The application of Australian Capital Gains Tax (CGT) and UK Inheritance Tax (IHT) can lead to an aggregate tax rate of 87% following the death of a loved one. Such a high tax rate should cause with clients who have lived in both jurisdictions to obtain specialist advice before they die to implement effective tax planning.
The UK charges IHT at 40% on estates that are above the lifetime nil rate band of £325,000. Other reliefs such as the main residence nil rate band (which is £100,000 from 6 April 2017 to 5 April 2018 for estates valued at £2 million or less), business and agricultural property reliefs may also apply. Furthermore transfers between married couples are exempt from UK IHT where both spouses have the same domicile for UK tax purposes.
UK IHT is levied on the basis of whether a person is UK domiciled for UK IHT purposes. UK domiciled persons pay UK IHT on their worldwide assets. Those persons not domiciled in the UK on their death, are only assessed to UK IHT on assets situated in the UK, but assets elsewhere in the world will not be subject to UK IHT.
‘Domicile’ is a term used to describe the country in which a person has their permanent home. Determining domicile can be complex and the tax law definition of domicile is different in the UK to that in Australia.
Broadly speaking, an individual will be UK domiciled if:
- Their parents were British;
- They were born and raised in the UK until at least age 16; and
- They still retain a permanent home in the UK or an intention to return to the UK as their long term home, or have not established a domicile of choice in another country.
Historically the UK IHT law stated that a person was ‘deemed domiciled’ in the UK for UK IHT purposes, if they were a UK tax resident for 17 out of the last 20 tax years. From 6 April 2017, an individual will be ‘deemed domiciled’ in the UK, after they have been a UK tax resident for 15 out of the last 20 tax years (subject to the passage of Finance Bill 2017). Therefore, if a person was born in Australia, but they have been a UK tax resident for 15 years or more, they may shortly become UK domiciled for UK IHT purposes. Individuals, who ceased to be UK tax residents prior to 6 April 2017, are not affected by the new 15 out of 20 years rule.
The UK government intends to change the law for individuals who were born in the UK with a UK domicile; so that where the individual is a UK tax resident for the current tax year and at least one of the two preceding tax years, they will be deemed to be UK domiciled.
Under UK tax law, an individual can change their domicile by moving to another country, but the onus is on the party concerned to prove that there has been a change in domicile status which in practice may be difficult to substantiate.
The CGT base cost of assets for the estate and the beneficiaries will be the market value of the asset at death. Therefore for a UK only estate with no Australian aspects, UK IHT is payable on the value of the worldwide estate on death and any increase in the market value of the asset from the date of death until the disposal is subject to UK CGT.
There is no IHT in Australia, but this does not mean that there are no tax implications of death. Australian CGT can apply on death.
The beneficiary inherits the deceased individual’s CGT cost base for asset acquired by the deceased after 19 September 1985 (the date of commencement of Australian CGT law). Therefore if an asset is sold by an Australian estate with no UK aspects, Australian CGT is payable on the difference between the deceased’s cost base and the sale price, assuming that the asset was purchased after 19 September 1985 by the deceased. Assets acquired by the deceased prior to 20 September 1985 are CGT free until the date of the deceased’s death; in this case the asset’s cost base is its market value on date of death. No CGT will be payable, where the asset was the deceased’s main residence and the property is sold within two years of death, but many taxpayers are unaware of this rule.
Complications when both UK IHT and Australian CGT Apply
There is no provision for UK IHT to be offset against Australian CGT under the UK/Australian Double Tax Agreement (or vice versa). The withdrawn Australian Taxation Office ID 2005/40 confirmed this position.
The consequence is that complications arise in the following scenarios involving UK IHT and Australian CGT on death:
- Where the deceased is UK domiciled and UK tax resident, but dies holding Taxable Australian Real Property (TARP), UK IHT will be payable at 40% (subject to reliefs). If the asset is sold Australian CGT will also be payable, on the difference between the cost to the deceased and the sale price. If tax is payable in Australia at the top marginal rate this will be 47% (excluding Medicare Levy – which does not apply if the beneficiary is not an Australian tax resident). The 50% CGT discount was abolished for those who are not Australian tax residents from 8 May 2012. This results in an effective tax rate of 87% (i.e. 40% UK IHT plus 47% Australian CGT) on the inherited asset.
- Where the deceased dies domiciled and tax resident in Australia for (Australian and UK tax purposes) and holding CGT assets situated in the UK. UK IHT will be payable at 40% (subject to reliefs) on the UK situated assets. If the assets are sold Australian CGT will also be payable, on the difference between the cost to the deceased and the sale price. E.g. an Australian tax resident beneficiary who is not a UK tax resident, earns over $180,000 AUD pa, CGT will be payable on the gain at 24.5% assuming that the 50% CGT discount applies (49% x 50%). If the cost base of the asset is low, this results in an effective tax rate of 64.5% (i.e. 40% UK IHT plus 24.5% Australian CGT) on the inherited asset.
- Where the deceased dies as a tax resident in Australia for Australian tax purposes, but is UK domiciled for UK IHT purposes, UK IHT will be payable at 40% (subject to reliefs). If the assets are sold by the estate, Australian CGT will also be payable, on the difference between the cost to the deceased and the sale price. I.e. 40% UK IHT plus 24.5% Australian CGT on the inherited asset (assuming that the 50% discount applies).
- Where an Australian tax resident beneficiary inherits assets from a UK estate that paid UK IHT at 40%, and later sells the asset, an effective tax rate of 64.5% is payable (i.e. 40% UK IHT plus 24.5% Australian CGT) on the inherited asset, assuming that the 50% Australian CGT discount applies.