A place in the sun

As the days start to lengthen, thoughts turn to summer and holidays in warmer climes. For some, this will mean buying a holiday home abroad.

Individuals buy property abroad with the intention of enjoying it during their lifetime, and what will happen when they die is likely to be far from their minds. However, those buying second homes overseas should consider succession questions at the time of purchase, and ensure that they understand the legal and tax implications of death, so that, when they die, their estate passes as they wish, and there are no unforeseen tax consequences.

Cross-border estates are complex by their very nature, and while the purchase of a single property may seem straightforward, issues such as domicile and residence, and whether any matrimonial regimes apply, should be considered, in addition to the legal and taxation regimes of all the jurisdictions involved. If the holiday home becomes a permanent one, then further advice should be sought.

Which law applies?

In England, private international law (PIL) provides that immoveable assets, such as real estate, are on death automatically subject to the succession law of the country in which they are situated. This is known as renvoi (literally ‘sent back’ in French). Movable assets, such as bank accounts, pass under the law of the individual’s domicile. This is known as a ‘schismatic’ system.

Other countries such as Denmark and Brazil have ‘unity’ systems, where the whole estate must be dealt with under one law, and if immoveable property is owned in such a country by a foreign national, the renvoi will be rejected and the whole estate governed by the law of the domicile of the foreign national.

The advent of the EU Succession Regulation (commonly known as Brussels IV), which became law in August 2015, has changed the rules on succession matters insofar as most EU states are concerned, and effectively put an end to renvoi for most successions involving EU member states.

All EU member states, with the exception of the UK, Ireland and Denmark, have adopted Brussels IV, which means that if an individual owns property in any of the participating member states, then the law of their habitual residence will apply to the whole of their succession, unless they elect for the law of their nationality to apply. So, a British national with a property in Spain can elect in their will for English law to apply to it. There are several advantages in having English law applying, such as the avoidance of forced heirship.

If an individual from a ‘third state’ (that is, a non-member state) does not elect for their national law to apply to their succession, then Brussels IV does not abolish renvoi where a third state refers back to the law of a member state. So, for example, if a US citizen with a house in France did not elect for their national law (the relevant national law being that of the part of the US they reside in, for example, California law) to apply, then French law would apply to the French property.

Article 34 of Brussels IV states that there is no possibility of renvoi between member states. There has been a lack of clarity about whether the UK is a member state or a third state, but Brexit has made this clearer: if no election is made, then, after Brexit, PIL will apply, and renvoi means the holiday home in the example above will fall to be administered under Spanish law. In any event, even before Brexit, as the UK has not adopted Brussels IV, it is unlikely that an English court would enforce the use of a single law to administer the whole estate, and so where there is no election, it is likely PIL will apply.

Domicile or residence

While the ability to elect for the law of one’s nationality to apply is reasonably straightforward – and those with dual nationalities can choose whichever they prefer – ‘habitual residence’ as a concept can be more difficult to establish.

The term is not clearly defined in Brussels IV and, as the recent case of Hallyday (first instance court of Nanterre, 28 May 2019, concerning the estate of the French-born singer) has shown, where individuals spend time moving between different homes (as elderly retired couples with homes in more than one country may do), establishing habitual residence may not be straightforward; habitual residence may not be the same as the individual’s tax residence or their domicile.

If an individual dies in an EU country that has adopted Brussels IV, and has not made an election for their national law to apply to their estate, then a dispute may arise if different potential beneficiaries want different outcomes. Hallyday is an ongoing dispute between the singer’s wife, who claims he was habitually resident in California, and his children from previous relationships, who claim that he was habitually resident in France – and that therefore French succession law, and forced heirship, should apply.

Residence and domicile are distinct concepts, and while residence may be important in order to establish the applicable law in certain cases (as above), domicile must be ascertained in order to understand the tax position on death.

Where a married couple who own a property as joint tenants are considering what will happen to the property on death, it is often the second death they need to consider

If a client is domiciled in England and Wales, or in another UK jurisdiction, then, on death, their worldwide estate will be subject to UK inheritance tax (IHT). If they are not domiciled in a UK jurisdiction, then only their estate in the UK will be subject to IHT (and this may be subject to double taxation treaties).

Domicile is a complicated concept, and means different things in different jurisdictions, but under English law, it is broadly where the individual considers their permanent home to be.

