Clients may not realise how complicated it can be to buy or inherit a property abroad. Jo Summers looks at the issues involved and the impact of the new EU regulation on succession
It’s becoming more and more common for UK clients to own property abroad. In some cases, they may have inherited the property from an overseas relative. In other cases, they’ve decided to buy a holiday home outside the UK.
This article looks at some of the pitfalls of foreign property ownership, including the recent European regulation known as Brussels IV.
Inheriting property abroad
It may sound like a dream come true, to inherit a property in another country. But tax can be a big headache, as can the foreign country’s succession laws. Most continental European countries have fixed succession rules, which determine who inherits what, and these rules may still apply even where the deceased had a valid will.
This could mean the foreign property inheritance is split between multiple family members, making it hard for anyone to sell or rent out the property. Local advice should be obtained before anyone ‘buys out’ the other heirs, in case there are any taxes or stamp duties to pay on the transfer.
Problems can also arise if the jurisdiction where the property is located does not recognise the UK concepts of ‘estate’ and ‘personal representatives’ (executors if there’s a will, or administrators if there’s no will). The heirs may inherit the assets directly from the deceased.
You may therefore find that the heirs have to appoint a local lawyer, under a power of attorney, to deal with the transfer of the foreign property. The heirs also need to get local advice before they do anything to accept the foreign inheritance. In many countries, the heirs inherit not only the assets, but also the debts of the deceased, as well as the liability to pay any taxes due.
I once handled a case where the client’s mother was of German origin. She died in the UK, but still had a home in Germany at the time of her death. My client went to Germany to make arrangements to transfer the property into his name. While he was doing so, he received a letter telling him that his mother hadn’t paid all the German equivalent of council tax due, and there was a small debt owed. Without seeking legal advice, my client paid his late mother’s bill, assuming this was a debt of her estate. As soon as he’d done so, he received another letter, this time from the German tax authorities. They told him his mother hadn’t paid income tax for a period of years, and there was a significant tax liability.
When my client pointed out that the tax bill was potentially larger than the value of the German property, the reply was that it didn’t matter. Because he was her heir, he was personally liable to pay his late mother’s debts. It was only at this point that the client sought local advice. He learned that it would have been possible to disclaim his inheritance, so he wasn’t liable for the debts. However, as soon as he’d taken steps to put the foreign property into his name, he’d accepted the inheritance, including the debts.
Where a client is due to inherit a property in another country, it’s vital to obtain local legal and tax advice before they do anything.
Buying overseas property
The same issues apply to anyone who is planning to buy a foreign property in their lifetimes, whether as an investment or as a holiday home. Unfortunately, it isn’t unheard of for clients to go on holiday and come back having bought a property that they fell in love with, without taking any prior advice.
Assuming the client is UK-resident and -domiciled, UK taxes will apply to that foreign property, even though it is situated outside the UK. So any rental income will be taxed here, UK gains tax will be due if the property is sold at a profit, and UK inheritance tax (IHT) will be due if the client still owns the property when they die.
However, there may also be a liability to foreign tax on the same property. Usually, any risk of double taxation is eliminated, either by the terms of an appropriate tax treaty, or by the UK authorities giving unilateral credit to take into account the foreign tax paid. However, there can still be tax problems in some cases. The biggest area of concern is often when spouses pass a foreign property to each other, either during their lifetimes or on death.
Spouse exemption issues
Most clients will be aware that, in the UK, assets passing between spouses (and registered civil partners) are exempt from IHT. This is the case both for lifetime gifts and for assets passing on death. However, many clients may be unaware that an unlimited spouse exemption is not always available in other countries (and indeed, it can also be limited in value in the UK, in specific circumstances).
Many countries only apply their spouse exemption to local residents, or to people who were citizens of that country when they died. The US, for instance, has a ‘marital deduction’, which is just like the UK’s spouse exemption. But it doesn’t apply where the spouse who died was a US citizen and the one who is receiving the property is not.
Similar issues arise in Spain, where the spouse exemption depends on residence in Spain. This could have an impact on standard UK will planning. Say a UK client leaves his UK and Spanish home to his widow (who is his second wife), but all the other assets to his children (by his first marriage). Because of the UK’s spouse exemption, there will be no IHT due in the UK on either the UK home or the Spanish property. But that may not be the case in Spain, where there may only be a limited spouse exemption, or perhaps none at all. And if Spanish tax is payable on the Spanish property, there is no IHT due in the UK on that asset, so there is nothing to set the Spanish tax against as a credit. Also, if the will provides for foreign tax to be paid from the residue before the children inherit, then the children will suffer the burden of paying the tax due on the Spanish property, even though they do not inherit it. Particularly with second marriages, that can obviously be a cause of dispute.
Joint ownership problems
There are other, non-tax-related, pitfalls to watch out for when buying a property in another country. For example, we’re used to the concept of joint ownership. When clients buy a property jointly, it’s common practice to explain the differences between joint tenancy and tenancy-in-common. And we know that if the clients don’t say otherwise, they’ll hold the property as joint tenants, so the survivor of them will automatically inherit the property.
