New Inheritance Tax (IHT) rules on UK residential property held indirectly by non-UK domiciled individuals or by excluded property trusts
The July 2015 Summer Budget published new Inheritance Tax residential property held indirectly by non-UK domiciled individuals or by excluded property trusts.
The rules come into force in April 2017 and will apply 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 new rules
The new rules mean 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 new rules will not 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 Capital Gains Tax (CGT) legislation introduced in Finance Act (FA) 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 as defined.
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.
The new 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.