INHERITANCE TAX

Domicile

There are many issues that can affect a liability to inheritance tax, including the country of domicile.

Under UK law it is necessary to have a country of domicile for tax purposes. This will usually be the place with which a person has the closest connection – normally the country of birth rather than the place in which they are currently living.

If you are not intending to return to live in Britain, it may be possible to establish an alternative domicile by taking steps to show that a new home abroad is permanent. You would then be classed as UK non-domiciled which can be extremely advantageous for tax purposes in an obscure tax haven, but definitely not in Spain.

So to put it simply, a UK citizen, with a UK passport, resident or non-resident in Spain is still domiciled in the UK unless steps are taken to change this. Although this assumption is made for the balance of this chapter it is to some extent irrelevant, for inheritance tax for Spanish assets is paid to Spain.

Guidelines

Inheritance tax is regarded by many as the crudest of taxes. Having spent a lifetime paying income tax yet another lump of assets amassed over the years will be claimed back by the tax authorities. With careful planning people need pay little or nothing in inheritance tax. It was once described as a ‘voluntary levy paid by those who distrust their heirs more than they dislike the Hacienda’.

On death, the surviving spouse or dependants have six months to inform the authorities and pay any inheritance tax. If this is not done, with the property remaining in the deceased’s name, it cannot be sold. There are also penalties for the non-payment of Spanish inheritance tax on time.

Spanish inheritance tax is payable when an inheritor is a resident of Spain, or the asset inherited is property in Spain. Spanish inheritance tax is not payable if the asset is outside Spain and the recipient is not a resident in Spain.

Inheritance tax is the liability of each beneficiary and not of the deceased’s estate. Surprisingly the actual tax payable is based on four factors:

• the amount bequeathed;
• tax exemptions and allowances;
• the relationship of the recipient to the deceased;
• wealth of the recipient.

There is no exemption between a husband and wife where each holds joint ownership of a property. In many countries a property can be held in joint names. If one person dies the property passes automatically to the other person. This is not the case in Spain where each person holds an equal share. Upon the death of one person, the other is subject to inheritance tax when inheriting the other half.

Spanish inheritance taxation law does not recognise a common law spouse. The relationship has no legal standing. They have no inheritance tax exemptions. They are also taxed at a premium rate and treated as non-relatives.

Inheritance tax structure mirrors the Spanish law of ‘compulsory heirs’ and takes an old-fashioned view of marriage.

Setting a value on the deceased’s estate

Property is valued either at market value, a value in the IBI statement, the value in the escritura or a value set by the Hacienda, whichever is greater. Stocks and shares, cars and bank accounts are valued at the date of death. The value of life insurance settlement is dependent on the recipient. Furniture, clothing and personal effects (ajuar) are treated as gifts having no value.

Exemptions

The law provides an individual exemption from tax of the first 16,000€ bequeathed where an estate is passed to a spouse, parents, children, brothers and sisters. This exemption applies to each inheritor, not to the total estate. For uncles, cousins and nephews, the exemption is cut by half to 8,000€. For more distant relatives, people not related and common law couples, there is no exemption. Conversely children aged 13 to 21 years of age attract higher exemptions. This applies to residents and non-residents.

Inheritance tax can be significantly reduced where a resident of Spain leaves a principal residence to a spouse, children, or a brother or sister (over 65 years), who has lived with the deceased for two years. All are eligible for a 95 per cent exemption in inherited value up to a maximum of 120,000€. To qualify, the residencia must have been held for three years, the property must have been lived in for three years and the inheritors must undertake not to sell the property for ten years. This exemption is only for a home or a family business and does not apply to investments or second homes. Non-resident holiday home owners cannot take advantage of this exemption.

Inheritance tax tables

Taxable amount €	Tax payable €	Tax %
8,000	600	7.5%
16,000	1,300	8.0%
32,000	2,900	9.0%
48,000	4,700	9.8%
64,000	6,800	10.6%
80,000	9,200	11.5%
120,000	15,600	13.0%
160,000	23,000	14.4%
240,000	40,000	16.7%
400,000	80,000	20.0%

Tax table 1 is a rounded abbreviated extract from a full table. It is for guidance only. To use this table take the amount inherited, less any allowances highlighted in the previous section, subtract any debts owed by the deceased such as an unpaid mortgage and funeral expenses. This is the taxable amount with corresponding tax payable.

Wealth of inheritor €	Multiplying coefficient
	A	B	C
0 to 400,000	1.00	1.60	2.00
400,000 to 2,000,000	1.05	1.70	2.10
2,000,000 to 4,000,000	1.10	1.75	2.20
+ 4,000,000	1.20	1.90	2.40
A = children, adopted children, grandchildren, spouses, parents, grandparents
B = cousins, nieces, nephews, distant relatives, descendants and ascendants
C = all others, including unmarried partners

Tax table 2 multiplies tax payable in table 1 by a factor ranging from 1.0 to 2.4 depending on the wealth of the recipient and their relationship to the deceased. In fact table 1 only applies to children, adopted grandchildren, grandchildren, spouses, parents and grandchildren who have a personal wealth less than 400,000€. All other benefactors, including those with high personal wealth and unmarried couples, pay more.

