by Michelle McNeill, Private Client Associate at Gillespie Macandrew

In earlier articles, we have discussed the process of purchasing property in Scotland and the income tax, capital gains tax and LBTT consequences of doing so. This article looks at some of the issues to consider when it comes to passing Scottish property down to the next generation, either during lifetime or on death.

Domicile

The key to understanding the Inheritance Tax and legal implications of owning property in Scotland is first to establish the owner's domicile status.

There are three types of domicile: Domicile of Origin, Domicile of Dependency and Domicile of Choice. At birth an individual acquires a Domicile of Origin - usually from their father. This is not necessarily the same as the country in which they are born. A child has a Domicile of Dependency until they are legally capable of changing it themselves (at age 16). Throughout their childhood, their Domicile of Dependency usually follows that of their father but it can also follow the mother or another guardian depending on the circumstances. Finally, an individual can change his or her domicile, known as a Domicile of Choice once they have reached the age of 16. Despite the name this is not as simple as choosing to change domicile. Instead, it arises when an individual severs many of their ties with their country of origin and, in their place, creates new, strong and lasting ties with another jurisdiction.

Why does domicile matter? Well, amongst other things, domicile has an impact on Inheritance Tax.

Inheritance Tax and planning for your Scottish property

Individuals who are domiciled anywhere in the UK are subject to UK Inheritance Tax (IHT) on their worldwide assets, whereas those who are not UK domiciled are subject to IHT on their UK assets only. It is also worth noting that, even where there is no actual UK domicile, an individual is Deemed Domicile for UK tax purposes once they are resident for 15 out of the previous 20 years.

It was common for non- UK domiciled individuals to place their UK property in an offshore structure to avoid paying IHT. Typically this would be an offshore company, of which the shares would be owned either by the individual outright or, more commonly, by an offshore trust. However, from April 2017 the rules changed. The value of the shares attributable to any UK residential property will now be subject to IHT. This could mean an unexpected IHT bill for those who would previously have escaped charge altogether.

In addition, where shares in an offshore company are not owned by the individual directly but by an offshore trust (typically a discretionary trust with a wide class of beneficiaries) there will be ongoing IHT obligations to consider. Following these changes as well as IHT on creation, there will potentially be IHT to pay every 10 years and an IHT liability on any assets leaving the trust, for example passing to the beneficiaries. Therefore existing offshore trusts which hold UK residential property, may have previously escaped IHT but may well find that, under the new rules, they are exposed to a possible IHT liability on the next 10 year anniversary of the Trust's creation. It is perhaps likely that HMRC will be keeping a closer eye on the Land Register in order to police this.

It is worth remembering that these changes apply only to UK residential property and do not extend to commercial property situated in the UK.

Death

There are a couple of things to consider when dealing with Scottish property on death. Firstly the process for dealing with such assets, which is different than in England and, like many European countries, there are forced heirship rules in Scotland, which do not exist in England.

1. Confirmation - dealing with Scottish property following death

Following death it is necessary for the deceased's executors to apply for "Confirmation" which is similar to Probate in England. Only assets in Scotland are included in the application if the deceased was not Scottish domiciled. The Sheriff Court in Edinburgh is responsible for dealing with such applications. The paperwork required depends on a number of different factors, such as whether there is a similar process in the country of domicile, who is entitled to administer the estate, and whether or not there is a Will to deal with the Scottish assets. Often an opinion from a solicitor or notary in the country of domicile is required as well as a notarial copy of the Will.

Alternatively, where (irrespective of the deceased's domicile) the equivalent of a grant of probate or letters of administration has been obtained in a Commonwealth country, or South Africa, it is possible to have this probate "resealed" by the Sheriff Court in Edinburgh. In this case a separate application for Confirmation is unnecessary and this can be a much simpler process.

Advice should be sought from a Scottish solicitor on the correct procedure when dealing with Scottish property on death, and they can present the necessary papers to the Sheriff Court in Edinburgh.

2. Legal Rights - forced heirship in Scotland - where there is a Will there is a way…or is there?

Scots succession law has a form of forced heirship known as "Legal Rights." These rules apply where the deceased was domiciled in Scotland at the time of his death.

The Legal Rights rules apply whether the deceased had a valid Will or not, which means that a Scottish domiciled individual cannot completely prevent their spouse or children from inheriting. The right is automatic - no application to the court is required.

Where there is a Will each child has the right to claim an equal share of either one third (if there is a surviving spouse) or one half (if there is no spouse) of their parent's net moveable estate. Moveable estate does not include land and buildings. However, the Scottish Law Commission in its report on Succession hinted at the possibility of future changes which could result in land and buildings being taken into account when dealing with a Legal Rights claim.

Although land and buildings are not currently subject to Legal Rights claims, care should be taken if the property is held in a partnership, a company or another corporate structure because this can result in the property becoming "moveable" for the purposes of Legal Rights. This can prove problematic especially for farmers who often hold farm land in partnership. If their wish is to keep the farm intact by passing it down to one child (who has perhaps been involved in farming for years) and one of their other children decides to claim their Legal Rights this can have devastating consequences, with the farm potentially having to be sold in order to settle the claim.

However, as mentioned earlier, Legal Rights do not apply to Scottish property if the deceased is not Scottish domiciled. Therefore, overseas investors considering investing in Scottish property need not worry about these rules unless there is a prospect that they might become Scottish domiciled at some time in the future.

As mentioned previously, Scots law is quite distinct from English law so it is important to seek specialist advice from a Scottish solicitor in relation to Scottish property matters.

This article is intended to provide only an overview of the Inheritance Tax and legal issues to consider when planning the succession of property in Scotland. Advice on any actions should be specific to each individual's circumstances.