Under English law, at birth, an individual’s domicile follows that of their father if the parents are married, and their mother if they are not. Changing domicile is a complicated process, and to lose an English / Welsh domicile of origin requires an individual to show that they have severed ties with their home country and made a permanent home abroad.

For those living in the UK, whether or not their legal domicile is still their country of origin, they will be deemed domiciled in the UK for all tax purposes once they have lived here for 15 of the last 20 tax years.

Many couples who buy holiday homes abroad have different nationalities, and the second home is often in one spouse’s home country. If the spouses have different domiciles, or if one of them reverts to their domicile of origin following the purchase of the home abroad, it is important to be aware of the IHT consequences.

In the UK, transfers between spouses, including on death, are usually free of IHT (section 18 of the Inheritance Tax Act 1984 (IHTA 1984)). However, there is an exception: where the deceased died domiciled (or deemed-domiciled) in the UK, and their spouse is not UK-domiciled (or deemed-domiciled), the spouse exemption is limited to the amount of the nil-rate band (NRB), currently £325,000 (in addition to the NRB, if available). This means that a UK-domiciled individual can leave up to £650,000 to their non-domiciled spouse before any tax is payable (assuming they have not used up the NRB with lifetime gifts). Where both spouses are non-UK-domiciled, and also on the transfer of assets on death from a non-UK-domiciled spouse to a surviving UK spouse, there is no limit to the spouse exemption.

It is possible, however, for a non-UK-domiciled spouse to elect to be treated as UK-domiciled. This election can be made during the lifetime of their UK-domiciled spouse, or after the spouse’s death. Such an election is not revocable, although it can be lost if the surviving spouse moves abroad and gains a new domicile in the future, for example.

It is possible for a deceased’s personal representatives to make an election for the deceased to be treated as UK-domiciled within two years of that person’s death. This will allow their spouse to claim the full spousal exemption.

What will pass under the will?

When embarking on succession planning, it is important to establish whether property will form part of the estate on death. In common law jurisdictions such as England and Wales, it is possible to own a property as joint tenants. What this means is that, on death, the property passes by survivorship to the joint owner and not under the will of the deceased (although it will still be subject to IHT). Where a married couple who own a property as joint tenants are considering what will happen to the property on death, it is often the second death they need to consider, as the property will pass under the will at that point. (Couples do, of course, have the option of owning a property as tenants in common, meaning that they each own a defined share in the property, which they can leave by their will.)

While joint ownership is generally not a concept in civil law jurisdictions, the ‘tontine’ method of ownership provides a similar solution in some civil law countries, such as France and Belgium. Owning a property en tontine is not exactly the same as owning it as joint tenants, as the rights are contractual. However, it is a way of avoiding the forced heirship rights of children, in that ownership passes to the other owner on the first death.

Most civil law jurisdictions have matrimonial regimes, and when a couple marries, they may enter into a community of property regime. This will differ from country to country. In some jurisdictions, the community of property will apply to all the couple’s assets; in others, it will only apply to assets acquired post-marriage. The matrimonial domicile may not be the same as the current domicile of either spouse.

Civil law countries often treat English nationals as having individual ownership (separation de biens), so that the community of property will not apply, but this should be discussed when the property is purchased.

Tax

Although it is now possible to choose English law to apply to succession concerning property in mainland Europe, local taxes will still apply.

In the UK, it is the estate which is subject to IHT and, unless the spousal or charity exemption applies, the degree of closeness of relationship between the beneficiary and the deceased does not make any difference to the tax position.

In most civil law jurisdictions, on the other hand, it is the beneficiaries, and not the estate, who pay IHT. Each category of beneficiary, such as spouse, child or non-relative, will pay tax at a specific rate, subject to an allowance. For example, in Italy, both children and spouses pay IHT at 4%, subject to an allowance of €1m. In Germany, beneficiaries will pay tax at a rate of anything between 7% and 50%, subject to an allowance and depending on their relationship with the deceased, and the amount gifted.

If the entire estate is left to the surviving spouse, as is typical under an English will, with the children only inheriting on the second death, then the children’s allowances may be lost on the death of the first of their parents.

Double taxation treaties

Where assets in the estate are subject to tax both in the UK and abroad, double taxation treaties may provide relief. Even where no treaties apply, the UK will usually give credit for the tax charged by another country.

