Introduction

International estate tax planning presents intricate challenges for high-net-worth individuals and families with worldwide assets. Navigating the complexities of diverse tax systems is crucial to manage estate tax liabilities effectively. Trusts and foundations play a significant role in international estate planning, offering mechanisms for asset protection and tax efficiency.

This guide aims to provide an overview of international estate tax planning, focusing on the strategic use of trusts and foundations. It will explore key considerations for individuals seeking to optimise their estate plan in the context of international taxation, including the implications of situs tax and effective estate planning strategies using trusts and endowments.

Understanding Situs Tax and its Importance in International Estate Planning

What is Situs Tax?

Situs tax is a type of taxation imposed on assets based on their location, rather than the residency of the asset holder. This means that regardless of where you live, if you own certain types of assets located in a specific country, you may be subject to that country’s tax rules.

Situs tax commonly applies to various forms of property, including:

• Real estate
• Financial assets like stocks and bonds
• Intangible assets such as intellectual property and trademarks
• Valuable personal property like art and jewellery

This tax is prevalent in countries like the United States (US) and the United Kingdom (UK) and also exists in other jurisdictions such as Canada, Australia, and various European nations. Each country has its own unique set of situs tax regulations and tax rates. Therefore, if you have international investments, it is crucial to understand the specific rules in each jurisdiction where your assets are located to ensure compliance and effective tax planning.

Why Situs Tax Matters for International Investors

Situs tax is a critical consideration for international investors because it can have significant financial and estate planning implications. If you possess property or financial assets in a country with situs tax regulations, you will be obligated to pay taxes to that country, irrespective of your residency. This can lead to a substantial tax liability, potentially reducing the overall returns from your investments.

Furthermore, situs tax can complicate your estate planning. Without proper planning, the tax burden associated with situs tax may reduce the value of inheritances for your beneficiaries. Dealing with international tax authorities often involves detailed documentation and extended timelines, which can further complicate and slow down the process of settling your estate. Therefore, understanding and strategically managing situs tax is essential for international investors to protect their assets and ensure smooth estate transitions for their beneficiaries.

Situs Tax Implications in the US and UK for Non-Residents

US Situs Tax Rates for Non-Residents

Non-residents in the US are subject to specific situs tax rates on income derived from US sources. These rates apply to various types of assets located in the US, making it essential for non-residents with US assets to understand these tax implications for compliance and effective financial planning.

US situs tax rates for non-residents include:

• Property Rental Income: Rental income from US property is taxed at a flat rate of 30% of the gross rental income.
• Dividends and Interest: Investment income, such as dividends and interest from US sources, may face a 30% withholding tax. However, tax treaties between the US and other countries can potentially reduce this rate. To benefit from these treaties, non-residents typically need to complete a W-8 BEN form, which informs the Internal Revenue Service (IRS) of their non-resident status and eligibility for treaty benefits.
• Capital Gains: Generally, non-residents are exempt from US capital gains tax on the sale of personal property. An exception exists for gains from the sale of US real estate interests, which are subject to taxation under the Foreign Investment in Real Property Tax Act (FIRPTA) (Cth).
• Estate Tax: US estate tax applies to certain assets with a US situs, such as real estate and stocks in US corporations, owned by non-residents. The estate tax exemption for non-residents is $60,000, and the taxable estate exceeding this amount is taxed on a sliding scale, with rates ranging from 18% to 40%. It’s crucial to note that the executor of the estate is held personally liable by the IRS for declaring these assets and ensuring tax obligations are met.

UK Situs Tax Rates for Non-Residents

Similarly, the UK imposes situs taxes on non-residents who hold assets within the UK. The specific tax rates and rules in the UK depend on the type of asset and the individual’s residency status. Understanding these rules is essential for non-residents with UK situs assets to manage their tax liabilities effectively.

UK situs tax rates for non-residents include:

• Non-Resident Capital Gains Tax (NRCGT) on UK Residential Property: Non-residents are subject to NRCGT on gains from disposing of UK residential property. The tax rates are aligned with those for UK residents, which are currently 18% for basic-rate taxpayers and 28% for higher-rate taxpayers.
• Inheritance Tax (IHT): UK inheritance tax may apply to assets with a UK situs, such as real estate, listed shares, and cash, held by non-residents. The standard IHT rate is 40% on the taxable estate value exceeding the current exemption threshold of £325,000. Additionally, a similar tax can apply to offshore trusts holding UK assets, potentially on a ten-year cycle.
• Income Tax: Non-residents are generally liable for UK income tax only on income derived from UK sources. The tax rates vary based on the income type, with different rates for dividends, interest, rental income, and other UK-sourced income.

