When someone dies owning assets located in the United Kingdom, a set of probate rules and an inheritance tax regime will apply which can be quite different from those in the United States.

With very few exceptions-the main being small cash sums at banks, personal possessions and joint property passing by survivorship-it will always be necessary to obtain a U.K. grant of representation in order to deal with assets in England and Wales (Scotland and Northern Ireland have different rules). This is so regardless of the value or composition of the U.K. estate.  

For example, consider Arthur McDonald, a fictional U.S. citizen who died in March owning £15,000 in a bank account in England, plus 200 Barclays Bank shares. His representatives must obtain a grant of representation even if he never lived in or visited England.  His U.K. assets will be frozen until a grant has been taken out and it will not be possible to sell the shares without it.

Who is entitled to take out the grant will depend on the decedent's domocile and whether he had a will or died intestate.  Even if a U.S. will can be proved in the U.K., which it normally can, other complications may arise. The most common problem is when the will names a U.S. trust corporation as sole executor.  Only a U.K. trust company, or any individual, is able to take out the U.K. grant.  In this case, the U.K. probate court would have to be satisfied that the U.S. trust corporation's governing document gave it specific authority to appoint a nominee or attorney to take out a grant on its behalf, in which case a U.K. attorney could be appointed to do so.

U.K. Inheritance Tax Filing Issues
Now that we know that Arthur's estate must obtain a U.K. grant, how do his representatives obtain one?  This is where the biggest practical concern arises: U.K. inheritance tax reporting and payment has to occur before a grant will be issued.

Detailed information about Arthur's assets and liabilities, both in the U.K. and worldwide, and his domicile must be obtained to ascertain the decedent's inheritance tax liability.

The extent of an individual's exposure to U.K. inheritance tax depends entirely on his domicile status. A U.K. domiciled person will be taxed on all assets wherever they are situated.  A non-U.K. domiciled person will be taxed only on assets located in the U.K. Domicile is the country or state that a person considers to be his real or permanent home-whether or not he actual lived there at the time of death.  This is largely a facts and circumstances test and generally considers the same factors as used to determine domicile for both federal and state purposes in the U.S.

There are, however, traps for the unwary.

"Deemed domiciled" is a U.K. concept U.S. lawyers need to understand. An individual resident in the U.K. in any 17 of the 20 U.K. tax years prior to death-known as the "17 out of 20 rule"-will be "deemed domiciled" in the U.K. at death, but only for inheritance tax purposes.  For example, if Arthur had been an income tax resident in the U.K. for 17 years, when he returned permanently to the U.S. on his retirement in March 2008 he would be treated as domiciled in the U.K. on his death in March 2009 and his worldwide assets would be subject to inheritance tax.  

Similarly, an individual will continue to be treated as domiciled in the U.K. for up to three calendar years after losing a general law domicile in the U.K.  For example, when Arthur left the U.K. on retirement in March 2008, his wife, Juliet, who had a U.K. domicile of origin-she acquired it at birth-went with him. Accordingly, Juliet's worldwide estate would remain within the U.K. inheritance tax net for up to three years from March 2008, when she acquired a new domicile of choice in the U.S.

If an individual gives up his or her domicile without acquiring a domicile of choice, for inheritance tax purposes the domicile of origin would be revived. If, for example, Juliet temporarily moved to France after Arthur's death-giving up her U.S. domicile of choice while she considers what she wants to do-her U.K. domicile of origin automatically would get revived until she acquires a new domicile of choice.

As it is a question of fact as to where the decedent was domiciled, it may be possible to argue the best possible domicile position for U.K. inheritance tax and U.S. federal estate taxes purposes.  But remember:
Do not claim a domicile that is inconsistent with the domicile status the decedent claimed in his lifetime income tax returns (both U.K. and U.S.).
The law of the decedent's place of domicile will determine the correct law of succession.
If a decedent dies non-U.K. domiciled, a claim cannot be brought against his estate in the U.K. under the Inheritance (Provision for Family and Dependants) Act 1975.  So, if Arthur dies leaving nothing to Juliet, she would not be able to claim against his estate in the U.K.

Normally, an Inland Revenue Account Form IHT400 (the U.K. equivalent of IRS Form 706) will need to be filed with Her Majesty's Revenue and Customs (HMRC).  Included in this will be:
Detailed valuations of the decedent's taxable estate.
Detailed information concerning domicile status if the decedent had a general law domicile outside the U.K.
Claims for any relief, exclusions or credits.

The deadline for filing Form IHT400 is the first anniversary of the decedent's death and there is no provision for extending this date. In practice, the IHT400 will need to be submitted earlier to enable an application for the grant of representation.

IHT207 is a much simpler form and may be used, broadly, where the decedent was not U.K. domiciled and never lived in the U.K., and the only assets situated in the U.K. were cash and/or quoted stocks and shares with gross value of less than £150,000.

Inheritance tax is due six months after the end of the month in which death occurs.  Interest will be charged on late payment.  However, if a grant is needed before this date, then the tax will be fully payable on the application for the grant-not including inheritance payable on certain property, such as real estate, where it is possible to pay in installments. This can create serious funding issues, with executors finding themselves unable to obtain a grant without paying the inheritance tax due on the death, but needing access to the assets to pay the tax.

