UK Inheritance Tax changes: how the US-UK Treaty could protect some Americans

The UK Government’s Budget of 30 October 2024 announced significant and wide-ranging tax changes to come into effect from 6 April 2025. This has left many clients struggling to grapple with what it all means for them and wondering whether they should be packing their bags to leave the UK before the end of the tax year.

One set of clients who may be able to put away the suitcases (for now) are US individuals who satisfy certain key criteria under the US/UK estate and gift tax treaty, as we explain below.

Changes to UK inheritance tax for individuals and trusts

From 6 April 2025, the extent of an individual’s UK inheritance tax exposure will be based on whether they fall within the newly introduced concept of a “Long-Term Resident”. This means that a person who has been UK tax resident for 10 of the past 20 years will be in scope for global UK inheritance tax. If a Long-Term Resident leaves the UK, they will have a “tail” period of between three and 10 years when their global estate remains in scope for UK inheritance tax.

The tax treatment of trusts is also changing. Currently, a trust settled with non-UK assets by someone not domiciled or deemed domiciled in the UK would be an “excluded property trust.” Under the pre-6 April 2025 rules, excluded property trusts were outside the scope of UK inheritance tax, even if the settlor later became UK domiciled or deemed domiciled. Essentially, an excluded property trust offered a legitimate long-term inheritance tax shelter based on the "snapshot" of the settlor’s non-domiciled status at the time the trust was created.

From 6 April 2025, the inheritance tax treatment of a trust will be tied to, and will fluctuate according to, the Long-Term Resident status of the settlor/grantor, so that once the settlor becomes Long-Term Resident the trust assets will fall into the inheritance tax net. This means the trust will have to pay 10-yearly anniversary charges and exit charges when assets leave the trust (or the settlor ceases to be Long Term Resident) at up to 6%.

For trusts settled after 30 October 2024, they will also potentially face a 40% inheritance tax charge on the death of a Long-Term Resident settlor/grantor who was a beneficiary of the trust (as is often the case for US trusts).

The US/UK Estate and Gift Tax Treaty (the Treaty)

The Budget made it clear that double tax treaties will continue to have effect under the new rules. The Treaty offers potentially useful protections and opportunities for US individuals, particularly those who are not UK nationals.

The Treaty works by first providing a framework to decide whether an individual is treaty domiciled in the US or UK, then agreeing how gift, estate and inheritance tax charges, reliefs and credits should apply depending on (i) the type and location of the asset and (ii) the individual’s treaty domicile at the relevant time. It is important to remember that the definition of treaty domicile is different from any other definition of domicile (or long-term residence), so an individual’s treaty domicile cannot be presumed without a careful analysis.

Article 5 of the Treaty allocates taxing rights as between the US and UK in relation to gift/estate/inheritance tax charges that arise both during lifetime and on death. Where an individual is not a UK national and is US treaty domiciled, Article 5 should enable the individual to significantly curtail their exposure to UK inheritance tax for personally held assets and, in some cases, for trust assets. Clearly, one area where detailed advice will be needed is whether the individual falls comfortably within the definition of a US treaty domiciliary, as this will be key to unlocking the biggest advantages of the Treaty.

Treaty Protected Trusts

The Treaty broadly appears to block UK inheritance tax from applying to trusts of non-UK property where at the time the trust was created the settlor was a US treaty domiciliary and not a UK national. Unlike some other double tax treaties like the UK/India or UK/Italy treaties, the Treaty is not limited to taxes on death. A Treaty Protected Trust should therefore be broadly exempt from the UK’s 10-yearly charging regime and, on the face of the Treaty wording, from the 40% charge on the death of a settlor-beneficiary. Although it is possible that the UK Government will take a different view and legislate to override the Treaty in these circumstances, as it stands the protection appears to apply.

It is also important to remember that a "trust" in the US is not necessarily a "trust" (or, strictly speaking, a "settlement") for UK purposes. Advice will be needed to clarify the point at which the UK would deem the trust to have been created, since this will be the point at which the settlor’s treaty domicile and nationality will be relevant.

Cutting the Long-Term Resident tail

Once a US individual has become UK Long-Term Resident, they will be within the worldwide inheritance tax net, and it is unlikely that they would fall within the definition of a US treaty domiciliary while still UK resident. However, if such an individual leaves the UK and returns to the US, the Treaty should give them personal protection against UK inheritance tax even though they are still in their Long-Term Resident tail period. This will be the case provided they satisfy one of the following (in order of priority):

• That they do not retain a permanent home in the UK;
• If they do, they also have a permanent home in the US and the US is where they have their closest personal and economic ties (their “centre of vital interests”);
• If it is unclear where their centre of vital interests is, their habitual abode is in the US; or
• If it is unclear where their habitual abode is, they are a US citizen but not a UK national.

For dual nationals, if none of the above lead to a clear answer, the US and UK tax authorities will agree between them how to tax the individual.

Overall, the Treaty has the potential to significantly improve the UK inheritance tax position of Americans who can comfortably position themselves as US treaty domiciled at the crucial moment. It is perhaps not surprising that as lawyers our key takeaway is that treaty domicile cannot be assumed – it needs to be reviewed carefully on a case-by-case basis.

This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.

© Farrer & Co LLP, February 2025