The Double Taxation Relief (Estate Duty) (Italy) Order 1968

• Successful reliance on the UK/Italy Estate Treaty (the ‘Treaty’) can be helpful to alleviate double taxation of the same assets in the UK and Italy both where the individual dies whilst still UK tax-resident or if they die after having returned to Italy but before having lost their ‘deemed domiciled’ status. The Treaty can also be helpful where the individual owns an offshore company which holds UK residential property.

• Despite its usefulness, reliance on the Treaty must be formally claimed by the executors and an in-depth analysis of the deceased’s domiciled will be crucial.

The UK has a limited network of estate tax treaties (also known as ‘double taxation conventions’), 11 in total. Some are considered ‘old treaties’ because they were signed in the sixties before the concept of ‘deemed domiciled’ was introduced in the UK in 1974. The UK/Italy estate tax treaty (the ‘Treaty’) is one of these older treaties, together with those with Pakistan, India and France.

In this article we focus specifically on the UK/Italy Treaty and consider how reliance on it can be used to prevent double taxation and, perhaps more importantly, to exclude a charge to UK inheritance tax when this would be imposed under UK domestic rules in the absence of a treaty.

The concepts of ‘domicile’ and ‘deemed domicile’ 

Under English law, the concept of ‘domicile’ relates to the country with which an individual is more closely connected. The concept has been developed through case law and can be acquired in one of three ways: as a domicile of origin, domicile of dependency or domicile of choice.

‘Domicile of origin’ is acquired at birth and is based on the individual’s parents, primarily their father.  Domicile of origin is determined by an operation of law and can never be extinguished.  Although it can be displaced by the acquisition of a domicile of dependency or a domicile of choice, it always lies dormant and can be revived if a domicile of dependency/choice is lost.

A ‘domicile of dependency’ is acquired when the individual is dependent on another by law, for example, an unmarried child under 16 or a mentally disordered person. If the person on whom the individual is dependent acquires a domicile of choice, the dependent will also acquire this domicile by virtue of their dependency.

An individual can change their domicile (‘domicile of choice’) if they reside in a new country and intend to reside there permanently and indefinitely.

‘Deemed domicile’, by contrast, is a statutory concept defined in UK tax legislation.  It is only relevant where an individual does not have an actual UK domicile (under the rules set out above). So, an Italian national who was born in Italy to Italian parents, and raised there until the age of 16, will have an Italian domicile under English common law.  However, if they reside in the UK for a protracted period of time – as the rules currently stand, for a period in excess of 15 years out of the previous 20 years – they could be considered deemed domiciled in the UK for tax purposes. Such status would not affect their actual Italian domicile as the two are not mutually exclusive.

An individual who is ‘non-domiciled’ under English common law and not yet ‘deemed domiciled’ will only be exposed to UK inheritance tax (‘IHT’) on their UK situs assets. If the individual later becomes deemed domiciled, under English domestic law and in the absence of treaty protection, they will be subject to IHT – at the rate of 40% subject to limited allowances, reliefs and exemptions – on their worldwide assets, wherever located. If the individual then leaves the UK, they will remain within the scope of IHT on their worldwide assets until they have been non-UK tax resident for three consecutive tax years (often referred to as the ‘three-year’ IHT tail).

Treaty to the rescue… long term residency in the UK 

If an Italian-domiciled individual becomes deemed domiciled in the UK for tax purposes and dies whilst still resident in the UK, it may be possible to rely on the Treaty in order to disregard their deemed domiciled status in respect of their assets situated in Italy.  In this case, the deceased’s Italian assets would be subject to lower tax rates in Italy and would benefit from higher personal tax-free allowances (franchigie).

It is sometimes argued that for individuals who have assets in third countries (i.e., outside Italy and the UK), reliance on the Treaty can produce the result that these assets escape tax in both Italy and in the UK. We do not perceive this construction to be correct and, more importantly, do not expect HMRC to accept it.

Italian returnees 

If a long-term UK resident who is domiciled in Italy but deemed domiciled in the UK for UK tax purposes returns to Italy and dies there after having resumed Italian tax residence under the ordinary regime (i.e. taxable in Italy on a worldwide basis), it may be possible to show HMRC that the three-year IHT tail does not apply.  In this case, UK IHT will only be payable on the deceased’s UK situs assets.  Albeit Italy will seek to tax the deceased’s worldwide estate. 

It is important to stress that the Treaty only applies to transfers on death (mortis causa) and not to transfers made during the individual’s lifetime.  Therefore, if a UK deemed-domiciled individual relocates to Italy he will still fall within the scope of UK IHT in respect of lifetime gifts or transfers into lifetime trusts. 

New rules on offshore companies holding UK residential properties

In 2017 the UK government introduced major changes to the domestic rules on IHT so that an individual who owns shares in a non-UK company which in turn own UK residential properties is no longer treated as owning a foreign asset (the shares).  Instead, their shares are deemed to be a UK asset (‘relevant property’) to the extent that their value is attributable to UK residential property. This rule, added to the Inheritance Tax Act 1984 at Schedule A1, has a specific section on double taxation relief arrangements. Under Paragraph 7 of Schedule A1, the shareholder, when relying on a relevant treaty, is liable to pay IHT unless the other non-UK country under the treaty levies an estate tax on the shares at a rate which exceeds 0% (or 0% by virtue of an exception or a relief).

Therefore, where an Italian resident owns an offshore entity holding UK residential property or an Italian domiciled individual with long-term UK tax residency owns shares in an Italy company holding UK residential property, it may be possible to rely on the Treaty to avoid a charge to UK IHT on the basis that the shares will be liable to tax in Italy on their death.

 Conclusions 

It is important to note that the application of the Treaty is not automatic. When an individual dies, their executors/personal representatives must formally claim reliance on the Treaty. Furthermore, an in-depth analysis of the deceased’s domicile is both necessary and vital before any IHT filing can be undertaken in the UK. If it can be established that the individual had retained an Italian domicile under English common law, it may well be possible to mitigate the estate’s exposure to UK IHT by relying on, and successfully claiming, protection under the Treaty.