The Government has now published the long awaited consultation on its proposals to change the inheritance tax ('IHT') treatment of UK residential property held by foreign domiciled persons alongside further details on the proposed new deemed domicile rules. These rules were first proposed by the then Chancellor, George Osborne, in his post-election Budget in June 2015. Following the shock of Brexit and the political turmoil that followed, there had been rumours that the proposals might be shelved altogether or perhaps postponed by a year, but in the event they are all going ahead as planned and with very few variations from the initial proposals.
The precise details outlined below are still being consulted on. However, given the timescales involved we recommend that you now need to review your arrangements for holding UK property and consider what measures to put in place to mitigate the effect of the new rules. The note below provides some background but the right strategy will depend on your circumstances so individual, tailored advice should always be sought.
IHT on UK Residential Property
From 6 April 2017, all UK residential property owned in an offshore corporate structure will be within the UK IHT net. This means that when an individual shareholder of an offshore company owning a UK residential property dies, IHT will be charged to the extent that any underlying assets of the company consist of UK residential property. This will be a huge change for individuals who are not domiciled in the UK. At present no IHT liability arises on property (or any assets) owned through offshore companies because the assets actually in the individual's estate are non-UK shares and all non-UK assets owned by non-doms are "excluded property" and not chargeable to IHT.
There will be no changes to the general IHT position for non-doms and therefore other UK assets including commercial property held by an offshore company, will remain outside the IHT net. However UK residential property (including let property) will no longer be excluded property and so it will potentially be taxable to IHT, however held. Where the use of the property has changed from non-residential to residential or vice versa, the property will be within the charge to IHT where it has been a residential dwelling at any time within the two years preceding the chargeable event. Where the property has a mixed use, it will be within the IHT net, but the tax liability which arises will only relate to the residential part of that property.
Trust Company Structures
Similarly, where an offshore company is wholly owned by an offshore trust, any UK residential property in the company will no longer be excluded property but will be within the IHT trust charging regime, which will normally mean that trustees will pay IHT on the value of the property at 10 year anniversaries and if the property is removed from the trust after 6 April there may be an IHT exit charge. For some older trusts where the life tenant has a pre-March 2006 qualifying interest in possession, upon the life tenant's death the property will be in their estate for IHT purposes. A further potential difficulty for property held through trusts is that, when the new rules come into effect, some existing IHT avoidance rules (the Gift with Reservation of Benefit rules) may apply for the first time, with the result that the whole value of the property may also be within the individual's estate for IHT purposes. This could happen in the fairly common situation where an individual is the settlor of a trust and continues to live in the property that the trust owns. It is already the case that where the trust owns UK property directly, that property is within the IHT charging regime.
Lifetime Gifts
These changes also have implications for non-doms planning to make lifetime gifts or changes to their offshore structure. From 6 April 2017, gifts made by a non-domiciled individual of shares in an offshore company owning UK residential property may trigger an IHT charge, either immediately or if they fail to survive seven years. For instance, where a donor dies on or after 6 April 2017 within 7 years of a gift of shares in an offshore company which owns UK residential property, the value of the property given away will be within his estate for IHT purposes. The redistribution of the share capital of an overseas company which owns UK residential property may also trigger an IHT charge.
Scope of the New Rules
The changes will be effective for all chargeable events which take place after 5 April 2017, regardless of how long the property has been owned by the company and whether or not the individual is UK resident. There are no transitional provisions or concessions for existing arrangements. Individuals with existing offshore structures (particularly those where the company currently pays the Annual Tax on Enveloped Dwellings) may conclude that once the IHT protection is lost, it is no longer cost effective for the property to remain within the company. However "de-enveloping" can involve triggering tax charges which may in some cases prove prohibitive. It was hoped that the government might introduce some form of relief to enable individuals to dismantle current structures but at present there are no plans to do this.
When the new charge does apply, IHT will be charged on the value of the residential property at the time of the chargeable event (e.g. death, gift or a trust's 10 year anniversary) taking into account any debts relating exclusively to the property (e.g. amounts outstanding on a mortgage which was taken out to purchase the property). Where the offshore structure holds debts which relate to the UK residential property alongside other assets or holds only a part share in the residential property, the debt will need to be apportioned. However, there is a rather ominous remark in the consultation document that any loans made between connected parties will be disregarded when determining the IHT value of the property. This may amount to a fundamental change of policy and we await more details.
It is acknowledged that where UK property is owned through an overseas company, HMRC might have difficulties in identifying whether a chargeable event has taken place and hence whether a liability to IHT has arisen, and therefore it is intended to put measures in place substantially extending the responsibility for both reporting to HMRC and for paying any tax. The new rules do not apply to property held through diversely held vehicles.
