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Is the US-UK Estate and Gift Tax Treaty a get out of jail free card for the well-advised American?

Posted on 13 December 2023

Unsurprisingly, in tax planning complete 'get out of jail free' cards are increasingly hard to come by but, in the right circumstances, the US-UK Estate and Gift Tax Treaty (the "Treaty") can offer complete freedom from UK taxation on certain assets.

The Treaty is a ‘domicile treaty’ that seeks to grant exclusive taxing rights to the country of treaty domicile, except for (i) immovable property and (ii) business property of a permanent establishment, where the taxing rights of the situs country are preserved. These exclusive taxing rights are not granted if the individual is a national of the country surrendering taxing rights. This is best explained by an example:

Jane is a US citizen and domiciliary who dies holding shares in Tesco. Under UK law, inheritance tax will be payable on the shares at 40% over and above Jane’s available nil-rate band of GBP325,000 ("NRB"). Even with credits under the Treaty, this will be a real tax cost to Jane’s estate, as the NRB is lower than the equivalent exemption in the US, currently USD12.92 million (scheduled to be cut in half, effective 1 January 2026). If Jane is not a UK citizen, the Treaty will give the US exclusive taxing rights and Jane’s Tesco shares will be protected from IHT. This is one of the few instances where UK citizenship directly matters for UK tax purposes. Like other OECD model treaties, where an individual is domiciled in both the US and the UK (under the domestic rules of each country), it is necessary to look at the tiebreaker rules in Article 4. The Treaty provides that a US national is domiciled in the US if they are not a UK national and have not been resident in the UK in seven of the ten years ending with the year of the transfer. Where this is not the case, it is necessary to examine whether the individual has a permanent home available to them in the US and/or the UK, and to identify their centre of vital interests, place of habitual abode and nationality (in that order).

In the event of a change in government, even if the concept of 'excluded property trusts' is abolished, provided such a trust also satisfies the conditions to be a 'treaty protected trust' under Article 5(4), then it would not be possible to change that treatment without re-negotiating the Treaty. Therefore, estate treaty planning (and income tax treaty planning, although beyond the scope of this article) could be a useful hedge for US persons in the event of either the abolition of the 'non-dom' concept and/or higher UK tax rates.

For further information contact Rafaella Peviani.

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