UK property is a popular asset with investors from all over the world. The UK property market offers a solid track record, clear legal title, strong yields and good liquidity. And, perhaps more than any other major city in the world, London is seen as a safe haven and an attractive destination for high-net-worth individuals.
Together with the UK’s excellent accessibility, highly cosmopolitan population, and huge cultural and gastronomic variety, it’s easy to see why it continues to act as a magnet for foreign investors. Many British expatriates also hold UK property assets, whether as family legacy or as assets for investment or income purposes.
When acquiring UK residential property, depending on the level of investment, it was common practice for foreign investors to use structures to reduce their tax exposure – initially to stamp duty land tax (SDLT) and ultimately to UK inheritance tax (IHT), which is charged at a rate of 40% (on any amount above the ‘nil rate band’ of £325,000. Indirect ownership also provided increased confidentiality by keeping an individual’s name off the UK Land Register.
Typically, a property would be purchased using a vehicle such as an overseas company, partnership or trust, or a combination of these vehicles. But relatively recent legislation means such structures are generally no longer effective for IHT planning. From 6 April 2017, non-UK domiciles holding UK residential property indirectly through overseas corporate structures (termed as ‘enveloped dwellings’ by HMRC, the UK revenue authority) were brought within the scope of UK IHT. The new rules apply retroactively to property holding structures set up before the legislation took effect.
The UK government has also brought in a package of measures designed to make it less attractive to hold high-value UK residential property indirectly. Residential property valued at more than £500,000 attracts a higher rate of stamp duty land tax (SDLT) of 15% if acquired by non-natural persons and is also then liable to the annual tax on enveloped dwellings (ATED) on an ongoing basis.
The benefits of enhanced confidentiality via indirect ownership of property are also set to be removed. On 15 March, the Economic Crime (Transparency and Enforcement) Act 2022 introduced a public register of the beneficial owners of overseas entities (which expressly includes companies and partnerships) that own property in the UK.
Let us first look at the issue of domicile. Under English common law, every individual is born with a ‘domicile of origin’, which generally follows the domicile of their parents at the time of their birth. Domicile is unrelated to the concept of residence or nationality. It is possible for an individual to be resident in one country, domiciled in a second country, and be a national of a third country.
As a result, many British expatriates, even those who have resided in another country for decades, still find themselves – often unknowingly – UK-domiciled and therefore subject to IHT on a worldwide basis. The only way to shed a UK domicile of origin is to acquire a ‘domicile of choice’ in a different country, which involves moving to that country, establishing a clear intention to reside there permanently or indefinitely, and adequately severing ties with the UK.
If a person has succeeded in acquiring a domicile of choice in a new country but subsequently abandons their permanent home or indefinite residence there, they will automatically revert to their UK domicile of origin until such time as they have demonstrably acquired another domicile of choice.
For non-UK nationals that own property in the UK, the issues are different. An individual with a non-UK domicile of origin can generally preserve his/her non-UK domiciled (non-dom) status for a long period after becoming UK resident, which means he/she is only subject to IHT in respect of UK assets. For long-term UK residents, however, this tax benefit can be removed by the acquisition of ‘deemed domiciled’ status, which is typically acquired at the beginning of the sixteenth tax year of residence.
The effect of being deemed domiciled in the UK is that the scope of IHT extends from UK assets to all assets on a worldwide basis. However, the impact can be greatly reduced by ensuring that non-UK assets are placed into a suitable non-UK resident trust – known as an excluded property settlement – before deemed domiciled status is acquired. This can ensure that non-UK assets remain outside the scope of UK IHT.
So having established the best options for non-UK nationals and UK expats in respect of IHT on their worldwide assets, let us now turn to their UK assets. As we have seen, indirect ownership structures are generally no longer effective in protecting UK residential property from IHT and other taxes – and there are only limited options for mitigation.
Disposal by sale or gift
This is generally the only realistic option for British expats who are seeking to shed their UK domicile of origin, because retaining UK residential property may risk undermining any acquisition of a domicile of choice in another country.
It is important to remember that gifts to individuals are considered as ‘potentially exempt transfers’ for UK tax purposes. This means that they will only be tax-free if the donor survives for at least seven years after making the gift (the ‘seven-year rule’). If the donor dies within seven years, the gift will be subject to IHT.
For non-UK nationals, either UK resident non-doms (or deemed-doms) or overseas investors, disposal of UK assets by sale or gift may not be an attractive option. For UK residents, the property may be their primary residence, or it may be regarded as a legacy asset that is intended to be passed down the family. It is also important to remember that if the donor continues to derive benefit from the asset, the gift will be subject to IHT under the ‘Gift with Reservation of Benefit’ rules (GWROB).
For overseas investors, UK property assets may provide diversification within a balanced international asset portfolio, the prospect of a good long-term investment return, or a potential safe haven if the economic or political situation in their country of residence takes a turn for the worse.
For those investors who do not wish to sell or gift a UK property, the only remaining viable alternative for protecting against IHT may be insurance. In its simplest form, life insurance, as with any insurance, is a contract that offers the policy holder liquidity in the form of a cash payment when they need it most.
The beneficial owner can take out a ‘permanent’ insurance policy to cover the full amount of IHT. This is a tried and tested method of funding a potential IHT liability where inheritance planning through gifts of cash or property are not available. Their beneficiaries can then use the proceeds of the policy to pay any IHT liability that becomes due.
Two common types of permanent life insurance policies are ‘whole life’ and ‘universal life’. Both are designed to last for the policyholder’s entire life provided that the required premiums are paid, and both have the potential to accumulate cash value over time that you may be able to borrow against.
Whole life insurance policies have a fixed premium, meaning you pay the same amount every year for your coverage. Universal life insurance policies offer flexible premiums that may allow you to adjust how much you’ll pay each year by accessing some of the policy’s cash value, although you will need to pay the minimum premium amount.
While the interest paid on universal life insurance can be subject to prevailing interest rates, interest on a whole life insurance policy is fixed. Universal life can therefore provide a variety of different payment options, including a flexibility of changing your death benefits, as well as the potential to accumulate cash value over time.
Good quality permanent life policies are guaranteed not to be reviewed or altered during the life of the policy – which means that the minimum premiums and the sum assured agreed at the outset will stay the same for the duration of the policy. The sum assured is payable on the death of the last of the policyholders – so in the case of a husband-and-wife joint life policy, whichever of the couple dies first the surviving spouse must maintain the premium payments until their own death.
To avoid the proceeds of the policy also incurring IHT, the policy should be written into trust, which ensures that the proceeds can be paid to the beneficiaries outside of the estate for IHT purposes and avoiding probate or any forced heirship rules that may apply.
Premiums will vary considerably for many reasons. The policyholder’s age and state of health, and the amount to be insured will be the major factors, but premiums may also vary a great deal from insurance company to insurance company, so it is best to use an advisor in the private client space, such as Sovereign, offer to find the best solution for your personal circumstances.
Premium financing may also be available for certain life insurance policies. Private banks and premium finance companies offer loans to high-net-worth individuals to borrow against permanent insurance policies. By leveraging, financing or borrowing the money to pay most of the premium, you may be able to magnify the returns.