your mate in the bar will say ‘No worries mate, you’re UK non-resident’. Hang on haven’t we been here before?

So let’s ignore the bar fly for once and do a check list:

1.    With one property in the UK and one abroad (rented or purchased) you should elect which one is to be treated as your main residence within two years of acquiring the second property. If you are in a foreign country that has no CGT then the UK property may be the one on which to make the election. Also if you are renting abroad then your UK property would be the one on which to make the election.
2.    To avoid CGT in the UK on property sale you must be non-resident and not ordinarily resident for a period of 5 years. But should you return within that period or exceed the 91 days on average per year you will be treated as UK resident and any property abroad or in the UK sold in that period could be taxable at up to 28% if not elected for under 1 above. Consider if you or a close family member is taken ill and have to return to UK within the 5 year period.
3.    If you rent out your UK property you should not only consider the election at 1 but also ensure that you have your tax affairs up to date before you leave UK so that rent for your UK property may be paid without deduction of tax as mentioned earlier. Otherwise, your UK agent or tenant will have to deduct tax at 20% of the rent and send it to HMRC. You will have to tally up with HMRC later.
4.    If you are working abroad on a contract then HMRC will ignore the whole of the period spent abroad for your work when you come to sell your UK main property. This is only for CGT purposes and does not apply to retirees.
5.    Finally, remember that any double taxation treaty in the country you are working or retiring to may have taxing rights on your income and gains. So, check that out too!
Now you and your mate can talk about football or macramé and not tax!

Jon Golding ATT TEP is a UK tax reduction specialist with PI Ltd in Kuala Lumpur, Malaysia. Contact (+60) 122871550 or e-mail:  jongoldingtax@gmail.com

Inheritance Tax Is Akin To Grave Robbery.

Key points * Inheritance tax is akin to grave robbery. * If abolished, does inheritance tax have to be replaced? * The ability to obtain multiple use of the nil-rate band. * Rising property prices will increase the numbers affected by inheritance tax. * The economic benefits of abolition.
WHEN I READ 'Rufus's law', by Richard Curtis (Taxation, 29 March 2007, page 345), I looked at my goldfish swimming in his little round bowl with Mrs Goldie and wondered what he would make of the Daily Express headline on scrapping inheritance tax. Unlike Rufus, who can chase caribou in Canada providing he remembers his dog passport, Goldie cannot really go anywhere and only has his little bowl to look out of at the never changing scenery! What would he think if he and Mrs Goldie passed on and left their only real possession, the round bowl, to the little Goldies and the bowl had to be sold to pay taxes? I showed him Rufus's law through the glass of the bowl and he was, like me, horrified at what he saw and started to blow bubbles furiously, but fortunately after ten seconds he had forgotten and was back to his calm self, swimming anti-clockwise around his little home. I am sure that Goldie would support The Daily Express in its campaign like the majority of the readership. Rufus obviously forgets the day he went to doggy training school and, as a new dog, made friends with Jack the Russell whom the other dogs all hated. Rufus initially could not understand why they hated his new friend, but after Jack had nipped his long legs many times he realised that the majority were right all along … Jack was a pain in the heels! Clearly, if 120,000 Express readers support the idea of abolishing inheritance tax they cannot all be wrong, as Rufus learnt in the dog training school all those years ago, but obviously has conveniently forgotten.

First, catch your worm

The Daily Express petition argues that 'By raising a 40% levy on earned assets, it is also effectively double taxation. It frequently piles financial misery and distress on families already suffering the pain of bereavement; that is nothing less than grave robbery'. Slightly emotive, but nonetheless accurate in many cases. On a death there are a number of forms to fill out and this is usually done by an acting solicitor who takes the emotional burden away from the families concerned. Most families see little of the paperwork at this difficult time and are protected to a great extent from day to day financial reminders of the deceased's demise. But then, when it is all over, they get a tax bill from HMRC which in many cases means they have to sell the family home they have inherited. Not only that, the family may have to find additional funding in the form of a loan (with interest) to pay the tax before the property can be sold. I think the analogy with grave robbing is actually quite generous! It's akin to the old days of Burke and Hare; but remember, even if the body was discovered on the anatomist's mortuary slab, the bodysnatchers could not be charged with any crime as a body was not property! I am starting to become emotive now and must address the points raised in the original article with a necessary detachment.

Is there a need to replace IHT?

