It was announced in the Summer Budget 2015 that, from April 6 2017, inheritance tax (IHT) would be extended to offshore structures holding UK residential property that to date have escaped IHT entirely. On 19 August, a further consultation paper was published giving fuller details on the proposed new law.
The main types of structures that will be affected by the changes are:
- Non-UK companies holding UK residential property where the shareholder is a non-UK domiciled individual.
- Non-UK companies holding UK residential property where the shareholder is a non-UK trust.
Since the 2015 budget announcement, many clients with structures potentially affected by the proposed changes have waited before making decisions on how to proceed. This was due in part to the lack of information about how the new rules will work. In addition, unwinding structures where properties are standing at a gain or where there is outstanding borrowing may also give rise to other UK tax charges. There was mention in the original announcement that some type of relief may be introduced to reduce tax charges if properties are removed from structures as a result of the proposed changes. The consultation paper now provides a clear steer on how the new rules will take effect and so clients need to start making decisions about how to proceed.
The proposed changes are mainly aimed at corporate structures, but it appears from the consultation paper that other structures may also be targeted. For example, offshore debt/loan trust structures may well be caught by new anti-avoidance provisions (either those disregarding loans made between "connected parties" or under a new targeted anti-avoidance rule designed to catch other types of IHT planning in relation to UK residential property) when arriving at the value of the property exposed to the IHT charges.
New tax charges
The consultation paper contains a comprehensive list of events that will be exposed to IHT from 6 April 2017 which were previously protected from tax. The main events of interest will be:
- The death of a shareholder (40% IHT exposure).
- The death of a shareholder within seven years of a gift of company shares (maximum 40% exposure, subject to taper relief if the shareholder survived more than three years from the date of the gift).
- IHT charge on each ten year anniversary of the settlement (maximum 6% IHT exposure).
- IHT charge when company shares are distributed from the trust (calculated by reference to how many quarters have elapsed since the last ten year anniversary, rising by 0.15% per quarter).
- If the settlor is not excluded from the trust, the property will be included in his estate on death (40% IHT exposure).
The current thinking is for the same properties that come within the non-resident capital gains tax (CGT) charge to be subject to the new IHT regime. Please note that certain key CGT exemptions will not apply for IHT purposes (the most relevant being properties that are used as an owner's only or main residence – these properties will also be exposed to IHT). In addition, the exclusions from the annual tax on enveloped dwellings (ATED) will not apply – so properties let to tenants will also be within the scope of the new IHT charge.
ATED was introduced in 2013 and the decision was made by many that the annual charge was a price worth paying in the light of the continued IHT protection afforded by the company structure. This may need to be re-considered in the light of the new rules.
The amount exposed to IHT will be the value of the company shares referable to the underlying value of the UK residential property. The consultation paper uses the example of a property worth £1 million held by a company whose shares are worth £950,000. In those circumstances, only the value of the shares (£950,000) is exposed to IHT and not the full market value of the underlying residential property.
Borrowing relating exclusively to the property should in principle be deductible for IHT purposes. However, borrowing arrangements should be reviewed as there are many traps and pitfalls for the unwary (for example the consultation paper states that borrowing between connected parties will be disregarded but provides no further details).
An IHT return will need to be submitted wherever an IHT charge arises (and in some cases where there is no IHT is actually payable but a reporting obligation arises). Responsibility for paying the tax will fall in the first instance on the trustees or the executors of the deceased shareholder's estate (failing which, the heirs) as appropriate.
In addition, the UK tax authorities will be given extended powers to ensure that UK residential property cannot be sold until any outstanding IHT has been paid and a new liability to tax will be imposed on legal owners of properties (including directors). Professional directors will therefore need to have a clear understanding of their obligations and exposure to tax under the new law.
Reliefs from unwinding company structures
Despite the initial comment in the Summer Budget 2015 announcement that transitional rules may be introduced to relieve tax charges arising on unwinding company structures, the government has decided that this will not be the case. Therefore if the decision is made to de-envelop UK residential property, the tax costs will need to be considered carefully:
- The company may be immediately subject to CGT on a disposal of the property. This will be either "ATED-related CGT" or the non-resident CGT charge (or a combination of the two).
- UK resident shareholders may be exposed to CGT (on any element of gain to the extent the company is not taxed on it) under the anti-avoidance legislation attributing certain company gains to shareholders.
- UK resident beneficiaries of trusts who have had the benefit of rent-free accommodation may be exposed to CGT by reference to this benefit (both in the current year and in previous tax years).
Stamp duty land tax (SDLT)
If there is outstanding borrowing, a distribution of the property subject to the debt may give rise to an SDLT charge (up to 12% on the amount of the outstanding debt).
If the decision is made to remove the property from the company, then the timing needs to be considered carefully. At first glance, distributing the property from the company as soon as possible may seem attractive to stop the ATED charge from running.
However, there will be circumstances where deferring the distribution until the end of the tax year is preferable. This might be the case where the shareholder is elderly or in ill health for example. In that case, retaining the IHT protection of the company until the last possible point may be attractive.
Targeted anti-avoidance rule
Non-UK companies are not the only way in which IHT is avoided on UK residential property. The consultation paper also announced the intention to bring in a new rule which will mean that any arrangements where their whole or main purpose is to avoid or mitigate a charge to IHT on UK residential property will be disregarded. Therefore all other structures, and not just those making use of a non-UK company to protect property from IHT, should be reviewed to determine the potential IHT exposure.
Of course, tax is just one factor to take into account when deciding how to proceed. Structures also afford other benefits (succession planning and increased flexibility for example). The position needs to be considered in the round before taking action.
In addition, property law issues also need to be considered, particularly in relation to leasehold properties. For example:
- Some leases give landlords the right to first refusal on a disposal of the lease.
- If a lease extension or enfranchisement is in prospect, a change in owner can have unintended consequences and increase the timeframe for an application.
The current consultation will run for nine weeks and will close on 20 October 2016. Given the short timescale between now and the end of the tax year, we advise that clients start to take advice and weigh up the different tax and other costs involved in de-enveloping. This will mean that they can make considered and well supported decisions, with time to implement any changes in an orderly fashion bearing in mind that the work will involve both UK and foreign law issues.
If you require further information on anything covered in this briefing please contact Debbie Pennington (firstname.lastname@example.org, 020 3375 7186) or your usual contact at the firm on 020 3375 7000. Further information can also be found on the Private Wealth Matters page on our website.
This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.
© Farrer & Co LLP, August 2016