If, however, the first to die is UK domiciled, but the survivor is non-UK domiciled, the spousal exemption is restricted to the prevailing nil rate band of just £325,000.

The Finance Act 2013 allows an election to be made so that the survivor can be treated as if they were domiciled in the UK and claim the full spousal exemption.

How is the valuable domicile election made?

The election can be made by the person themselves (a lifetime election) or, if they have died, by their personal representatives (a death election). A lifetime election can be made at any time. A death election must be made within two years of the death of the deceased.

The election must be made by notice in writing to HMRC and must contain the date from which the election is to take effect.

When an election is made, the person making election will be treated as domiciled in the UK for all inheritance tax purposes from the date stated in the election. Whether to make an election and the date from which it is to take effect will require specialist advice as it could mean that a transfer that did not give rise to a charge at the time it was made now becomes chargeable.

How does this work in practice?

Let's consider this example:

Simon, who is UK domiciled, transfers property worth £2,000,000 in 2015 to his spouse, Pilar, who is non-UK domiciled. In 2017, Pilar settles high value non-UK assets into an offshore trust. Simon dies in 2020.

At the time of Simon's transfer, the value transferred is exempt up to £325,000 and a potentially exempt transfer ('PET') to the extent of the balancing £1,675,000. On Simon's death, the PET becomes chargeable.

Pilar's settlement was excluded property. Following Simon's death, Pilar has a choice of electing to be treated as domiciled in UK. If she does, the gift from Simon in 2015 will become fully exempt. However, Pilar will then be treated as domiciled in the UK from 2015 for all IHT purposes. This means that the settlement will be immediately chargeable to IHT.

Once an election is made it cannot be revoked. However, when a person who has made an election has ceased to be resident in the UK for income tax purposes for a period of four successive tax years beginning any time after the election has been made, the election will cease to have effect at the end of the fourth tax year. This is potentially useful where the surviving spouse doesn't intend to remain in the UK.