How using an excluded property trust could reduce your IHT liability

15/11/2022

Trusts are a popular financial instrument when it comes to financial planning and managing you and your family’s financial future.

One particular style of trust that has commonly been used by non-doms based in Hong Kong who are moving to the UK as well as non-doms already UK resident, is an excluded property trust (EPT) arrangement.

Changes to UK financial legislation in 2017 meant that EPTs became less effective for some individuals. However, over the past year or so we’ve had many conversations with clients whose particular circumstances mean that an EPT is still an appropriate option to mitigate against future potential Inheritance Tax (IHT) liability in the UK.

Read on to find out more about EPTs, the 2017 legislation, and how it still may be possible for you to use an EPT to mitigate future IHT liability on the value of your estate.

EPTs were commonly used by UK expats planning to return home

If you are non-UK domiciled with assets outside the UK, IHT will not be charged on those assets in the event of your death. But if at some stage you do become UK-domiciled, then all your worldwide assets will become subject to IHT.

Excluded property trusts were for a long time very useful for people who were non-UK domiciled, but who believed at some stage that they could revert to UK domicile status or attain that status for the first time.

Such a trust allows you to effectively “ring fence” your non-UK assets so that, on return to the UK and potentially reverting to a UK domicile of origin, their value would sit outside your estate for IHT purposes.

As I’m sure you’ll appreciate, EPTs became highly popular with returning expats. However, changes to the taxation of non-doms by the UK government in 2017 have had a substantial impact on the utility of such trusts.

The 2017 Finance Act reduced the effectiveness of EPTs

The 2017 Finance Act, which came into force in April of that year, included new criteria that determined whether someone had non-dom status.

The legislation added a whole new category of deemed domicile called “formerly domiciled resident” (FDR), which reduced the effectiveness of EPTs.

An FDR is defined as someone born in the UK, but then subsequently became domiciled elsewhere, such as in Hong Kong, by acquiring a domicile of choice.

You’re a formerly domiciled resident if you:

  • Are born in the UK with a UK domicile of origin
  • Have acquired a non-UK domicile of choice
  • Are then resident in the UK and were resident in the UK in at least 1 of the 2 previous tax years.

The effect of the legislation is that, if you’re an FDR and return to the UK from Hong Kong for anything more than a short period, any EPT you have set up will no longer be valid, and any assets you hold outside the UK (including within such a trust arrangement) will be considered as part of your estate for IHT purposes.

EPTs can still offer a tax-planning opportunity

However, if either you or your spouse has never been UK-domiciled or were not born in the UK, there is still an opportunity to use an EPT to create an advantageous tax position for you both.

The 2017 Act affects anyone who has been UK-domiciled at some time – but assets held by non-UK residents aren’t affected when moving to the UK.

You are then able to put those assets in trust and, on moving to the UK, the value of those assets will sit outside your estate for IHT purposes, with a potentially substantial tax saving for your beneficiaries.

Careful allocation of your assets, and effective use of an EPT, could substantially reduce your potential IHT liability if you return to the UK for an extended period.

There are two potential issues to be aware of:

  • Assets should not be gifted to the non-UK domiciled spouse who then benefits from them, as this would contravene HMRC “gift with reservation of benefit” (GROB) rules.
  • This planning arrangement does not work for non-doms who previously had a UK domicile of origin, who were born in the UK, and who became a UK tax resident.

It could be an ideal time to review your IHT planning

The changes to non-dom taxation as a result of the 2017 Act make it imperative for you to review your trust and inheritance planning arrangements.

You may well have trust arrangements in place that will no longer do the job they were set up to do. In these circumstances the best approach could well be to unwind all your arrangements and start again.

You should also review your arrangements if either you or your spouse are Hong Kong domiciled, born in Hong Kong, and planning to move to the UK to live. In those circumstances you may well be able to use an EPT for tax planning purposes.

Get in touch

If you want to review your IHT and other tax planning arrangements, then please get in touch.

You can contact us by email or, if you prefer to speak to us, you can reach us in the UK on +44 (0) 208 0044900 or in Hong Kong on +852 39039004.

Please note

The Financial Conduct Authority does not regulate estate planning, tax planning or will writing.

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