Trusts

The tax position can be particularly onerous in relation to trusts. English wills often refer to trusts; care must be taken here, as many civil law jurisdictions do not recognise them or, if they do, may tax them heavily.

The 1985 Hague Convention on the Law Applicable to Trusts has been ratified by 14 countries, including Italy and Switzerland. France signed the convention but has never ratified it. In 2011, it introduced a measure whereby foreign trusts can now be taxed in France. This means that if there is a trust in an English will covering property in France, then it will be subject to French ‘droit de succession’ (the equivalent of IHT). In France, however, there is no IHT payable between spouses, and there are generous allowances for other close relatives, such as children. Trusts, however, are treated as non-relatives, and may be taxed at the highest rates – for a discretionary trust, this can be as high as 60%.

If the country where the assets are situated does not recognise the existence of a trust, then there can be many adverse consequences for the trustees. For example, the trustees may be treated as the beneficial owners of the property, and taxed accordingly. They may also be treated as personally liable for debts and charges on assets.

On the death of a trustee, the forced heirship rules of the country in question may be deemed to apply as though the trustees owned the assets personally, giving their own family a right to claim a share of the assets.

While the use of a usufruct is common in many civil law jurisdictions, such as France, it can cause tax traps for unwary Britons domiciled in the UK

Even in countries that have ratified the Hague Convention, there can be a conflict between the tax authorities – which may treat trustees as beneficial owners and wish to tax them accordingly – and the trustees themselves, and their legal advisers – who will argue that the trustees should not be personally liable for tax, as they have not been personally enriched by the trust assets. This has been the case in Italy, where the Supreme Court recently considered the point (see Italian Supreme Court decisions 15451, 15453, 15455 and 15456, 7 June 2019) and appeared to back the notaries’ view by ruling that an Italian gift trust does not apply to the transfer of a property to trust, as the gift is at that time not yet complete.

A usufruct is the closest structure to a trust in civil law jurisdictions. The ‘bare ownership’ of the property is held by one person with the title to property, subject to a right of another person to use the property for life or a set period and receive the income from it. While the use of a usufruct is common in many civil law jurisdictions, such as France, and can be a good solution for elderly individuals domiciled there, it can cause tax traps for unwary Britons domiciled in the UK.

A usufruct is usually considered to be an interest in possession trust by HM Revenue & Customs (HMRC) for IHT purposes (see HMRC’s trusts and estates newsletter, April 2013), which means the property will be relevant property and subject to a 20% charge to IHT when property enters the trust, and 10-year anniversary charges and exit charges when property leaves the trust.

For capital gains tax (CGT) purposes, however, HMRC does not treat a usufruct as a settlement. As paragraph 31305 of HMRC’s CGT manual says, “a usufruct governed by French law would be regarded as a non-trust arrangement as it is broadly similar to a Scottish proper life rent”. This means the value of the property on the death of the usufructer will not get the free uplift under section 62 of the Taxation of Chargeable Gains Act 1992.

While an elderly French couple can enter into a usufruct and continue to live in the property, this is not possible for those domiciled in the UK. The transfer can fall foul of the reservation of benefit rules and will be subject to IHT on death (section 102 of the Finance Act 1986).

One will or two?

A big question is whether individuals with assets in more than one country should have separate wills in each jurisdiction, or one will covering their worldwide assets.

It is often a good idea to have wills in each jurisdiction where assets are held. This can avoid practical problems, such as having to obtain probate in one jurisdiction before applying in another, and means that it will not be necessary to obtain notarised translations of wills and affidavits of law. Another advantage is that, given the problems that can arise when the word ‘trust’ arises in an English will, it can avoid the use of the word so that none of the problems I discuss above arise.

There can also be a problem with executors and trustees. Many jurisdictions do not recognise executors, so if the property vests in the executors IHT may arise on the transfer of the property to the executors and then ‘gift tax’ may arise on the transfer from the executors to the beneficiaries.

However, it is important that when more than one will is made, the second will is carefully worded so that it does not revoke the first. It is also important to ensure that all of the testator’s estate is dealt with in the wills. At least one of the wills should apply to the worldwide estate, except the country where the holiday home is situated. Otherwise, a partial intestacy may arise.

Conclusion

A home abroad is a dream for many, but there are many traps for the unwary to be alert to. Advice should be taken on purchase of the property, and should be reviewed regularly, especially if the client’s circumstances change.

Angharad Lynn is a senior associate at VWV.