Richard in his article suggests that if inheritance tax is abolished 'what will we replace it with?' Well I would say that many countries such as Hong Kong, Australia and New Zealand that have no estate duty taxes seem to find that the lack of such a tax has not hindered the economy or provision of services and infrastructure to their burgeoning economies. Hong Kong has more billionaires per percentage of population (according to Forbes Magazine, 18 billionaires per population of seven million) than any other country and chooses not to impose estate duty levies. Why is this? Because the powers that be know it would be counter productive in terms of inward investment and attracting high net worth individuals to remain there. The obverse of this is now being mirrored in the UK with emigration from these shores to Australia increasing as reported in The Times on 19 April. Those individuals now leaving will not be able to escape their inheritance tax burden unless they successfully change their domicile, but it does mean a lot of wealth is leaving the country and this is likely to continue. If inheritance tax was abolished, those high net worth non-UK individuals who are reticent about staying in the UK longer than seventeen years could make a greater financial commitment to the UK which in turn would boost the economy and the Treasury would receive, I believe, far more than the £3.2 billion lost in inheritance tax revenues. Those UK individuals leaving these shores would no longer be forced to look for loopholes and offshore havens to secrete their wealth. So the answer in pure economic terms is that one does not have to replace an abolished tax with a replacement, or have Hong Kong got it all wrong? I think not!

Mrs Goldie and IHT

The second point in the article mentions the eponymous Mrs Parkinson who inherits her father's flat worth £285,000 on which inheritance tax has to be paid and she is 'furious at being penalised' because of the hike in south-east property prices. Richard quite rightly states that after the nil rate band has been taken into account the actual effective rate is a mere 4%! I warmed to his suggestion of taking out insurance to pay the ultimate inheritance tax bill. However in most cases, because of age and life expectancy, the premiums would have been potentially exorbitant and in this particular case where would he, a pensioner, find the annual premiums?
Some would say that this was not the best case study for the Daily Express to report. I disagree; it is typical and defines the inequity in this tax. There are many cases like Mrs P who inherit a property which has a paper valuation on which tax is imposed notwithstanding IHTA 1984, s 191. But these types of estate are at a disadvantage because, in contrast to estates of higher value with liquid funds, they are unable to utilise the nil rate band every seven years to pass on assets to the children entirely free of inheritance tax. Instead they get one nil rate band and pay tax on the balance at an iniquitous rate of 40%. In this case you can look at the problem from inside the goldfish bowl or from outside and it looks totally different. Richard looking into my goldfish bowl sees only a 4% rate of tax, but Mrs Goldie looking out (Mr Goldie having expired and been flushed away quietly one night so as not to upset the children) does not. Similarly Mrs Parkinson does not see her nil rate band as a particular individual benefit as everyone gets it (and some others benefit from it more than once!). What she and many others see is tax at 40% on the balance, however small, and this is the whole point. It's similar to Rufus, the dog with everything including mange, possibly, racing against a Dachshund and Richard proudly saying it was a fair race because they started from the same spot. I won't bang on about tapered relief or a higher nil rate band because at the end of the day there should be no inheritance tax and therefore no such inequities.

Demographic profiling

The Daily Express readership in Richard's article seems to be a fairly broad representation of the UK populus and is probably more typical than any other daily paper conducting a representative poll on such a matter. I would think that, say, the Financial Times would have A and B classification almost entirely through its readership and the Daily Sport might be D and E both of which would be unrepresentative. A majority of the Daily Express readership may not currently have an inheritance tax problem, but with property prices rising as they are, the problem won't stay away too much longer. Soon they will be inheriting properties that are increasing at double digit percentages in value and this increase will be added to their increasing double digit property values, swelling the estate to take it well into the 40% band. The readership cannot be criticised for being perceptive of the looming liabilities likely to be faced. Why should their beneficiaries not pay inheritance tax on their property value at the end of the day especially as they have lived in the property free from capital gains tax? The answer is simple … one man's profit is another man's loss. As property prices increase, the purchasers of those properties have to take out bigger and bigger loans to fund the purchase. The loan which will invariably be a repayment loan has interest to be paid back and this interest is being funded out of income which could have been spent on other things that attract VAT.
If I was in the Treasury I would rather have 17.5% now rather than the hope of 40% in goodness knows how many years' time. The Daily Express readership with its fixation on property price increases has latently showed a fundamental business flaw with the logic of imposing inheritance tax in an increasing property market. A lot of Hong Kong's wealth is based on real estate value increases, but you will not see estate taxes imposed because they would rather have jam today rather than the expectation of honey tomorrow … but then their business acumen has never been questioned! I return to Richard's article and his quotation from Cicero — 'who benefits'. Well, in the circumstances of inheritance tax, Oscar Wilde's quotation written on his wallpaper would be more appropriate 'It is killing me, one of us has to go'.

