Inheritance Tax and UK Residential Property

Significant changes were announced in the 2012 UK Budget to the treatment of UK residential properties held by ‘non-natural persons’ – broadly, companies and similar structures – under a new regime known as the Annual Tax on Enveloped Dwellings (‘ATED’).  The new measures took effect in April 2013, with a subsequent extension to the regime announced in the 2014 Budget, bringing more properties within the scope of the new charges.

The ATED introduced three new charges:

  • an annual charge based upon the value of the property;
  • a punitive 15% rate of Stamp Duty Land Tax for new acquisitions through non-natural persons (companies and certain other entities); and
  • a new capital gains tax (‘CGT’) charge on the subsequent disposal of these properties.

The ATED regime impacts only residential property held for anything other than investment purposes – in essence, property which is available for the ultimate beneficial owner and family – and initially applied to properties valued at £2m or more.  The extension is phased in for properties valued in the range £1m-£2m (from 1 April 2015) and £500,000-£1m (from 1 April 2016).

A new measure, announced in the Summer Budget on 8 July 2015 and due for introduction in April 2017, may now make offshore planning ineffective for the vast majority of UK residential properties, irrespective of their value or usage.

The principal benefit for non-domiciliaries of offshore property-holding companies is the inheritance tax (‘IHT’) protection that they provide.  This protection continued after the introduction of the ATED, and the decision as to whether a property should continue to be held in an offshore company became one of the trade-off between the longer-term costs under the ATED regime and the enduring benefit of IHT protection.  For elderly owners, for example, the estimated cost of the annual charges could be outweighed by the IHT saving on death.

With IHT protection lost with effect from April 2017, it may be more difficult to justify holding residential properties in offshore companies.  It seems that the only real UK tax benefit to using offshore property-holding companies is UK income tax mitigation, and only then if the rental streams are significant enough to warrant it on cost grounds and:

  • the ultimate beneficial owner is both non-resident and non-domiciled in the case of company ownership, or
  • the settlor of a trust is UK resident, and neither he nor his spouse can benefit under the terms of the trust (with the property held at underlying company level).

If the property is held personally by the non-resident, rental income is charged to UK income tax at marginal rates of up to 45%, depending on the aggregate rental income.  Furthermore, there is now a restriction on the tax relief available for loan interest paid in respect of buy-to-let properties, limiting the tax relief to the 20% rate and increasing the overall effective rate of tax.

By comparison, offshore companies in jurisdictions such as the Isle of Man are subject to a flat rate of income tax of 20%.  Ignoring practical issues, this will be the only possible UK tax benefit from 2017 onwards.  IHT protection is lost and CGT now applies to all UK residential property held by non-residents, regardless of capacity, under either the ATED regime or a new general CGT charge introduced from April 2015.

The new general CGT charge applies to those residential properties, held in all forms of non-resident ownership, which are not caught by the CGT charge under the ATED regime.  The tax charge is based upon the gain accruing after April 2015.

The income tax benefits noted above will not apply to either non-domiciliaries living in the UK who are the owners of offshore companies and settlors of offshore trust structures who continue to benefit from the trust.  In both cases, the individual in question is subject to UK income tax on UK source income.  The net taxable rental is chargeable on them at their marginal rate of tax.

The focus of recent anti-avoidance is UK residential property, based upon a perceived abuse by non-domiciliaries.  It should be noted that these changes have no impact on commercial property, which remains unaffected by ATED, the general CGT charge and the changes which come into force in April 2017.  For these properties, offshore company and trust and company structures continue to be effective mechanisms for eliminating the IHT exposure and mitigating other UK taxes.

 

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