By Clare Munro, Tax Partner
Ever since the government announced in summer 2015 that it would change the tax regime for non-UK domiciled people (non-doms), there has been a slow drip-feed of announcements about how the changes would be implemented. However the information for which many (including many of our clients) have been waiting concerns the proposal to bring all residential property into the scope of UK inheritance tax (IHT). After a year's wait, the government has issued a consultative document and it gives a good indication of how the new rules will operate.
As a non-dom you are only subject to UK inheritance tax on UK assets. This means that if you own your UK home or residential investment property directly, then its value is subject to IHT. If, on the other hand, you set up an offshore company to own the property, then what you own is shares in a foreign company, being an overseas asset, rather than the underlying UK property. It has therefore become standard practice to organise property holdings in this way (with a trust added above for long term UK residents).
Changes from 6 April 2017
The consultation document confirms that all residential property held for non-doms within an overseas structure will be brought within the charge to IHT with effect from 6 April 2017. It will apply where the property is owned via an overseas company or structure, whether or not there is an offshore trust in place. There is no change to IHT where the structure is owned by UK domiciled people as the value will already be in scope.
The result is that, where certain 'chargeable events' take place after 5 April 2017, to the extent that the value of the offshore company is derived from UK residential property, it will be subject to IHT. Chargeable events include most obviously the death of the underlying shareholder, but the triggers for an IHT charge actually go much further than that and potentially include gifts of shares in the offshore company and charges in relation to trusts when the shares are gifted to or extracted from the trust, and at ten-yearly intervals.
The government is aware that this is likely to be difficult to police and will introduce a power to impose the IHT charge so that the underlying property cannot be sold until the IHT has been paid. Additionally there will be an ability to recover the IHT from the legal owner, including directors of any company which owns the property.
The consultation suggests ways in which a residential property might be defined, predictably excluding structures like care homes and student accommodation. The proposals deal with changes of use to the building so that, in order to be within the IHT charge, the building must have been capable of residential use at any point in the two years preceding the chargeable event or transfer. So, for IHT purposes a building continues to be taxed as a ‘dwelling’ for two years after it has been converted to a commercial or other use. That should mean that there is no need to time apportion the value for the new charge. However, there will be a need for apportionment of value where the property has been in residential and non-residential use at the same time, for example where there are flats above a shop.
Planning for the future
In Summer 2015, the government said it would consider assisting those who wanted to unwind their company structures; whilst offshore company ownership of UK land is now unlikely to generate any tax benefits there can be significant tax costs to extracting the property from the company. We had therefore been expecting that the new rules would include some measure of relief (even if it was unclear how generous this would be). Unfortunately, the consultation document has completely squashed those hopes and it now looks as though the new rules will take effect from 6 April 2017 without any form of tax incentive or relief for those wanting to unwind their trust/company structures. For many there will therefore be a difficult choice between the cost of restructuring now or the costs of maintaining an inefficient structure going forwards.
Looking for the positives in the IHT situation, there is still planning to be done. A residential property purchase can be funded with debt so as to reduce the net value of the UK property in an inheritance tax computation. This will be effective provided that the debt is not sourced from a connected party.
Additionally, for non-doms, overseas assets whose value is not derived from UK residential property will still be sheltered from IHT. This would include commercial property. Non-doms are to lose their protected status once they have been UK tax resident for 15 out of the last 20 years; they will be considered to be UK domiciled for all tax purposes, including inheritance tax. However, by setting up an offshore trust for non-UK assets before the 15-year point, they will be able to shelter those assets from IHT for the future.
The current consultation asks a series of questions, and draft legislation has not been provided for all the details, and so it is possible that the proposals will be refined or amended before they become law. There is an anomaly in that a small number of the UK’s Capital Taxes Treaties (India, Pakistan Italy and France) over-ride the application of the existing deemed domicile rules to prevent IHT being charged on death in certain circumstances, with the taxing rights retained by the country of domicile.) India in particular is interesting as Indian Estate Duties were abolished some time ago. The draft legislation does not change this and we have seen no suggestion that these treaties are to be renegotiated – although as there would seem to have been a change of policy on some areas this perhaps cannot be discounted.
We will be putting out more letters, blogs and articles in the coming months, but the time between now and April 2017 is short and so, if this change affects you, please speak to your contact partner or to our tax partner, Clare Munro firstname.lastname@example.org.