The UK government set out proposals in the Summer Budget on 8 July 2015 for new inheritance tax (IHT) rules on UK residential property held indirectly by non-UK domiciled individuals or by excluded property trusts. From April 2017, it intends to bring all UK residential property held directly or indirectly by foreign domiciled persons into charge for IHT) purposes, even when the property is owned through an indirect structure such as an offshore company or partnership.
Individuals who are domiciled in the UK are subject to IHT on all their worldwide assets, subject to reliefs and exemptions. However, individuals who are neither UK domiciled nor deemed domiciled for IHT purposes (“non-doms”) are only subject to IHT on assets they own in the UK. Foreign assets owned by non-doms are excluded from the scope of IHT – such assets are referred to as “excluded property”.
UK residential property – the individual
If a non-dom individual dies owning UK property directly, their personal representatives or the beneficiaries of their estate are liable to IHT at 40% on the value of the UK property subject to the usual exemptions. It is irrelevant whether the deceased was resident in the UK or not.
However, as IHT is only charged on UK property directly held by non-doms, it is relatively easy for a non-dom to own such property through an offshore vehicle so as to secure an IHT advantage on UK property in a way not available to a person domiciled in the UK. This is referred to as “enveloping” the property: the offshore company owns the UK property beneficially and the individual owns the shares of the company.
UK residential property – the trust
Once a non-dom becomes UK domiciled or deemed domiciled for IHT purposes, their worldwide assets are subject to UK IHT unless they have been settled into an “excluded property trust” prior to the individual becoming domiciled or deemed domiciled here.
No IHT is charged on the transfer of foreign assets into the trust or at any later date in the life of the trust provided the trust is funded before the non-dom becomes deemed domiciled and the trust does not at any relevant time hold any UK assets directly. Excluded property trusts therefore tend to hold UK property through an offshore company. The settled property is then the foreign shares not the UK property. There is no provision in the IHT legislation to “look-through” the company and charge IHT on the underlying UK property.
The government intends to amend the rules on excluded property so that trusts or individuals owning UK residential property through an offshore company, partnership or other opaque vehicle, will pay IHT on the value of such UK property in the same way as UK domiciled individuals. The measure will apply to all UK residential property whether it is occupied or let and of whatever value.
The government does not intend to change the IHT position for non-doms or exclude property trusts in relation to UK assets other than residential property, or for non-UK assets. Nor will these reforms affect people who are domiciled in the UK.
The IHT charge on indirectly held UK property will be based on the Annual Tax on Enveloped Dwellings (ATED) rules, though these proposals will go further than ATED. ATED is limited to properties with a value of £1m and over (reducing to £500,000 and over from April 2016) and is not charged on properties held by offshore companies (and by certain other entities) that are let at arms’ length to unconnected parties. The scope of the IHT charge will have no such minimum threshold and the various ATED reliefs will not be applicable here.
The intention is that broadly the same properties currently covered by the non-residents CGT legislation introduced in Finance Act 2015 will be subject to IHT. The definitions of UK residential property and the definition for persons chargeable as enacted in FA 2015 for non-residents CGT will be used as a starting point for these reforms with any necessary adaptions where appropriate. As with non-residents CGT, diversely held vehicles that hold UK residential property will not be within the scope of the IHT charge but any closely controlled offshore company, partnership or similar structure will be within the new provisions.
IHT will therefore be imposed on the value of UK residential property owned by the offshore company on the occasion of any chargeable event. This would include:
- the death of the individual wherever resident who owns the company shares;
- a gift of the company shares into trust;
- the ten year anniversary of the trust;
- distribution of the company shares out of trust;
- the death of the donor within seven years of having given the company that holds the UK property away to an individual; or
- the death of the donor or settlor where he benefits from the gifted UK property or shares within seven years prior to his death. The reservation of benefit rules will apply to the shares of a company owning UK property in the same way as the rules currently apply to UK property held by foreign doms and generally to UK doms.
This will require a change in the legislation to provide that shares of offshore companies or similar structures are not excluded property to the extent that they derive their value directly or indirectly from UK residential property (as defined for non-residents CGT) or to the extent that the value of those shares is otherwise attributable to UK residential property. There will be no change to the taxation of UK property held by corporate structures which are owned by UK domiciled individuals or trusts that are not excluded property. The relevant property regime will also need to be amended in certain respects.
UK residential property may not be the only asset owned by the offshore company. The company may beneficially own non-UK assets such as foreign land or equities or own UK commercial property that is not subject to the change. Moreover offshore companies holding UK land may be held in more complex structures involving groups. Further complications will arise where the non-dom individual or excluded property trust does not wholly own the company.
The government will consult on the details of these proposals so as to ensure that it is only the value of the UK residential property that is subject to tax (less any borrowings taken out to purchase such UK property).
It is intended that the same reliefs and charges will apply as if the property was held directly by the owner of the company. Hence a deceased individual who owned the company shares directly will have the benefit of spouse exemption if the company shares are left to a spouse. However, spouse exemption will not generally be available if the offshore company shares are held by trusts other than qualifying interest in possession trusts and the settlor is taxed on death under the reservation of benefit provisions.
Enforcement and avoidance
Certain amendments will be made to the IHT legislation to ensure that liability, reporting and enforcement issues are addressed adequately in relation to offshore companies and non-residents generally. Further details will be given in the consultation.
HMRC is aware of a number of ways in which foreign domiciled individuals and trusts may seek to avoid IHT by manipulation of the rules involving excluded property. The anti-avoidance legislation will therefore be targeted and reviewed very carefully to stop this. Such arrangements may also be within the proposed extension of the DOTAS (Disclosure of Tax Avoidance Schemes) regulations in relation to IHT.
Enveloped properties – de-enveloping
Properties held in companies or other envelopes can be ‘sold’ by transferring the shares of that company. Such a transaction is not subject to any Stamp Duty Land Tax (SDLT). ATED was introduced in Finance Act 2013 to ensure that people enveloping residential property in corporate vehicles pay a price for that privilege by a higher SDLT rate on entry into the corporate structure and ATED. ATED is targeted only at residential property held through a company where it is occupied rather than let out to an unconnected person. Properties let to unconnected parties qualify for relief and are therefore exempt from the ATED charge.
HMRC’s research suggests that the most common reason for enveloping properties is IHT planning undertaken by non-doms. Under the present IHT regime many non-doms would not consider de-enveloping primarily because the cost of ATED does not outweigh the current benefits of the envelope and in the case of let property ATED does not apply anyway.
The proposed changes to the IHT rules will change the IHT treatment, so some non-doms and trusts may wish to remove the envelope and move into a simpler more straightforward structure outside the scope of future ATED charges, ATED reporting or ATED-related CGT. If the property is mortgaged or has increased in value since 2013 there may however, be significant costs in de-enveloping.
The government will consider the costs associated with de-enveloping and any other concerns stakeholders may have during the course of the consultation regarding de-enveloping.
A consultation will be published towards the end of the summer inviting views and representations from interested parties and stakeholders. It is envisaged that legislation will be included in Finance Bill 2017 with the changes being effective on or after 6 April 2017.