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Property: The long arm of the UK taxman

Created:
1 December 2006

The UK taxman has a long arm when it comes to reaching after UK taxpayers who think they've escaped his clutches by settling down to a new life abroad. And now, following a recent court ruling, he can reach even further.

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So, while you can buy a house anywhere in the world, there are only two ways to avoid paying hefty amounts of tax in the UK. The first is to make sure you are non-resident - a status that's easy enough to achieve - which means that you won't have to pay UK income tax on assets and income owned and earned outside the UK. The second is to make yourself non-domiciled - which is much harder to achieve if you were born in the UK - but, if you can manage it, you will not have to pay UK income tax, capital gains tax or inheritance tax (IHT).

non-resident

The rules relating to non-residency are clear: to attain non-resident status you must not spend more than 90 days a year in the UK. Until the recent court case, claimants of non-resident status understood that the days spent travelling to and from the UK did not count. You could fly in to London from your house in Spain or Italy on Monday then fly out on Tuesday safe in the knowledge that both days of travel were discounted from the 90-day total. But now, even a flying visit for a precious grandchild's birthday will count towards your 90 days. If you breach your 90-day limit, you will be liable for UK income tax on your worldwide income and gains and you will have to include details of all earnings and gains on your tax return. If you already pay a local income tax, and the country has a reciprocal tax agreement with the UK, then HM Revenue & Customs (HMRC) will only require you to make up the difference if the amount is lower, although you will not receive a refund if you pay a higher rate.

non-domiciled

Non-domiciled status is harder to achieve, but it is well worth doing if you have truly settled down outside the UK. That's because the UK tax authorities say that if you are UK-domiciled - that is, your roots are in the UK - your estate is liable for IHT, no matter where you are living.

Domicile is something you acquire at birth, though, so you need to be pretty active about shaking it off. But if you can be regarded by the tax office as non-domiciled, then your estate will not be taxed at 40 per cent after your death. And, depending on where you have made your new home, you might be able to avoid inheritance tax altogether. However, if you move to a country that does not have IHT - such as Italy - then, when you die, the UK taxman will insist that your estate coughs up the full 40 per cent on all your assets.

John Howell, senior partner at the International Law Partnership in London, says if you spend more than 180 days a year in your country, then you will certainly be considered as a tax resident there by the country's authorities and its tax rules will apply. That's the first step towards becoming non-domiciled.

The next step, says Mr Howells, is to sever all ties with the UK. "You must be able to show that you have nothing more to do with the UK, although you can visit for short breaks," he says. "You cannot own property there or have a bank account. Even after you have done this, you will be considered to be domiciled in the UK for the first three years after you have left." Your funeral must also be held abroad.

Plenty of people do choose to become non-domiciled, though, because of the much lighter tax burden that exists in other countries.

Most European countries operate a true inheritance system of tax, in that the inheritors pay tax, not the deceased's estate, which is the case in the UK. This means that the rate you pay in places such as Belgium and Spain depends on your relationship to the person who has died. In the UK, on the other hand, tax is deducted at a flat rate of 40 per cent, no matter who inherits (with the exception of a spouse).

Germany also allows tax-free inheritance for spouses and, unlike in the UK, for children, too.

Italy, Jersey, the Isle of Man and Luxembourg are even more generous: there is no inheritance tax or gift tax to pay in these countries.

In the Netherlands, depending on whom you're planning to leave everything to, the rate can be as low as 5 per cent, while in Belgium, you can give assets away and the recipients, again depending who they are, might only pay 3 per cent tax.

Although Spain has one of the highest rates of IHT - at more than 80 per cent - the Spanish tax is, in fact, levied at different rates depending on your relationship to the person who died, and your wealth. Large chunks of the estate can be exempted and the rate can be as low as just 8.5 per cent. Essentially, the closer your kinship, the lower the rate. So, if you're poor or only moderately well off, you pay a lower rate of IHT.

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