Weight of the world

International estates are not just complex from a legal point of view but can also become quite complicated from a tax perspective. In this article, I explore the differences in taxation between the UK and other EU countries where UK nationals are likely to own assets.

The UK inheritance tax (IHT) position is that when someone dies, their estate becomes a trust and IHT is due on the estate. Everyone has a nil-rate band (NRB) allowance of £325,000, which means that there is no IHT payable in the UK if the estate is less than this amount. Any amount in excess will be taxed at a rate of 40%. There are also other allowances that may apply, such as the spousal exemption, business property relief and agricultural property relief, and the main residence nil-rate band.

The concept of domicile plays an essential role in UK IHT, as it will determine if taxes will be paid only on the UK assets or on the overseas assets as well. In April 2017, deemed domicile provisions were introduced which affected those individuals that severed their ties with the UK. Prior to this point, after three consecutive tax years living outside the UK, an individual would be considered as having lost their UK domicile for IHT purposes. However, since April 2017, it will be necessary for an individual to spend more than five consecutive tax years outside the UK before they lose their domicile. 

This is a major issue for many Spanish nationals who lived in the UK for many years before deciding to relocate back to Spain, and die before the five-year rule ends. In this case, their beneficiaries, if they are Spanish tax residents, can find themselves in a situation where the entire estate should be declared in the UK (due to the deceased’s domicile) and in Spain because of the tax residency status of the beneficiaries. 

I am fortunate to work with colleagues who practise French, Italian and Spanish law, and to illustrate more clearly the taxation of an international estate, there follows a case study adapted to these three jurisdictions.

Spain 

Spain and the UK have no double taxation treaty for IHT. Contrary to the UK position, beneficiaries in Spain play an active role in the administration of an estate, as they are personally liable to pay IHT prior to the asset being transferred to them. Therefore, it is necessary to pay IHT at the time the asset is transferred to the beneficiary. 

From an IHT point of view, the authorities will be keen to know whether Mark is a tax resident. If Mark is a Spanish tax resident, then the entire estate will be subject to Spanish IHT. If he is not, then he will only have to declare the Spanish assets. James’ tax residency can play an important role if both he and Mark were Spanish tax residents, as this will determine the local tax legislation applicable.  

Spanish IHT can be paid either by personal obligation (if Mark is a tax resident in Spain) or real obligation (if assets are located in Spain). The rates of tax and allowances vary depending on the region involved. There is also the link between the deceased and the beneficiary: the more closely they are related, the higher the allowance. Mark will be classed as being in group III (nephews). James’ property is in Andalucía. 

If Mark is not a Spanish tax resident, we will have to look only at the location of the Spanish assets. The allowances for group III in Andalucía amount to €7,993.46.

In this case, we will only include the Spanish assets of €500,000, which will be increased by a 3% presumption of the value of the chattels (€15,000). Once the allowance is applied, the taxable amount will be €507,006.54. According to the tariff for Andalucía, €115,017.79 is due. However, because Mark is in group III, a multiplying coefficient of 1.5882 will be applicable, resulting in a taxable amount of €182,671.25. Mark will be able to claim the portion of UK IHT paid on the Spanish asset. 

If Mark was a tax resident in Spain, then he would have to file and pay Spanish IHT on all the estate. Therefore, the total estate would amount to €1,085,000, to which a 3% presumption would be added to determine the value of the chattels (€1,088,255) and once the small allowance is deducted, the taxable amount would be €1,080,261.54. Therefore, according to the applicable tariff, €310,454.81 would be due. 

However, since Mark is a Spanish tax resident, the multiplying coefficient will vary depending on his wealth. If Mark’s assets are less than €402,678.11, then the multiplying coefficient would be 1.5882 but if he owns assets of higher value, then the multiplying coefficient can increase to 1.6676, or 1.9059 if he owns assets in excess of €4m. 

Mark would be able to claim in Spain the tax paid in the UK for the UK property, but this can be a lengthy process. 

France 

To ascertain how James’ assets will be taxed in France on his death, we must consider the UK–France 1963 double tax treaty on IHT. Assuming that James was not considered under the French internal tax rules to have been tax-resident in France (in addition to being domiciled in England and Wales under the UK tax rules), then France will only be entitled to charge IHT on those of James’ assets that are deemed by the treaty to be ‘situated’ in France; in this instance, his French holiday home (and its contents). 

Under the treaty, bank accounts are deemed situated in the deceased’s country of tax domicile – England, in this case – meaning that France will not have the right to tax James’ French bank account. However, France will be entitled to tax James’ tangible moveable assets in France, including the contents of his holiday home and any car, boat or other vehicle he may own in France. The default position under the French tax rules is that the contents of a property are valued at 5% of the value of all the French assets, including any bank accounts in France (even if the bank accounts are not themselves taxable in France). 

If the contents of James’ holiday home are considered either to be very valuable or not to have much value at all, it may be worth having a formal inventory drawn up by a notary or auctioneer in France, so that the contents are then taxed based on their actual value instead of the default 5%, but bear in mind that this will entail an extra cost. 