The Spanish inheritance tax system penalises inheritance to non-relations and to the rich. It is designed to maintain a family structure and benefit the poor.

Regional variations

Madrid, Catalonia and Valencia have different inheritance tax rates. Madrid has inheritance laws stating that unmarried couples can take advantage of the lower tax rates applied to married couples providing they are on the local register of unmarried couples.

Andalusia tax authorities have eliminated inheritance tax for individual family inheritors who are official residents of Andalusia and receive less than 125,000€. The 95 per cent allowance also rises to 99.9 per cent. The total value of the estate should not exceed 500,0006 and the wealth of each inheritor should not exceed 400,000€. Registered unmarried and same-sex couples also obtain this exemption.

These regional variations now recognise and come to terms with some of the old fashioned principles of Spanish inheritance tax.

Examples

In order to better understand the computation of inheritance tax, three examples are chosen. They all start with a property valued at 300,000€ held in joint ownership. One person dies and bequeaths the other half of the property to the surviving spouse. They have two children. The examples look at different combinations of resident, non-resident, married and non-married. For the benefit of simplicity the figures are rounded and the location is not one with regional tax variations.

• 1.Married couple, non-resident – a typical holiday home owner
• 2.Married couple, resident – a typical ex-pat
• 3.Unmarried couple, resident

In the first example the total inheritance tax bill would be halved if the property was left in equal parts to the children and surviving spouse. In the third example the tax bill would be 1,300€ if the couple married or lived in Andalusia.

LEGITIMATE METHODS OF AVOIDING SPANISH INHERITANCE TAX

Over the years many methods have been used to lessen the impact of this tax. Some of these have been illegal and led to greater problems and higher taxation at a later date. These methods have included the non-declaration of death, under-declaring the value of assets and using a power of attorney after death. With the introduction of new European tax laws on disclosure these practices will become a thing of the past. No professional advisor will risk high fiscal penalties for the sake of assisting clients in evading taxation.

Trusts

One such method is to create a trust, in which assets pass into the hands of a company, with each family member becoming a shareholder. When one member dies, the shares are transferred to other family members. This attracts little tax. The location of this company may be offshore. Making a trust is best left to experts. It attracts annual charges and therefore is best suited to large financial holdings. The only real alternative to a will is to set up a trust structure during a lifetime. With careful planning this can eradicate delays, administration costs and taxes, as well as giving other benefits. For these reasons the use of trusts can be quite dramatic. A trust is not dissimilar to a will except that assets are transferred to trustees during a lifetime, rather than being transferred to executors on death. The trust deed is comparable to the will.

Life interest

You can transfer the property to a chosen heir while still alive and maintain a usufructo over it, retaining a right of use while living. The ownership has formally passed to another person. This legal move, which is viewed by the tax authorities as a gift, still attracts some inheritance tax, albeit at a reduced level, depending on the age of the people involved.

A simpler solution can be achieved by selling the property to a chosen heir. We do know that selling a property can cost around ten per cent of its value so in the previous examples this will be 30,000€. Compare this to the tax bill for an unmarried couple! A life expectancy of five years is however necessary as tax authorities assume – quite correctly – that this it is to avoid tax.

Equity release

Some companies are offering an equity release facility to individuals owning a property in Spain.

However, this should not be confused with schemes offered in the United Kingdom and certain other countries where elderly individuals are to accept a lump sum payment in lieu of the ‘sale’ of their property, and continue to live in it rent free for the remainder of their lives. After their deaths the beneficiaries have no financial interest in the property as legal title belongs to the lender. This form of arrangement does not exist in Spain.

Most of the equity release schemes in Spain are in effect remortgages. These schemes allow a property owner to take out a mortgage, normally without capital repayments, against the security of his or her property. Provided the borrowed funds are properly reinvested outside of Spain, this is likely to reduce Spanish inheritance tax on death. The loan can be as much as 100 per cent of the property valuation for suitable applicants, and most lenders will agree the loan in most leading currencies, although the interest rate will vary according to the currency chosen. The lender may allow some of the loan monies to be used as so wished, but will require most of it to be invested and offered as further security for the loan. A typical loan is for a five-year period, after which it would have to be renegotiated. The lender may not be obliged to renew and may demand repayment at the end of the original loan period.

To avoid inheritance tax in this way all the normal rules must be followed. For a Spanish tax resident, the mortgage will reduce net assets in Spain. Of course, the loan proceeds must be invested outside Spain, either via a trust for beneficiaries or in a will to non-Spanish residents. If you are not a Spanish tax resident, the mortgage proceeds must be invested outside Spain and should not pass to any Spanish residents on death.

These equity release schemes only aim to reduce Spanish inheritance tax; if you are a UK domicile, upon death these schemes will not reduce any UK inheritance tax liability.

Give it away

This is by far the most generous concession on inheritance. It allows anyone to give away anything they like, including cash, property or works of art, with no tax liability whatsoever. Again there is one condition – the gifting person must remain alive for at least five years after making the transfer.