Epilogue

All old American TV series included the 'epilogue' at the end which rounded up the episode. Incidentally, the US does have estate taxes, but I won't mention the state of their economy. My epilogue is that the abolitionists are looking from the fish bowl outside and can see the inequity of inheritance tax and its manipulation of market forces whereas those non-abolitionists are looking into the bowl and don't even consider that implication. The law of physics says that light is refracted when it hits water, so fish can see you coming before you get to the bank of the river. I think it is the same here; we, those of us in the bowl, will never see eye to eye with those outside the bowl. So inheritance tax will probably stay and the words of Oscar Wilde on his death bed — 'I am dying, as I have lived, beyond my means' — will apply to most of us in the end.

Jon Golding ATT TEP former tax author is UK Tax and Trusts adviser with PI Ltd, Kuala Lumpur. Contact jongoldingtax@gmail.com Tel: +6012 287 1550

Expat U.K. Property Investor? What They Didn't Tell You!

Property prices in the United Kingdom fell for the eighth month in a row in January according to the Halifax the mortgage lender. Yet there is still a buoyant rental market giving good returns as demand for good rental properties is high throughout the UK. This investment opportunity with falling UK property prices and buoyant rental income is attractive for those who chose to diversify. However, investing in the UK comes with price tags attached such as stamp duty, inheritance tax and income tax on the rents. It is important to be clear of the ‘price tag’ before committing a large investment of this sort. A UK property purchase decision should also encompass consideration of the following important factors:

1. Stamp duty imposed on the purchaser on properties purchased in excess of £125,000
2. Income tax deductions at 20% on net rental income by the agent or tenant under the non-resident landlord scheme;  
3. Capital gains tax exemption implications; 
4. Inheritance tax at 40% on UK situated assets for foreign domiciled individuals where the value of the property exceeds the £325,000 nil rate band.

Stamp duty

Stamp duty land tax (SDLT) is payable by purchasers of UK property in excess of £125,000 which means that most people investing in good quality properties in London could be paying anything between 4% and 7% for properties over £500,000 and above.

Following the recent UK anti-avoidance legislation a stamp duty saving scheme of transferring expensive London properties into offshore companies/trusts to avoid tax does not work and existing schemes came under scrutiny for an ‘annual charge’ tax. Now, on properties over £2 million, a 7% SDLT charge applies or a 15% rate if into an offshore company. Also an annual charge is to apply to residential properties valued over £2 million held within the "envelope" of a company or other non-natural person.  The annual charge starting at £15,000 per annum up to £140,000 per annum will encourage those who own expensive UK properties within a company to take it out of the envelope. Also there is a potential capital gains tax charge too, see CGT below. However, there are exclusions applying to the charge which commences on 1 April 2013.

Rental income

Rents need to be collected and it is preferable to have a good letting agent rather than rely on the tenant to deduct tax and account for it to the UK Revenue! An agent will charge between 10-15% of gross rents and will ensure that rental income is collected and void periods are limited, cover defaults insurance and ensure maintenance costs are kept to a minimum. The agent will also account to the UK Revenue the tax that is required to be paid quarterly under the Non-Resident Landlord scheme. In some cases exemption can be applied for under the NRL1 (individual landlords) and NRL2 (companies) but in most cases tax will be payable on net rents at 20%.

Capital gains tax (CGT)

The non-residence of the Malaysian landlord is key to avoiding UK CGT and providing this is the case the capital appreciation on sale will not be taxable. UK residents have CGT to pay on investment property gains of 18% or 28%.  However, there are already provisions under the Taxation of Capital Gains Act 1992 which attribute gains of certain non-resident companies to UK participators, or under which settlors or beneficiaries of non-resident trusts can be charged to tax on gains accruing to Trustees.  It would be sensible to consider very carefully whether a UK property portfolio should be held in either an offshore company vehicle or offshore trust or a combination of both that was previously the norm.

Inheritance tax (IHT)

This is by far the worst potential tax implication of investing in UK property because the tax rate can be 20% for lifetime gifts of property or 40% for gifts on death. Foreigners owning UK properties are not excluded from UK IHT because UK situated property is taxable at the rates mentioned even for non-domiciles. A nil rate band applies to each person of £325,000 so if a London property is valued on the owner’s demise at £1 million the estate will have to pay IHT of £270,000 within 6 months of the death! There may be the opportunity to pay this tax by 10 yearly instalments but unless the property is being left to a spouse it could be that it may have to be sold to pay the tax. If there is a loan for the purchase of the property then this will be deducted from the value of the property before the charge to IHT is applied.

Where UK property is held jointly (not tenants in common) then the need for probate is avoided but this still does not exclude an inheritance tax return being submitted. In this connection a UK Will should be drawn up that passes on the property to the intended beneficiaries rather than have a Malaysian Will ‘resealed’ under the Colonial Probates Act 1892.