In France, the IHT allowances and rates vary depending on the relationship of the beneficiary to the deceased, rather than IHT being an estate-based tax as it is in the UK. Under current French tax rules, a nephew has a tax-free allowance of €7,967 and must pay IHT at the rate of 55% on the value of anything he inherits above that. 

For example, if James’ holiday home is worth €450,000 and his bank account is worth €50,000, the contents of the property will be valued (under the default calculation) at €25,000 (so, 5% of €500,000), making total taxable assets in France of €475,000 (€450,000 + €25,000). After deduction of his tax-free allowance (€7,967), Mark will pay French IHT at the rate of 55% on the balance of €467,033, making total French IHT due of €256,868.

It may have been better French tax planning for James to leave his French assets to his sibling (Mark’s parent). Under such an arrangement, if said parent had predeceased James or disclaimed their legacy, and Mark had inherited in their stead (by représentation), Mark would have also inherited his parent’s more generous French tax-free allowance of €15,932, and more generous sliding scale tax rate of 35-45%, and therefore would have paid less French IHT when inheriting the French assets from James. This would have resulted in French IHT due of €204,138, and a non-negligible IHT saving of just over €50,000 for Mark. 

Say James dies domiciled in England and Wales, with a holiday home and a bank account in France and no surviving spouse or children. He leaves his estate to Mark, who is resident in France for French tax purposes. In this scenario, if Mark has been living in France for at least six of the 10 years preceding James’ death, then in principle – according to article 750 ter of the French Tax Code – all the assets that Mark inherits from James, whether situated in France or elsewhere, are subject to French IHT. However, the above-mentioned double tax treaty takes precedence over the internal tax rules of France and the UK, and article 5(2) of the treaty provides that where a person was at the time of their death domiciled in some part of Great Britain, duty (in other words, IHT) shall not be imposed in France on any property not situated in France. 

Consequently, even if Mark is tax-resident in France when James dies, France will only be entitled to charge IHT on those of James’ assets (inherited by Mark) that are deemed by the treaty to be ‘situated’ in France – as in the first scenario above. 

In both scenarios, if James dies while physically outside of France, a French IHT return must be submitted and the French IHT paid within 12 months of the end of the month in which he died, failing which late payment interest (currently 0.2% per month of delay) and a penalty (currently 10%) will apply. Note, however, that if James dies in France (irrespective of his tax residence or domicile), the French IHT return must be submitted and the French IHT paid within six months of the end of the month in which he died, failing which late payment interest (rate as above) will apply straight away, and a 10% penalty will apply from the first day of the 13th month after the month in which he died (that is, as from the same date as if James had died outside of France).

In practice and in both scenarios, IHT must be paid on the French property in both countries, but England and Wales will allocate a credit equal to the IHT imposed by France in relation to the French property (but not exceeding the UK IHT due in relation to the same asset). The exact amount of credit can sometimes be difficult to ascertain due to the different approaches taken by each country when calculating IHT.

Italy 

Given that James was domiciled in the UK, Mark will only have to declare James’ Italian assets in Italy and pay taxes on these assets only. He will therefore need to lodge a declaration of succession in which he should describe what the Italian assets inherited are and their values (the property value declared in this document will be its cadastral – its tax value, not its market value) and identifies the heirs so that the Italian Tax Authority (Agenzia delle Entrate) (ITA) can calculate the IHT due and who is liable to pay these.  

The taxes he must pay are: 3% of the cadastral value of the property (a property transfer tax, similar to stamp duty land tax in the UK), to be paid before the declaration of succession is lodged with the ITA; and 6% of the total value of the Italian assets inherited as IHT (the amount of which is calculated based on the relationship the heir has with the deceased, which in this case is 6% of the total value, as the heir is the nephew). The IHT will be calculated by the ITA and a demand will be sent to Mark requesting that these amounts are paid (usually within 60 days of the demand being received). 

As James was domiciled in the UK, Mark will have to pay IHT in the UK on both the UK and the Italian assets. However, he could take advantage of the UK–Italy 1968 double tax treaty relating to IHT payable in both countries, whereby James can ask HM Revenue & Customs for credit equal to the amount of tax paid in Italy on the Italian assets (in this case, 6% of the value of the Italian assets). He must submit this request within five years of James’ death. 

If Mark is resident in Italy, the same applies in terms of IHT, as what must be declared in Italy depends on where the deceased was resident and not where the heirs are resident. 

If Mark receives any income from the assets inherited, for example, from any shares from the UK investments, he must declare this income in Italy and pay taxes on the same. He must also declare the English property and the Italian property he inherited in his annual IHT returns. 

In both cases, unless he plans to make his uncle’s property in Italy his main residence, he will have to pay Italian municipal property tax every year.

The declaration of succession must be lodged within one year of James’ death, otherwise penalties will incur on the taxes due until it is lodged.

Conclusion

International estates can be complicated not just from a legal point of view but also from a tax angle, so getting the right advice is crucial from the outset to manage client expectations and avoid unnecessary issues with clients.