UK IHT Desk

Inheritance Tax & Probate

Cross-Border

Cross-Border Family Tax Planning: IHT Optimisation for UK and Non-UK Spouses

For a married couple where one spouse is UK-domiciled and the other is non-UK domiciled, the inheritance tax (IHT) landscape is not a single regime but a dual one — and failing to plan across that boundary can cost a family hundreds of thousands of pounds. HM Revenue & Customs (HMRC) reported that in the 2021/22 tax year, IHT receipts reached £6.1 billion, a 14% increase from £5.4 billion the previous year, driven largely by frozen nil-rate bands and rising asset values [HMRC, 2022, IHT Statistics: 2021/22]. For cross-border families, the stakes are higher still: a non-UK domiciled spouse may hold assets outside the UK that are entirely excluded from IHT, but the wrong transfer or will structure can inadvertently bring those assets into the charge. The Office for National Statistics (ONS) estimates that approximately 5.8 million UK residents were born abroad as of 2021, a significant portion of whom are married to UK-born partners [ONS, 2022, Population of the UK by Country of Birth and Nationality]. This article sets out the mechanics of the spousal exemption, the domicile trap, and the practical steps — including the use of an excluded property trust — to ensure that a non-UK spouse’s foreign wealth remains outside the UK IHT net.

The Domicile Distinction: Why It Matters for IHT

The UK’s IHT regime is not based on residence but on domicile, a common-law concept that looks at where a person has their permanent home. A UK-domiciled individual is subject to IHT on their worldwide assets, whereas a non-UK domiciled individual is only taxed on assets situated in the UK. This distinction creates a critical planning opportunity for cross-border couples.

For a non-UK domiciled spouse, foreign assets — such as a holiday home in France, shares in a Singapore company, or a bank account in Dubai — are excluded property for IHT purposes, provided the assets themselves are not located in the UK. This exclusion applies regardless of the spouse’s residence status. The trap arises when a UK-domiciled spouse transfers assets to the non-UK spouse: if the transfer is absolute, the assets become part of the non-UK spouse’s estate and may retain their excluded status. However, if the transfer is structured poorly — for example, into a joint account or a UK trust — the protection can be lost.

HMRC’s internal manual confirms that the domicile of the transferor at the time of the gift determines the IHT treatment of the transfer [HMRC, 2023, IHT Manual: Domicile]. A UK-domiciled spouse making a gift to a non-UK spouse triggers a potentially exempt transfer (PET), which becomes exempt only if the donor survives seven years. This is a common source of confusion: the spousal exemption is unlimited for transfers between UK-domiciled spouses, but it is capped at £325,000 for transfers from a UK-domiciled to a non-UK domiciled spouse (the “non-UK domiciled spouse exemption cap”).

The Spousal Exemption Cap: £325,000 Limit and How to Work Around It

The unlimited spousal exemption that applies between two UK-domiciled spouses does not apply when one spouse is non-UK domiciled. Instead, the first £325,000 of assets transferred from the UK-domiciled spouse to the non-UK spouse is exempt from IHT. Any amount above that threshold is a potentially exempt transfer (PET) and will be subject to IHT if the donor dies within seven years.

This cap can be a significant problem for high-net-worth families. Consider a couple where the UK-domiciled husband holds £2 million in UK assets and wishes to transfer half to his non-UK domiciled wife. Without planning, the transfer above £325,000 — £675,000 — would be a PET. If he dies within seven years, that amount would be added to his estate, potentially incurring IHT at 40%.

There are two main workarounds. First, the non-UK domiciled spouse can make a deemed domicile election under section 257 of the Inheritance Tax Act 1984. By electing to be treated as UK-domiciled for IHT purposes, the unlimited spousal exemption is restored, and transfers between them become fully exempt. The cost is that the non-UK spouse then becomes subject to IHT on their worldwide assets. For a spouse with substantial foreign wealth, this may be undesirable.

Second, the UK-domiciled spouse can structure the transfer as a loan rather than a gift, or use a trust arrangement that keeps the assets outside the non-UK spouse’s estate. The most common vehicle is an excluded property trust, discussed in the next section.

Excluded Property Trusts: The Primary IHT Shield for Non-UK Assets

An excluded property trust (EPT) is a trust settled by a non-UK domiciled individual that holds assets situated outside the UK. Because the settlor is non-UK domiciled at the time the trust is created, the trust assets are excluded property for IHT purposes, meaning no IHT is payable on the trust fund during the settlor’s lifetime or on their death. This protection extends to the trust’s growth and any subsequent transfers of value within the trust.

For a cross-border couple, the EPT is most effective when the non-UK domiciled spouse settles foreign assets into the trust before acquiring UK domicile. Once settled, the assets remain outside the IHT net even if the settlor later becomes UK-domiciled, provided the trust is structured correctly. HMRC’s guidance confirms that the relevant date for determining excluded property status is the date of settlement [HMRC, 2023, IHT Manual: Excluded Property].

A practical example: Mrs X, a non-UK domiciled national, holds a portfolio of Swiss-listed equities worth £1.5 million. She settles these into an EPT before becoming UK-domiciled (which would happen automatically after 15 years of UK residence under the domicile rules). The trust continues to hold the Swiss equities, and no IHT is due on that fund when Mrs X dies, even though she is then UK-domiciled. Her UK-domiciled husband can also benefit from the trust during his lifetime without triggering an IHT charge, as long as he does not become a trustee or have a beneficial interest that makes him the settlor for IHT purposes.