Investments and UK inheritance tax

Think carefully where investments are located. It may be that investments are better located in an offshore trust so this requires no further consideration as they should be protected by some tax avoidance scheme. It may be that investments can be located in the UK or in Spain in which case they should be allocated to the will of that particular country. It is just a matter of doing some calculations. UK inheritance tax liability does not accrue for me items below, over that the tax rate is 40 per cent:

• anything given to a spouse;
• any gift to a charitable body;
• the value of an estate less than £275,000 (excluding anything given to a spouse);
• anything given more than seven years before death;
• on gifts made before death if they did not, in total, exceed £3,000 in any one tax year.

Equalising a UK estate not exceeding £275,000 in value means it is exempt from UK inheritance tax, so married couples should try to equalise their estates to take full advantage of this exemption. If a husband whose wife is wealthy in her own right leaves his entire estate to her, he would only be adding to the potential charge on her estate upon death. Instead, he should consider leaving all or part of his estate direct to other beneficiaries – his children, for example.

Maintaining a loan

Inheritance tax is only payable after debts have been deducted. If it was possible to have a 100 per cent interest-only mortgage or loan then this is a guarantee of no inheritance tax. This is not possible as a mortgage but is possible as a loan. It is a matter of doing the figures. Some financial advisors are only too pleased to do it! Charges are high.

Holiday home owners

A Spanish holiday home owner will probably have a main residence in the UK which will be subject to the inheritance laws of that country. In fact the decreased worldwide assets will be subject to the laws of the UK even if inheritance tax has already been deducted in Spain for the Spanish property. In this situation any tax paid in Spain can be deducted against a UK tax liability to avoid a double tax charge.

DENNEY

The relationship between Spanish and UK inheritance law was not always so clear. It was not until 1999 that the issue was finally cleared up in a landmark judgment known as the Denney case. The issue was Denney, an Englishman who died domiciled in Spain: does Spanish law or English law govern the succession to his estate?

Anthony Denney lived in Spain for many years. He died in 1990 and his Spanish will made his second wife Celia Mercedes Royde-Smith universal legatee, without prejudice to the rights that the children of his first marriage might have under his national law. The question was – were his children entitled to inherit part of the estate as obligatory heirs under Spanish law? It took nine years to find out the answer.

Anthony Denney’s three children by his first marriage challenged the widow’s claim to the estate in the Spanish Courts, claiming that under Spanish law part belonged to them. Their grounds were that because English Private International Law refers to the law of Spain and Article 12.2 of the Spanish Civil Code accepted the reference back from English law, therefore Spanish law gave them compulsory rights to a part of the estate. However, Article 12.2 of the Civil Code is ambiguous and there were no judgments from the Supreme Court to provide guidance on how it should be interpreted.

It should have been merely a matter of obtaining a definitive judgment on a point of law, but a major complicating factor proved to be the question of the ownership of Denney’s collection of modern art, which had been lent by him to the Dallas Museum of Art in 1970. Shortly after Denney’s death the museum was instructed, in letters signed by Anthony Denney and later discovered to be forged, to transfer the loan collection to the Museum of Modern Art in Toulouse. Transport costs and insurance were paid for by the City of Toulouse. In 1993 the City formally accepted the collection as a gift from Denney’s widow, even though officials knew that it had not been declared to the Spanish tax authorities and that Denney’s children by his first marriage had lodged an inheritance claim in the Spanish courts.

The widow denied that the children had any right to bring their inheritance claim before the Spanish courts and also argued that the case should not be heard without the Mayor of Toulouse being present, because the city, which she claimed was now the owner of the collection, would be affected by the outcome. The Mayor of Toulouse, for his part, announced that the litigation in Spain was a private matter in which neither the city nor the state nor the regional council were in any way involved.

The litigation in the Spanish courts followed three stages:

Stage 1 January 1995: The Spanish Court of First Instance found no evidence to suggest that the collection had ever left the deceased’s estate; it rejected the widow’s argument that the Mayor of Toulouse owned the collection and declared the Denney children forced heirs under Spanish law.

Stage 2 July 1995: The Provincial Appeal Court overturned the decision of First Instance, without considering the substance of the inheritance claim, on the grounds that the Mayor of Toulouse ought to have been called to the case.

Stage 3 27 May 1999: The Supreme Court in Madrid ruled that there were no reasons why the City of Toulouse should have been called to the case and overturned the judgment of the Provincial Appeal Court. Then, after considering recent developments in Private International Law and the trend towards a more restricted application, it rejected the claim of the Denney children and revoked the Judgment of First Instance. The order of the Provincial Appeal Court, ordering the costs at First Instance and of the appeal to be paid by the Denney children, was overturned. No ruling was made in respect of costs because of the complexities of the legal issues involved and the fact that similar cases had never come before the Supreme Court.

FURTHER INFORMATION

The most frequently asked question from ex-pats concerns wills and inheritance. Little information exists on this subject thus making it fertile ground for financial advisors and abogados.