But this may not be the case in the country where the clients are buying their new property. In France, for instance, the standard joint ownership, which applies automatically, is equivalent to our tenancy-in-common. This means each owner has a divisible share of the property, which his or her heirs will automatically inherit upon death (rather than passing to the survivor). It is possible to have the equivalent of joint tenancy, by way of a ‘tontine’ contract, but this has to be put in place at the time of purchase. Alternatively, married owners can elect the ‘community of goods’ marital regime to ensure the survivor of them inherits. Sadly, notaries dealing with property transfers rarely mention these options, because the notary’s role doesn’t include giving structuring advice. This means clients also need separate legal advice, which adds to the cost of buying the property.
Do clients need foreign wills?
If clients have overseas property, do they need to have a local will to set out who inherits? Or will an English will be valid in the country where the property is located?
Many countries apply their laws and taxes to all real estate in their jurisdiction, but apply the law of the testator’s domicile (or residence, nationality or citizenship) to any moveable assets. As a result, different succession laws may apply to the house than to its contents. The rules will also differ depending on how the local property is held. The client may have been advised to hold the property via a company. In this instance, the client will own moveable assets (the company shares), which are normally governed by the law of domicile or nationality. Indeed, owning property via a company may be a solution if the client doesn’t like the local succession laws that would otherwise apply to the real estate.
There are local variances, however. French law will apply to any French property, even if owned by UK nationals, but in Italy and Switzerland, the law of the owner’s nationality will apply. This means an English law will can specify who inherits the Italian or Swiss property owned by an English national.
It may sound like a dream come true, to inherit a property in another country. But tax can be a big headache, as can the foreign country’s succession laws. Most of the continental European countries have fixed succession rules
These differences in succession laws have been a cause for concern within the EU for many years. It is clearly a barrier to the free movement of goods / persons if probate (or the local equivalent) has to be obtained in every EU member state where the deceased had assets. Most families will need expensive legal advice if any foreign element applies, to navigate the minefield of different succession laws.
After years of discussion, on 4 July 2012, the EU adopted a new law (EU Regulation 650/2012) introducing EU certificates of succession. Known as Brussels IV, the regulation allows the deceased’s heirs to obtain a certificate of succession in one EU member state, stating which law applies and who inherits. The idea is that this certificate is then accepted in all the other EU member states where the deceased had assets.
This means the regulation also had to introduce a system for determining which law applies to each succession. The default position is that the succession laws of the jurisdiction where the deceased was habitually resident will apply, unless there is another jurisdiction to which the deceased was more closely connected (for instance, if the deceased had only just moved countries).
However, the deceased can elect instead for the laws of their nationality to apply. This election must be in a will or equivalent document.
These new rules came into effect on 17 August 2015. The big problem (or advantage, depending on your point of view) is that the new rules do not apply at all in the UK, Ireland or Denmark, although the UK and Ireland retain the right to opt in later.
Even though the UK hasn’t opted in, Brussels IV can still be useful for clients with assets in the EU. The succession law that applies (either due to an election, or under the habitual residence default provisions) does not itself need to be the law of a participating member state. This means that an English national client who has assets in, say, France and Germany, could elect for the laws of England to apply to the French and German successions.
English clients living in another EU member state (except Ireland or Denmark) can also make use of these new rules. So, an English national living in France could elect for English law to apply (which has freedom of disposition), rather than the laws of France (where the individual is habitually resident and which has forced succession rules).
Potential pitfalls of the regulation
However, as with any new rule, there are some uncertainties and potential pitfalls.
Importantly, Brussels IV doesn’t override matrimonial regimes, so if a couple holds assets in a country under a ‘community of goods’ regime, this could override any succession election (on the basis that the assets pass automatically to the survivor – in the same way as under a joint tenancy in England – so never form part of the deceased’s estate in the first place).
Similarly, Brussels IV doesn’t apply to issues such as joint ownership of property, divorce or trusts.
Finally, Brussels IV doesn’t deal completely with the question of ‘renvoi’. This term (from the French for ‘send back’) refers to the conflicts of laws system for determining which laws apply where the laws of more than one jurisdiction could be relevant.
Take this example from a case I am currently working on. The deceased was UK-resident when he died, but we determined that he was still domiciled in France at the date of his death. Under English succession laws, we apply English law to his real estate here, but the laws of his domicile (France) to his moveable assets.
However, the advice from the French notary was that they no longer considered the deceased to be French-domiciled (as they define the term), as he was long-term resident in the UK when he died. In England, we had referred the succession of the movables back to France, but the French were expecting English law to apply to the whole estate. So the English had sent the case back to France and the question was whether the French would accept that renvoi.
A recent decision of the French courts has determined that the French will accept the renvoi in these circumstances, so French law applies (even though under French domestic succession laws that was not the expected result).
Brussels IV has not abolished the concept of renvoi (despite this being in earlier drafts of the regulation). Renvoi is still permitted where the following conditions are all met.
- The law of succession is determined by habitual residence (no election has been made for the laws of nationality to apply).
- The jurisdiction where the deceased was habitually resident is a third-party state (such as the UK, which is not a Brussels IV state).
- The private international law of that third state would make a renvoi to a state that has implemented Brussels IV.
So even after Brussels IV, the English system is to send the succession of the movables back to France, being the country of domicile, and French succession laws will then apply. Brussels IV doesn’t prevent this renvoi, as the UK is a third-party state (and France is a participating state).
The message is clear and simple. Even since the introduction of Brussels IV, clients should get advice before buying or inheriting any property outside the UK.