Tax

Sparing No One: Cross-Border Taxation of Globally Mobile Individuals – Part 2

Naomita Yadav Lara Crompton and Emma Cooper-Hedges 9 October 2023

Sparing No One: Cross-Border Taxation of Globally Mobile Individuals – Part 2

This article continues to examine – via the circumstances of Prince Harry and Meghan, the Sussexes – the issues that arise when a taxpayer is subject to tax in two countries such as the US and UK. This is the second half of a detailed two-part analysis.

This is the second part of a two-part examination of cross-border tax matters for “globally mobile” individuals. (See part 1, here.) The article takes up the well-chronicled example of the financial affairs of Prince Harry and Meghan, the Sussexes. The authors of this article are Naomita Yadav, partner; Lara Crompton, special counsel, and Emma Cooper-Hedges, senior associate, at Withers, the law firm. The editors of this news service are pleased to share this detailed and important analysis. The usual editorial disclaimers apply and as always, readers are welcome to respond. Email tom.burroughes@wealthbriefing.com

Talking transfer taxes
Both the US and UK transfer tax regimes are based on the concept of “domicile,” which can be loosely defined as the place that an individual considers their “home” and where they intend to reside permanently (43). By relying on the individual’s subjective intent, domicile is highly facts and circumstances driven as compared with more objective tests applicable in the income tax context.

The Sussexes present an unusual domicile case study, namely, that of a senior member of the British royal family and his spouse resigning their monarchical posts, moving to the US, and publicly announcing their intent for their Santa Barbara home to be their primary residence. Did Harry and Meghan change their domicile when they moved across the pond, and what does this mean for their gift, estate, and inheritance tax exposure in the US and the UK?

US tax liability
Like US income taxes, US gift and estate taxes are generally applicable to all US citizens, wherever located (44). Therefore, since Meghan is a US citizen, gifts or bequests from her estate generally remain subject to US gift and estate tax rules. Harry’s US gift and estate tax liability could arise in one of two situations:

-- if Harry is determined to be a US domiciliary (or citizen) at the time of transfer; or
-- if Harry transfers US situs assets when he is a non-citizen, non-domiciliary of the US (45)   

In the first instance, US transfer taxes would apply to Harry’s worldwide estate (or gifts of property located anywhere in the world). In the second instance, only US situs assets (which are determined differently for gift versus estate purposes) would be subject to US transfer taxes.

Harry’s US domicile and Federal Transfer Tax issues
There is no clear test based on presence for a given number of days in a year to determine domicile. Assuming Harry does not obtain US citizenship, his domicile for US purposes is difficult to determine. Critical to this analysis is his subjective intent upon moving to the US, which includes, as a flip side, an intent to abandon his UK domicile. An individual can have only one domicile, therefore, to acquire a US domicile, a non-US citizen must lose their non-US domicile.

Were he an ordinary British citizen, Harry’s circumstances might indicate someone who has entered the US with a nonspecific goal, whose family locus is in the country (his wife and children are US citizens, combined with a rather public falling out with his own family), and whose business concerns (such as with the Netflix deal) are in the US. This would lean in favour of having created a US domicile. But of course, Harry is not a regular British citizen. He is, even now, fifth in line to the throne of one of the oldest remaining monarchies.

Harry's split with the royal family was public, as was his retirement as a working royal, and his proclamation of making a home in California (46). He has also not kept a routine of visits to the UK – rather, each visit since his move to California has had a specific purpose, such as attending Queen Elizabeth II’s funeral. The place he returns to when not travelling for a specific purpose appears to be California, but whether this is adequate to overcome his unique ties to the UK is difficult to assess. One deciding factor could be his financial locus – whether his assets are now predominantly in the US or remain in the UK. This would include, for example, weighing the potential value of his new business ventures against any remaining claims or inheritance in the UK. If his financial ties are also weighted in favour of the US, combined with other factors, this would more clearly determine that his domicile is the US in the eyes of the IRS.

Either way, it would behove the Duke of Sussex to ensure that whichever domicile (US or UK) he wishes to claim, that he has objective support of his subjective intent lest both countries claim he is domiciled there. For example, applying for a US green card and moving more assets to the US would more clearly support his domicile claim there. Or making more family visits to the UK, retaining more assets there, and maintaining a US presence on a non-immigrant visa would support a UK domicile. A murky domicile opens the doors for transfer tax claims by both jurisdictions.

If Harry’s US domicile is unclear, tax authorities in the US are more likely to claim that he is not US domiciled if he transfers any US assets because there is no “lifetime exemption” as such (47). Gifts of US situs assets (for example, real property), excluding any intangibles, over the annual exclusion amount (48) ($17,000 per donee) are taxable at 40 per cent. Estate transfers of any US situs assets (including intangibles) are exempt up to $60,000, subject to 40 per cent estate tax.

However, if he makes a transfer of non-US assets – for example, UK real estate – US tax authorities are more likely to claim that he is US domiciled because any value over the available lifetime exemption (unified credit) would be subject to gift or estate tax in the US.

One planning technique for mitigating the effect of unclear domicile for US federal estate tax purposes would be for Harry to own any assets under a foreign “blocker” entity rather than in his own name. This structure would hedge against a non-US domicile upon his death. If assets are owned by Harry through a foreign (that is, non-US) entity that is treated as a C corporation for US tax purposes, upon his death, heirs or other takers under testamentary documents will inherit shares of a non-US corporate entity, which are treated as a non-US situs asset (49).

Should he make lifetime gifts, that too would be a gift of a non-US situs asset. In either case, it protects from US transfer tax if he is not a US domiciliary at the time of the transfer. Unfortunately, if he is not a US domiciliary at the time of death, he will (as of now) be treated as a UK domiciliary. However, the foreign blocker entity would not assist his UK inheritance tax (IHT) exposure, as explained further below.

Regarding lifetime (gift) transfers, a unique opportunity may exist from a US perspective for lifetime wealth transfer in the form of a gift of intangible assets, which includes stock or other entity interests. A lifetime gift of entity interests by a non-citizen, non-domiciliary (except for some expatriates) is not subject to US gift tax even if the entity is a US entity (50).  

Were Harry to make a gift of intangible assets, if he has a basis to assert non-US domicile, he may be able to achieve wealth transfer unfettered by any US gift taxes. Further, if the IRS challenged his position regarding domicile and won – a difficult feat given his unique ties to the UK – he would then be entitled to offset that gift against the lifetime exemption that is available to all US domiciliaries, and which is at an all-time high of $12.92 million per person (51). He may also be able to gift-split with Meghan, (52) who has the same amount of exemption available to her (assuming she has not made past gifts in excess of annual exclusion amounts), and further reduce the value of any taxable gift.

Marital transfers are also an important area to consider for the Sussexes. If an individual (US domiciled or not) leaves their estate to their US citizen spouse, a full marital deduction is available, but if the spouse is not a US citizen, it is not available unless the assets are left in a special type of trust called a qualified domestic trust (53).  Assuming the value of Meghan’s estate would exceed her available exemption at her time of death, she will want to ensure that she includes a qualified domestic trust for Harry in her estate plan to avoid US estate tax on her death, followed by a potential UK IHT charge on Harry’s passing. Failing to use a qualified domestic trust could substantially decrease the value of assets that can be passed on to their children.

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