 Action plan

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•       Target for higher capital growth and/or rental income e.g. London and South East England vs central and Northern England.
•       Appoint solicitor and letting agent who are respectively familiar with drawing up purchase agreements for non-domiciles and non-resident landlord rental withholding tax.
•       Consideration of a IHT free trust to cover the tax payable when the Malaysian owner passes on.
•       Non residence is maintained to ensure CGT exemption. The UK residence rules are changing from 6 April 2013.

EXAMPLE

A purchaser wants to invest £1 million in UK property for capital appreciation and rental income. The purchase of a London property would give capital appreciation of about 6% p.a. but incur SDLT of 5% i.e. £50,000. Rent on the property could be expected to be £2,500 per month. Instead he purchases 10 properties in the North East of England for £100,000 each paying no SDLT as all are under the £125,000 SDLT threshold. Rents could be about £350 per month each. Two years later he is offered £130,000 for three properties. He then gives one property to his son studying in Leeds at University. The purchaser passes on three years later leaving the remaining properties to his son each valued at £150,000. No SDLT is payable on the gift or where property is transferred by Will.

The net rents received would be taxable at 20% but if he had purchased one London property which made a loss because of, say, void rental periods or excess maintenance it could only be relieved in future years. If any of the ten properties made a loss that loss could be set against the income from the other properties in the current year before tax is applied.

 The gains on the sales of the three properties would be exempt from CGT provided that the purchaser was non-resident.

The gift to his son of the Leeds property is covered by £130,000 of his nil rate band so the tax liability on his demise will be £282,000 (£900,000 – (325,000 – 130,000) x 40%).

Jon Golding ATT TEP former tax author is UK Tax and Trusts adviser with PI Ltd, Kuala Lumpur. Contact jongoldingtax@gmail.com Tel: +6012 287 1550

Why Commorientes Can Affect UK Inheritance Tax

Sudden death!

Jon Golding ATT TEP, UK Tax and Trusts advisor with PI Global, explains why commorientes can affect UK Inheritance Tax (IHT) because "an important distinction arises in these cases regarding husband, wife and civil partner transfers in mitigating IHT"...
Where two people (e.g. husband and wife or civil partners) die in, say, a plane crash in circumstances such that it is uncertain which of them has died first then the rule is that for all purposes affecting title to property the younger is deemed to have survived the older person. This only applies where there is doubt as to survivorship where, for instance, there has been a disaster. However, if medical evidence suggests one of them survived the other if only by a few minutes then the rule does not apply.

 

 The survivorship clause

Section 184 of the Law of Property Act 1925 provides for the younger to have survived the elder in cases of disaster where it is not known which of them died first. Section 184 may be overridden where a clause is inserted in the will which states ‘provided that […] survives me for a period of twenty-eight days’ so that the normal distribution is in accordance with a testator’s wishes. The twenty-eight day clause insertion in a will under section 1 of the Law Reform (Succession) Act 1995 results in each estate passing as though the other had predeceased and for IHT purposes this will mean that, for instance, in partnerships (couples who are not married) each party may in such circumstances wish their estate to go to their own family members so utilising their relevant nil rate bands of £325,000. Jon Golding says “… in drawing up a will one should consider if the survivorship clause will have an unintended result in terms of UK tax and also the deceased’s wishes.”

 

The exception

In the case of spouses or civil partners who die in commorientes circumstances then the situation is complicated further by the IHT inter-spouse/civil partner exemption under IHTA 1984, s 18; as there is an exempt transfer on the death under section 18(1) then the transfer to the younger spouse or civil partner is not a chargeable transfer. However, the younger of the spouses/civil partners is deemed to have inherited the elder spouse’s/civil partner’s estate under the Law of Property Act 1925, s 184 but for the purposes of IHT under IHTA 1984, s 4(2) eliminates mutual gifts between individuals in such circumstances and there is no transfer of value to the younger spouse/civil partner on which inheritance tax can be charged. There is a view therefore that the elder’s estate of the married couple escapes inheritance tax completely and therefore a survivorship condition, which is normally desirable, is deliberately excluded in the event of the spouses/civil partners dying simultaneously.
In the case of civil partnerships this may not be desirable for the reasons as noted above but in a case where a married couple’s children benefit from their parents’ estates then depending on the size of the elder parent’s estate there could be a substantial saving in IHT at 40%. This view is confirmed by HM Revenue & Customs IHT manual at IHTM12197 which supports the view above that the elder spouse’s estate is not subject to IHT at all! See example below which applies to English domicile law (Scotland and N Ireland are different).