The current position is that non-UK domiciled individuals (“non-doms”) can shelter UK residential property from UK inheritance tax (“IHT”) by simply owning the property via an offshore company. This is a long standing potential tax advantage available to non-doms and, historically, has been widely used. HMRC are of the view that this type of tax planning offers an unfair advantage to non-doms and therefore have published proposals to change the position from 6 April 2017 onwards. This proposal forms part of wider changes to the UK tax treatment of non-doms.
What are the proposed changes in relation to UK residential property?
In short, UK residential property will no longer be sheltered from UK IHT if it is owned by an offshore company. From 6 April 2017, shares in a non-UK company or similar entity that derive their value from UK residential property will be within scope of UK IHT.
What is the likely impact of these changes?
How the proposed changes will impact on a particular non-dom will depend on how the offshore company is owned.
From 6 April 2017, when the non-dom shareholder dies, the shares in the offshore company will form part of their estate for UK IHT purposes and potentially be subject to UK IHT. If the non-dom were to gift the shares in the offshore company to another individual (eg their children), the non-dom would need to live for a further 7 years after the date of the gift in order for the gift to be exempt from UK IHT. If the shares were settled into trust, there would be an immediate 20% IHT charge on the value of the company shares and potentially further IHT charges if the non-dom were to die within the next 7 years. Further IHT issues could arise if the non-dom were to continue to occupy the property post gifting the shares.
Offshore trustee as shareholder
Perhaps the most common structure is for a non-dom to own UK residential property via an offshore trust with an underlying company (with the underlying company owning the property). This type of structure should be reviewed both carefully and urgently. Many of these structures will have been reviewed from a UK tax perspective in recent years due to other tax changes which eroded their UK tax efficacy (namely, the introduction of the Annual Tax on Enveloped Dwellings (“ATED”), ATED related capital gains tax and capital gains tax for non-residents). However, many clients may have retained the existing structure on the basis that it continued to offer IHT protection (which at 40% was potentially a big saving). However, these new proposals are likely to require a complete rethink in relation to these structures.
Firstly, the shares in the offshore company will be subject to a 6% IHT charge every 10 years with further “exit” charges if the shares are transferred out of the trust. Also, it seems possible in certain circumstances for there to be a double charge to UK IHT on death of the trust settlor if the settlor is not specifically excluded from benefiting from the trust. This is because the new proposals may result in the property being within the estate of the non-dom (and potentially subject to 40% IHT) without any relief or deduction for any IHT already paid by the trustee. This potential double charge to IHT was flagged to HMRC as part of the consultation process. It was suggested to HMRC that some sort of “transitional period” should be introduced to allow non-doms to restructure their affairs in order to own UK residential property personally without the restructuring triggering further tax charges. However, these requests have been refused by HMRC.
Other proposals which should be borne in mind
HMRC have in recent years tightened up the rules on when a debt (eg a loan) will be deductible for IHT purposes (with the net value being subject to IHT). At present, subject to satisfying various conditions, both third party and connected party loans may be deductible for IHT purposes. However, the new proposals suggested by HMRC will only allow a deduction for third party loans. This would be a significant, and potentially costly, change if introduced.
How will the IHT be collected?
The way in which the IHT will be collected will be of concern to many directors of offshore companies. HMRC have suggested introducing rules which require any IHT to be paid before a UK residential property is sold and extending the obligation to pay any IHT to the legal owner of the property (ie, the directors of the offshore company). Whilst introducing these rules does not, on the face of it, present a problem to directors of offshore companies, there could be problems where events which would trigger an IHT charge are missed.
A number of chargeable events for IHT purposes are “notional” (ie the events may not result in a director considering UK IHT may be payable), for example the 10 year anniversary of an offshore trust, the gift of shares in a non-UK company into trust etc). There is no actual event within the company itself which would indicate a chargeable event has occurred. It would appear possible that a number of chargeable events could be missed before the property is sold by the company, which could be a nasty surprise for the company directors at the time of sale.
What should be done now?
Reading the new proposals, it would be easy to conclude that UK residential property currently held in an offshore company should be restructured. However, there are a number of other possible UK tax implications of doing so. It is important, therefore, to review all existing structures which own UK residential property alongside all of the existing applicable rules in order to ensure that no surprise UK tax charges arise. Undertaking such a review is likely to be beneficial not just to the ultimate client but also from the perspective of offshore company directors.
Kevin Loundes, Associate Director