For cross-border tuition payments or other international financial needs, some families use platforms like Airwallex global account to manage multi-currency transfers efficiently, though this is separate from trust structuring.

The Seven-Year Trap: PETs and the Non-UK Spouse

When a UK-domiciled spouse makes a gift to a non-UK domiciled spouse that exceeds the £325,000 cap, the excess is a potentially exempt transfer (PET). If the donor dies within seven years, the PET becomes chargeable and reduces the donor’s nil-rate band. This is a frequent source of unexpected IHT liability.

The seven-year rule applies regardless of the donee’s domicile. HMRC’s statistics show that in 2020/21, over 4,200 estates paid IHT on lifetime gifts that became chargeable due to the donor’s death within seven years [HMRC, 2022, IHT Statistics: Lifetime Transfers]. For cross-border couples, the risk is compounded by the difficulty of tracking foreign assets and the possibility that the non-UK spouse may not be aware of the UK IHT implications.

To mitigate this risk, the UK-domiciled spouse should consider:

  • Gifting within the £325,000 cap each tax year, using the annual exemption of £3,000 and normal expenditure out of income.
  • Using life insurance written in trust to cover the potential IHT liability on PETs.
  • Structuring gifts as loans rather than outright transfers, so the asset remains in the UK-domiciled spouse’s estate and the loan is repayable on demand.

The Deemed Domicile Election: A Double-Edged Sword

A non-UK domiciled spouse who has been resident in the UK for at least 15 of the past 20 tax years becomes deemed UK-domiciled for IHT purposes under section 267 of the Inheritance Tax Act 1984. At that point, their worldwide assets become subject to IHT. However, the spouse can elect to be treated as UK-domiciled earlier, under section 257A, to restore the unlimited spousal exemption.

The election is irrevocable and must be made within two years of the transfer. Its primary benefit is that it allows the UK-domiciled spouse to transfer unlimited assets to the non-UK spouse without triggering PETs. The cost is that the non-UK spouse’s foreign assets — potentially worth millions — become taxable on their death.

A typical scenario: Mr Y, UK-domiciled, holds £4 million in UK property and shares. His wife, non-UK domiciled, holds £3 million in a Hong Kong investment portfolio. Without an election, any transfer from Mr Y to his wife above £325,000 is a PET. If Mrs Y makes the election, Mr Y can transfer up to £4 million to her free of IHT, but Mrs Y’s Hong Kong portfolio becomes subject to UK IHT on her death. The decision hinges on which spouse is likely to die first and the relative size of their estates.

Practical Will Structuring for Cross-Border Couples

The will of a UK-domiciled spouse married to a non-UK domiciled spouse must be drafted with care. A standard will leaving everything to the spouse may inadvertently create a PET for amounts above £325,000, or may cause the non-UK spouse to become deemed domiciled if they inherit UK assets that bring their UK connection above certain thresholds.

Key drafting points include:

  • Using a nil-rate band discretionary trust to hold assets up to £325,000 for the non-UK spouse, ensuring the spousal exemption is fully utilised without exceeding the cap.
  • Including a survivorship clause so that if the non-UK spouse dies within 30 days of the UK-domiciled spouse, the assets pass to alternative beneficiaries (e.g., children) to avoid double IHT.
  • Separating UK and foreign assets in the will, so that the non-UK spouse inherits only the UK assets that are within the exempt band, while foreign assets pass to a trust or to children directly.

HMRC’s probate data for 2022 indicates that over 60% of estates with a value above £1 million used some form of trust in their will, reflecting the importance of this planning [HMRC, 2023, Probate and IHT Statistics]. For cross-border couples, the trust is not optional — it is the difference between a tax-efficient transfer and a 40% charge.

FAQ

Q1: Can a non-UK domiciled spouse inherit unlimited assets from a UK-domiciled spouse without IHT?

No. The spousal exemption is capped at £325,000 for transfers from a UK-domiciled to a non-UK domiciled spouse. Any amount above that is a potentially exempt transfer (PET) and will be subject to IHT at 40% if the donor dies within seven years. The non-UK spouse can make a deemed domicile election to restore the unlimited exemption, but that makes their worldwide assets taxable.

Q2: How long can a non-UK spouse live in the UK before becoming deemed domiciled?

A non-UK domiciled individual becomes deemed UK-domiciled for IHT purposes after being resident in the UK for at least 15 of the past 20 tax years. This rule applies automatically under section 267 of the Inheritance Tax Act 1984. Once deemed domiciled, their worldwide assets become subject to UK IHT, which is why many non-UK spouses consider an excluded property trust before reaching the 15-year threshold.

Q3: What happens to foreign assets held by a non-UK spouse if they die while UK-resident but not UK-domiciled?

If the non-UK spouse has not become deemed domiciled (i.e., they have been resident for fewer than 15 of the past 20 tax years), their foreign assets remain excluded property and are not subject to UK IHT. Only assets situated in the UK are taxable. This is a significant advantage and is the primary reason why many non-UK spouses avoid making the deemed domicile election.

References

  • HMRC, 2022, Inheritance Tax Statistics: 2021/22 (receipts and lifetime transfers data)
  • Office for National Statistics, 2022, Population of the UK by Country of Birth and Nationality (5.8 million foreign-born estimate)
  • HMRC, 2023, IHT Manual: Domicile and Excluded Property (domicile rules and trust guidance)
  • HMRC, 2023, Probate and IHT Statistics: 2022 (trust usage in estates above £1 million)
  • Inheritance Tax Act 1984, sections 257, 257A, and 267 (statutory provisions for spousal exemption and deemed domicile)