As an example, Arthur's wealthy uncle, John Drummond, died owning £1 million in a U.K. quoted company. In a falling market his executors were desperate to sell the shares. This could not be done without a U.K. grant.  In turn, a U.K. grant could not be obtained without paying the inheritance tax due on the value of the company shares at the time of the application-about £400,000. In this situation, the only viable option may be to take out a loan for payment of the tax.

Double Taxation And Treaty Issues
It is beyond the scope of this article to consider U.S./U.K. estate and gift tax treaty issues, other than to note that even where it is very clear that the U.S. has the primary taxing rights, if the U.S. tax has not been paid and no valid receipt can be produced to HMRC by the time of the application for the U.K. grant, then the U.K. tax would still be payable up front, even though ultimately a refund would be obtained.  

The 'Credit Crunch' And Valuation Issues    
The U.S. and the U.K. use different rules for determining what is comprised in-and the value of-a decedent's estate for tax purposes. Rules governing the applicability of exemptions, relief and deductions, are also different. While tax rates are slightly less onerous in the U.K.-the inheritance tax is currently charged at a flat rate of 40%-the U.K. is less generous regarding the portion of an estate that can be transferred free of tax.  For the U.K. tax year 2009/10, the inheritance tax nil rate band threshold is set at £325,000. Valuation rules are different, too.  Unlike the U.S., the U.K. has no alternate valuation date. Value for inheritance tax purposes will be fixed at the date of death except in very limited circumstances, when it may be possible to substitute gross sale proceeds. This option only applies to quoted securities and real estate sold within a certain period after the death, but may provide an attractive planning opportunity for some estates.  

When Estate Planning Goes Wrong
There is a great deal of flexibility in the U.K. to achieve a desired tax result if the will or rules of intestacy do not provide the most beneficial result.  

Deeds of variation provide for the rewriting of a will or applicable intestacy rules. Deeds of variation can be made within two years of the decedent's death.  Deeds can only vary assets that actually pass through the estate-executors, for example, cannot vary non-estate assets such as benefits designated under Independent Retirement Plans.  

For example, if Arthur left his entire estate outright to Juliet, his U.K. citizen/domiciled spouse, U.S. estate tax would be payable (subject to applicable exemptions) but no U.K. inheritance tax as full spouse relief. On Juliet's death, her estate-if U.K. domiciled-would be subject to U.K. inheritance tax on her worldwide assets, including those inherited from Arthur.  That amounts to 85% taxes on worldwide assets on the combined deaths.  By signing a deed of variation redirecting her entitlement into a QDOT, the QDOT structure will be treated as having been created by Arthur under his will for inheritance tax purposes and not as a gift by Juliet. This will avoid the potential double tax charge by deferring the U.S. federal estate tax charge to Juliet's death, when the U.K. inheritance tax would be payable.  

Posthumous severance of a joint tenancy property is also possible (effective for inheritance and capital gains tax purposes only).

Disclaimers are also possible. U.K. disclaimers are similar to qualified disclaimers in the U.S., but there is one fundamental difference: The effect of a disclaimer in the U.K. is to treat the beneficiary as having renounced, not as having predeceased.

This could cause a problem where a will provides for what should happen if a beneficiary predeceases. In the U.S., the qualified disclaimer would apply. In the U.K., these provisions may not and, depending upon the wording of the will, could result in the renounced interest falling under the intestacy rules.

Tax During The Administration Period
Besides inheritance tax, there are other U.K. taxes to keep in mind during the administrative period.

Like the U.S., the U.K. has a capital gains tax. Under U.K. rules, executors take the decedent's residence for U.K. capital gains tax purposes.  If the decedent was resident in the U.K. at death, his estate is subject to capital gains tax on worldwide gains. If he was not a U.K. resident, the executors are not liable for capital gains tax even on U.K. gains.

For example, Juliet later returned to the U.K. and died owning substantial assets in the U.S. which were sold by her executors at significant gains-even with the step up in basis on death.  As she had been resident in the U.K. for capital gains tax purposes, these gains are subject to U.K. capital gains tax. The fact that the funds were never transferred to the U.K. made no difference.

A different set of rules applies to income tax. Here, the residence of the executors (rather than the decedent) will determine
income tax liability.  If the estate has multiple executors with mixed residences, consider having a non-U.K. resident executor take out the grant so the estate is only subject to U.K. income tax on U.K. situs income. If a U.K. resident executor takes out the grant of representation, the estate is subject to U.K. income tax on worldwide income (although there is a concession if the decedent was non-U.K. domiciled).  

Also keep in mind that beneficiaries of residual assets will be treated as receiving income before capital in any tax year. For example, the distribution of a chattel will be treated as a distribution of income.

For a U.S. citizen who owns assets in both the U.S. and the U.K., integrated tax planning is critical. Even with effective planning, practical problems may arise in an estate as a result of fundamental differences in the way the two countries' probate and tax compliance systems operate.  

There are plenty of potential traps for the unwary and, with such estates, it will be essential for advisors and attorneys on both sides of the Atlantic to keep a global perspective and to ensure that action taken in one country does not have unwelcome consequences in the other.

Dora Clarke is a partner in the London office of Withers LLP, an international law firm.  She advises on all aspects of probate, succession and tax planning, often with an international element, particularly for high-net-worth families. For further information, visit www.withersworldwide.com or email Dora Clarke at [email protected].