The UK’s tax system is a worldwide based system and thus whether income arises in the UK or elsewhere, and whether assets are located within the UK or elsewhere, is immaterial; all is brought within the charge to UK tax. This is true whether the tax is Income Tax, Capital Gains Tax or Inheritance Tax (IHT).
However, overseas located property does not fall subject to IHT where such property is owned by non-UK domiciled individuals; such property is referred to as excluded property. The UK’s common law rules determine whether property is UK or non-UK located for IHT purposes.
Issues of relevance where an individual dies owning overseas located property (or gifts such property in lifetime) include:
· double taxation;
· liabilities other expenses;
· forced-heirship; and
Many UK domiciled individuals possess property outside the UK which, as a consequence, may precipitate an equivalent charge to local IHT in the country in which the property is situated; in the absence of some form of relief double tax arises.
Fortunately, double tax relief is in principle available either under one of the double tax conventions on IHT to which the UK is a party or under the UK’s domestic provisions. The form of such relief is basically the same under either option and permits an offset against any UK charge of the tax paid in the overseas country.
Whilst this in principle alleviates double taxation, any depreciation in sterling may still result in a net UK IHT charge arising (see below).
Where the overseas property is real estate it may well be that such property is subject to mortgage.
In calculating an individual’s liability to IHT on death liabilities of the deceased are deductible in ascertaining the quantum of the estate. However, liabilities charged against overseas property (e.g. a mortgage) must in the first instance be deducted against such property.
This has two consequences; first, the IHT liability attributed to the property on death (and payable by the person inheriting the property; not a testamentary expense) is reduced and second, non-UK domiciled individuals (who are subject to IHT on UK situs assets only) cannot reduce their UK estate by such overseas incurred liabilities.
In addition, expenses incurred in realising/administering overseas property (up to 5% of the market value of the property) are deductible in calculating the value of the property.
IHT (as with other UK taxes) is computed in sterling (not the overseas foreign currency) and thus movements, both favourable and otherwise, between sterling and the foreign currency needs to be taken into account. In the event of the depreciation of sterling an increase in IHT will arise even in the event that though no appreciation in the property in foreign currency terms has occurred (similarly precipitating a possible Capital Gains Tax charge, unless arising on death).
Some countries have so-called “forced heirship” rules (e.g. France, Scotland), a concept alien to English law; such rules may impact unknowingly on any UK IHT charge. Thus, for example, the will of a UK domiciled individual may leave a French holiday home to their spouse which, as an inter-spouse transfer, precipitates no UK IHT charge. However, French law dictates that some proportion of the property must be left to the children; in this case, such proportion is then in principle subject to UK IHT.
Whilst double tax relief in theory removes double tax charges on the same property for IHT purposes this may not always be so (see comments above). In appropriate circumstances, it may therefore be preferable to own overseas property through an intermediate vehicle which whilst not, per se, affecting any UK IHT charge may remove not only any overseas IHT charge but may also circumnavigate any local forced heirship laws (e.g. owning a Spanish holiday home through a UK registered company; tax haven companies preferably to be avoided).
The use of trusts may also be useful in terms of such structuring overseas property ownership vis a vis mitigating a UK IHT charge although many countries (in particular many mainland European countries) do not recognise the English trust concept and may levy local IHT as if the trust did not exist.