UK Residents: New Deemed Domicile rules
Another fundamental aspect of the taxation of UK resident non-domiciles is also changing and UK residents will have to consider how this will impact on their tax affairs generally, in addition to the new IHT charge. From 6 April 2017 individuals who have been UK resident in the UK for 15 of the last 20 years will be deemed domiciled in the UK for income tax, Capital Gains Tax ('CGT') and IHT purposes. Currently there is no deemed dom rule for income tax and CGT whereas for IHT the deemed dom rule is changing from 17 of the last 20 to 15 of the last 20 years of residence. The most significant impact is that once a UK resident becomes deemed domiciled they will be subject to UK income tax and CGT on their worldwide income and gains on an arising basis.
Rebasing
There are some limited rebasing rules. Individuals who become deemed domiciled on 6 April 2017 will be able to rebase directly held foreign assets to their market value on 5 April 2017, so that any gain which accrued before April 2017 will not be charged to CGT in the UK. Any further increase in the value of an asset between April 2017 and the date of disposal will be charged to CGT in the normal way. However, rebasing will be limited to directly held assets which were located abroad on 8 July 2015 and will be restricted to those who had paid the remittance basis charge in any year before April 2017. Those individuals who become deemed domiciled in years after April 2017 will not be able to rebase their foreign assets.
Mixed Funds - Transitional provisions
As a further transitional measure there will be a temporary window, to last for one tax year from April 2017, during which individuals will be able to rearrange their mixed funds overseas to separate clean capital, foreign income and foreign gains into separate accounts. This will provide certainty on how amounts remitted to the UK will be taxed in future and enable people to choose the most tax efficient method of remitting those funds. This is quite a generous relief although it also has limitations. It will only apply to mixed funds which consist of amounts deposited in bank and similar accounts, though where an asset was purchased from mixed funds, if it is sold overseas during the transitional window, then the proceeds can be separated in the same way. However, this form of "cleansing" will not be available where an individual is unable to determine the component parts of their mixed fund, for instance where there are no or insufficient records.
Offshore Trusts
There are some changes proposed to the taxation of trusts to sit alongside the new deemed domicile rules although these are currently much more limited than expected and we are anticipating that these proposals may yet be subject to further change. The current proposal is that limited protections will be introduced to ensure that settlors should not automatically become subject to CGT on all gains as they arise and to income tax on all foreign income as it arises on settlements which they set up before they became deemed domiciled. However the concession will only (broadly) apply until the settlor or certain family members benefit from the trust, at which point this protection will be lost. Further if anything is added to the trust after the settlor has become deemed domiciled, then this concession will also cease to apply.
Scope of New Rules
Once a deemed domiciled individual has been non-resident in the UK for six consecutive years, the clock re-starts so that they can once again access the remittance basis of taxation for foreign income and gains.
There is a slight concession in the latest proposals in that deemed domicile status is lost for IHT purposes only after a four year period of consecutive non-residence. This should mean that if an individual dies after this time, but before they have spent six consecutive years outside the UK, then their foreign assets will be outside their estate for IHT purposes. However it should be noted that this will not make any difference to the IHT levied on indirectly held UK residential property (under the new rules described above) nor on UK assets generally.
A major proviso to these new rules is that they don't apply to individuals who were born in the UK with a UK domicile of origin, even though they subsequently acquired a domicile of choice elsewhere. These individuals will become deemed domiciled in the UK for tax purposes if they are resident in the UK after 6 April 2017. This is the most draconian of all the measures and the trusts of such individuals will not be protected from IHT or benefit from any of the concessions mentioned above. The one minor concession is that for IHT purposes only these 'returning UK domiciles' will not be treated as being domiciled in the UK until they have been resident for at least one of the two prior tax years.
Next Steps
All the above details are still being consulted upon and so precise details are likely to change. However, given the time scales involved, you will now need to review the relative merits of retaining or dismantling existing arrangements for holding UK property and also consider the availability of other methods of covering or reducing any new IHT liability.
If you will be deemed domiciled either on 6 April 2017 or if you are likely to be at some point thereafter, you will need to assess the likely effects on your finances and begin to put in place any necessary measures to mitigate the impact of the new rules. If you will be deemed domiciled from next April, you may also wish to consider deferring liquidity events or sales of offshore assets to take advantage of rebasing. The right strategy for you will depend on your particular circumstances so individual, tailored advice should always be sought.
If advice on a particular circumstance is required please contact your Boodle Hatfield lawyer or:
Salpy Kouyoumjian
t: +44 (0)20 7079 8245
e: skouyoumjian@boodlehatfield.com
Geoffrey Todd
t: +44 (0)20 7079 8286
e: gtodd@boodlehatfield.com
