Succession planning is a complex task involving many legal considerations. Who will inherit the assets? Where are the assets located? Is a trust a good option? Which taxes are levied? These questions become even more complex when one is dealing with a cross-border estate. The potential for conflict between jurisdictions is immense, especially when we take into account the fact that estates, inheritances and gifts are, in one way or another, taxed by virtually all countries.
Certain elements of connection are important in this matter: the nationality and/or domicile of the individuals involved in the succession, as well as the location of the assets. From a civil-law point of view, cross-border successions within the European Union are regulated by Resolution (EU) No.650/2012, also known as Brussels IV or the Succession Regulation.1 The regulation entered into force on 17 August 2012, but most of its provisions will not apply until 17 August 2015.
Domicile principle
It is outwith the scope of Brussels IV to address tax matters related to succession.2 In 1982, the OECD proposed a Model Convention on Estate, Inheritance and Gift Tax (1982 OECD MC), which has inspired many bilateral treaties on the matter.3 As a general rule, the 1982 OECD MC adopted the principle of the deceased’s domicile, but made exceptions for real estate assets, as well as mobile assets that belong to a permanent establishment or have a fixed base for their activities. Countries may adopt different criteria to tax successions, and so the need to harmonise this matter arises.
According to the principle of domicile, a country would have the right to tax all the successions of people that were domiciled in its territory, no matter where the assets are located. This principle can work both ways, so one country may focus on the deceased’s domicile, while another may focus on the beneficiary’s domicile. In the case of cross-border succession, this may lead to double taxation, or to double non-taxation. The principle of domicile is coherent with the principle of universality adopted by the majority of countries on income tax matters. The problem is that one country then has the power to tax goods and assets located outside its territory.
Territoriality principle
On the other hand, the principle of locus rei sitae or territoriality enables a country to tax only the transmission of goods and assets located in its territory. The domicile of the deceased or the beneficiary is irrelevant. Again, in cross-border matters, if one country considers domicile relevant, and the other prefers to consider the location of the assets, double taxation or double non-taxation may occur.
It is not common, but it is possible to find references – for example, in the US – to the principle of nationality, whereby a country taxes the successions of its citizens.
Hybrid rules
If double taxation is a problem for taxpayers, double non-taxation is a problem for countries. That is why most countries adopt hybrid rules, incorporating the best of both worlds. These hybrid systems usually consist of taxing non-residents if their assets are located in the country’s territory, and also taxing all transmissions by residents domiciled in that territory, even if the assets are located abroad. Some countries have gone further, allowing beneficiaries domiciled in their territory to be taxed, even if the assets and the deceased are elsewhere.
Avoiding double taxation
The OECD Model Convention on Estate, Inheritance and Gift Tax was initially adopted in 1966, but it only covered estates and inheritances. It was then updated in 1982 to include gift taxes. The 1982 OECD MC is more widely adopted, and has been amended, and used as a reference, by most countries. Tax treaties with estate, inheritance and gift taxes within their scope are rare in comparison to treaties on income and capital, but they do exist, attempting to resolve the double taxation issue.
In order to avoid double taxation, the 1982 OECD MC first separates assets into three categories:
- real estate, which is to be taxed in the country where it is located;
- moveable assets that belong to a stable establishment or to a fixed base, which are to be taxed where the establishment or base to which they belong are located; and
- other assets, which are to be taxed in the country where the deceased/donor is domiciled.
In order to harmonise the different tax systems, the OECD proposes two methods of eliminating double taxation:
- the exemption method: the country where the deceased/donor is domiciled spontaneously exempts the assets that, according to the 1982 OECD MC, are to be taxed by the other country; and
- the imputation method: the country where the deceased/donor is domiciled gives a rebate on the same amount of tax that should be paid to the other country according to the 1982 OECD MC.
The first method is dependent on the good faith of the countries. The principle is included in article 31 of the Vienna Convention on the Law of Treaties, but the convention has not been adopted by all countries. On the other hand, the imputation method is perhaps more likely to be adopted, as it may address eventual differences between tax rates that countries apply to such transactions.
In fact, the imputation method has been adopted in two conventions – one between France and Canada, and the other between France and Algeria. Both conventions relate to income and capital, and contain provisions to address double taxation on successions involving residents and assets located in these countries. Both treaties allow the deduction of taxes levied on the other country.
Other examples may be found in the tax treaties between the UK and Ireland, and the US and Ireland. Although different in some respects, the aim of these treaties is the same: to avoid double taxation in cross-border situations. Additionally, Ireland adopts a unilateral relief system, by which it undertakes to offset taxes paid to countries with which it does not have a tax treaty.
Trusts
It is also important to make a brief reference to trusts, considering their relevance not only to common-law jurisdictions, from where they derive, but also to civil-law countries, as a civil-law jurisdiction may be the place of domicile of the beneficiaries and/or the place of localisation of assets. Brussels IV addresses this topic marginally, to the extent that a trust is created under a will or under statutes in connection with interstate succession. In such a case, the regulation should apply with respect to the devolution of the assets and the determination of the beneficiaries.
For tax purposes, the 1982 OECD MC is intended to be applicable to trusts as well, according to the 1982 OECD MC commentary. In fact, although trusts are not explicitly included in the text of the articles, they often provide for a transfer of the right to enjoy the benefits of a given asset (by its beneficiaries) without change in legal ownership (it is kept by the trustee), and therefore fall into the scope of article 2 of the 1982 OECD MC. To address this matter, the 1982 OECD MC commentary distinguishes between: trusts where the beneficiary has an immediate right to the whole of the income and capital of the trust; trusts where an identified beneficiary or beneficiaries have a right only to the whole or part of the income or enjoyment of the property but not the capital; and trusts where the instrument does not specify the rights of the potential beneficiary or beneficiaries, with the trustee being given discretion as to whether and for whose benefit property or income is to be distributed.4
When setting up structures to plan for succession, it is important to take many aspects into account. From a legal perspective, Brussels IV addresses civil-law concerns, but the lack of harmonisation among countries when it comes to tax aspects is of concern to taxpayers – no one wants to be taxed twice or even more. The 1982 OECD MC aimed to fill this gap and some countries have already taken steps to address this matter, but the time has come to revisit the subject.
- 1For further information on the scope of Brussels IV, see Richard Frimston, ‘The regulation whose time has finally come’, STEP Journal, October 2012, page 17
- 2Regulation (EU) No.650/2012, Official Journal of the European Union, (27 July 2012), page L 201/108
- 3The League of Nations addressed this matter in 1925. Patricia Brandstetter, Taxes Covered: A Study of Article 2 of OECD Model Tax Conventions, (IBFD, 2011)
- 4Brandstetter