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Legal Advice for those left behind following the death of a US citizen
For those left behind following the death of a US citizen, grappling with the complexities and sophistication of US tax legislation and probate procedure can be challenging enough but what happens when such a decedent also owned assets in the UK and their estate is caught within the UK tax net?
Here are just a few of the basic issues you should be aware of:
With very few exceptions (the main being small cash sums at banks, personal possessions and joint property passing by survivorship) it will nearly always be necessary to obtain a local grant in order to deal with assets in the UK. This is so regardless of whether the value of the UK estate is £10,000 or £10m, consists of a single holding of UK shares or of a much larger property, cash and investment portfolio. Entitlement to take out a Grant will depend on where the decedent was domiciled at death and whether they had a Will or died intestate. Separate rules and procedures apply in relation to applications in England and Wales (one jurisdiction for this purpose) and in Scotland or Northern Ireland.
Inheritance Tax (IHT)
The extent of an individual's exposure to IHT depends entirely on their domicile status. A UK domiciled person will be taxed on all assets wherever they are situated. A non-UK domiciled person will be taxed only on assets situated in the UK . Remember, however, if you have been income tax resident in the UK in any 17 of the 20 UK tax years prior to your death (the 17 out of 20 year rule) you will be treated as domiciled in the UK at death (but only for IHT purposes) regardless of your actual status at law.
Whilst tax rates are less onerous in the UK – IHT is currently charged at a flat rate of 40% - the UK is less generous as regards the portion of an estate that can be given away free of tax on death. For the UK tax year 2007/08 the IHT threshold is set at £300,000. The rules determining what is comprised in a decedent's estate for tax purposes, and those governing the applicability of exemptions, reliefs and deductions are different in the UK as, in certain circumstances, is the approach to valuation. Unlike in the US , for example, there is no alternate valuation date option under the UK regime. Value for IHT purposes will be fixed at the date of death save in very limited circumstances when it may be possible to substitute gross sale proceeds (this only applies to quoted securities and realty).
In all but a limited number of cases, an Inland Revenue Account Form IHT200 (the UK equivalent of IRS Form 706) will need to be filed with Her Majesty's Revenue and Customs (HMRC) and the value of the decedent's taxable estate, their domicile status (if they have a general law domicile outside the UK) and any reliefs, exclusions or credits claimed in the Account will need to be agreed. The deadline for filing Form IHT200 is the first anniversary of the decedent's death and there is no provision for extending this. In practice, however, the Account will often need to be submitted earlier to enable an application for probate to be made.
IHT Payment Deadlines
IHT is payable on the earlier of the application for representation to the decedent's estate or six months after the end of the month in which the death occurred. So, if you die on 1 April, tax will need to be paid no later than the end of October of the same year if your estate is to avoid an additional interest charge. The major difference with the UK system, therefore, is that it is not possible to obtain probate until all IHT due on assets owned by the decedent at death (other than tax on certain installment option property) has been paid. In exceptional circumstances, this can give rise to serious funding issues with executors finding themselves in the Catch 22 situation of not being able to obtain a grant without paying the IHT due on the death and not being able to access assets in order to pay the tax without the grant.
As the US always retains the right to tax its citizens, there will be a potential double tax charge whenever such a citizen is subject to an IHT situs charge on their assets in the UK or is treated as domiciled in the UK for IHT purposes. The US/UK estate and gift tax treaty is designed to prevent an estate paying tax twice over on the same asset in these circumstances. In the main, The Treaty achieves this by granting exclusive taxing rights to the country of fiscal domicile (the Treaty sets out the basis for determining fiscal domicile). It preserves, however, the right of both countries to tax their citizens as though the Treaty had not come into effect and reserves primary taxing rights in relation to real estate land and business assets to the country in which the property, land or business asset is situated. As a result of this, the Treaty prescribes credits to prevent double taxation arising.
As the payment deadlines for IHT do not match those applicable to estate taxes in the US , practical problems can arise in claiming Treaty tax credits where an estate is subject to tax in both the US and the UK. This is because the Treaty reserves to the UK the right to charge tax under its domestic rules if overseas tax assessable in priority has not been paid. Let's look at an example –
At the time of his death, US citizen, Roland Carruthers, was deemed domiciled in the UK for IHT purposes having lived and worked in Central London for almost 20 years. Under the Treaty, however, the US had the primary tax charge.
Roland had amassed a sizeable fortune, with property, business and investment interests throughout the world. His UK estate, however, was limited to a house in Hampstead, a collection of vintage cars, and various bank accounts. Roland had executed separate Wills in the US and the UK under which separate individuals were appointed as executors.
Soon after his death, Roland's UK executors received a valuable offer on the Hampstead property which they were advised by local agents to accept in view of difficulties with the housing market in the area. The purchaser's only condition, however, was that the sale be completed quickly.
Roland's UK executors were aware that they could not complete a sale without a UK Grant of probate.
They could not obtain a Grant, however, until they had dealt with their reporting obligations to HMRC which required them to file Form IHT200 for the estate (reporting worldwide assets) and to pay what they calculated to be the tax due in the UK on Roland's death. As Roland was not a UK citizen the UK executors were relying on the provisions of the Treaty to take all but the house in Hampstead out of charge to tax in the UK.
The UK executors were advised by their counterparts in the US, however, that US tax payments were not due until 9 months after Roland's death and, because of difficulties in ascertaining the exact extent of Roland's worldwide estate, these liabilities were proving difficult to calculate. Further, in view of the potential tax at stake in the US, the executors wanted to take stock of asset values at the alternate valuation date six months from the date of death before making any payments on account. As they were intent on applying for an extension of the due filing date for the 706 it was likely to be some time after the 9 month payment date before the payments made on account in the US were allocated.
In view of the savings provisions in the Treaty, Roland's UK executors were concerned that Treaty relief would be disregarded by the Revenue on their application for probate in the UK.
The savings clause can have a major impact as the circumstances of Roland's estate indicate. HMRC Inheritance Tax will continue to impose tax according to UK domestic law until evidence has been provided that the US tax has been paid (or a specific exemption or allowance has been accepted in the US ). For the deemed domiciled decedent such as Roland this would, in principle, mean a UK charge on the worldwide estate, leaving his executors to reclaim UK tax overpaid once the Treaty provisions could be enforced. In practice, the Revenue may, in these circumstances, be persuaded to limit the UK charge to UK situs property, but even so this could result in significant cash flow problems for the estate and funding issues for Roland's UK executors.
Tax during the Administration period
IHT may not be the only UK tax a decedent's executors should be worried about. They may, for example, have reporting obligations in relation to income received and capital gains realised during the administration period. Income and capital gains are taxed under separate regimes in the UK , and the rules for determining an estate's status for these (and the consequences of this) are different for each tax. An estate may be UK resident for one tax but not the other. If the estate is CGT resident, executors may, in certain circumstances, be liable to tax on gains realized outside the UK even if the proceeds of relevant sales or disposals are never remitted to the UK. The remittance rules do not apply to estates.
For the American who owns assets in both the US and the UK, integrated tax planning pre-death is key but, as will be obvious from the above, even with effective planning in place, practical problems e.g. of timing and cash flow may arise in an estate as a result of fundamental differences in the way the two countries' probate and tax compliance systems operate.
There are plenty of traps for the unwary and, with such estates, it will be essential for those on both sides of the Atlantic to keep a global perspective and to ensure that action taken in one country does not have unwelcome consequences in the other.