Leveraging the US-Australia Estate Tax Treaty for Situs Tax Mitigation

The Role of Estate Tax Treaties in International Planning

Estate tax treaties play a crucial role in international estate planning by:

• Clarifying Taxing Rights: They define the taxing rights of different countries based on the situs of assets.
• Preventing Double Taxation: These treaties ensure that assets are not taxed in multiple jurisdictions.
• Defining Primary Taxing Jurisdiction: They establish which country has the primary right to tax specific assets.

For example, estate and gift tax treaties, such as the one between the US and Australia, extend certain tax benefits to NRAs. These treaties broaden the applicability of tax credits to individuals who are not residents of the treaty countries but own assets within those jurisdictions. Specifically, the US-Australia Estate Tax Treaty offers advantages to Australian NRAs with US situs property.

Key Benefits of the US-Australia Estate Tax Treaty for Australians

The US-Australia Estate Tax Treaty offers significant benefits to Australians who are NRAsof the US and own US situs assets. The key advantages include:

1. Extension of the US Estate Tax Threshold:
   Australian NRAs are entitled to the same US estate tax threshold as US domiciliaries. Currently, this threshold is set at 11.58million,havingbeenreducedfrom11.58million,havingbeenreducedfrom12.92 million in 2023. This increase allows Australian NRAs to hold more US situs assets before being subject to US federal estate tax.
2. Exclusion of Non-US Situs Property:
   Under the treaty, only assets legally located within the US are considered when determining estate tax liability. Property situated outside the US is excluded from the US estate tax calculation for Australian NRAs. This exclusion provides a significant advantage in estate planning for those with worldwide assets.

By leveraging these benefits, Australian NRAs can effectively mitigate situs tax liabilities, ensuring more efficient and strategic management of their international estates.

Strategic Use of Trusts and Endowments for Situs Tax Management

Utilising Trusts for Estate and Tax Efficiency

Legal structures such as trusts and endowments are effective tools for managing situs tax liabilities. These structures not only safeguard assets but also provide considerable tax benefits, making them invaluable for estate planning. By placing assets into a trust, individuals can often postpone or lessen their tax liabilities, significantly benefiting their estate planning and overall tax strategy. Trusts are particularly useful in international estate planning as they can be structured to navigate the complexities of situs tax in different jurisdictions.

Endowments and Unit Trusts for Share Portfolios to Avoid Situs Tax

Investing through an endowment structure or a unit trust presents a strategic approach to avoiding situs tax on share portfolios. Endowments offer several advantages for managing share portfolios from a tax perspective:

• Long-Term Investment Alignment: The typical five-year restriction period associated with endowments aligns well with the investment horizons for offshore and share portfolios, which are generally considered higher-risk and suited for longer-term holdings of at least seven to ten years.
• Flexibility During the Endowment Period: Investors are typically allowed certain flexibilities, including the option for one surrender and one interest-free loan.
• Tax Benefits for High Marginal Rates: Endowments can be particularly beneficial for investors with higher marginal tax rates, as they are taxed under a five-fund approach, potentially resulting in lower income tax and capital gains tax rates.

Utilising these structures can effectively reduce potential estate taxes and streamline the estate winding-up process.

Conclusion

Navigating international estate tax planning requires a comprehensive understanding of situs tax and its implications, especially for those holding worldwide assets. Situs tax, levied based on the location of assets, can significantly impact estate values in jurisdictions like the US and UK, where non-residents are subject to estate and inheritance taxes on their situs assets. Estate tax treaties, such as the US-Australia Estate Tax Treaty, offer avenues for mitigation, particularly for Australians with US situs property, by extending tax thresholds and excluding non-US assets from taxable estates.

To effectively manage situs tax and ensure efficient international estate planning, strategic tools like trusts and endowments are invaluable. These legal structures provide tax efficiencies and asset protection, helping to minimise estate tax liabilities and streamline estate transfers. For tailored guidance and expert assistance in navigating the complexities of international estate tax and implementing effective estate planning strategies using trusts and endowments, contact our experienced team at PBL Legal today.

Frequently Asked Questions