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April 10, 2017

Inheritance Tax on Residential Property in Offshore Structures

Finance Bill 2017 has introduced a number of changes which will affect the Inheritance Tax (IHT) exposure of non-UK domiciled taxpayers who hold UK residential property though offshore structures.

As a part of these changes, new rules will ‘see through’ to residential property held via offshore close companies and will be included in the non-domiciled individual's estate for IHT purposes.

Overview of Current Rules

For non-domiciled taxpayers, IHT will normally only be charged on UK situs assets (i.e. assets in the UK).

Property outside the UK is normally excluded from IHT where the individual beneficially entitled to it is domiciled outside the UK.

Domicile is a common law concept and broadly refers to the country with which a person has a substantial and enduring connection with.

As a result of the current rules it was possible to hold UK situs assets like residential property in offshore companies and trusts (aka “enveloping”).

By enveloping the UK assets in offshore structures, the non-UK domiciled taxpayer could avoid IHT as they only retained an interest in a non-UK asset (e.g. non-UK shares).

Proposed Changes

Over recent years successive governments have acted to increase the tax burden associated with holding UK residential property in complex structures, such as through the introduction of Non-Resident Capital Gains Tax (NRCGT), the Annual Tax on Enveloped Dwellings (ATED), a 3% surcharge on Stamp Duty Land Tax (SDLT), and higher rates of Capital Gains Tax (CGT) on residential properties.

If enacted, the proposed changes in the Bill would extend IHT to the following assets:

  • >5% interests in close companies or partnerships owning UK residential property;
  • Loans or collateral, securities, or guarantees for a loans which have been used to acquire (directly or indirectly) or maintain or enhance UK residential property.

A ‘close company’ is a limited company with 5 or fewer participants or where all the participators are also directors. Whilst this definition is normally limited to UK companies, the draft legislation extends to companies that would be a ‘close company’ if they were resident in the UK.

It should be noted that these changes concern UK residential property and so commercial property remains unaffected by the new legislation.

These changes will also affect trusts settled by non-domiciled settlors.

“Two Year Tail”

From 6 April 2017, non-excluded assets caught by these new rules can still remain within the IHT net even if they are disposed of or replaced for excluded property.

The value of the non-excluded assets will remain within the IHT net for two years from the date of disposal/replacement.

Deemed Domicile Rules for Long Term UK Residents

From 6 April 2017, an individual who is not domiciled in the UK will be deemed to be UK domiciled for income tax, CGT and IHT purposes where they are UK resident in 15 out of the preceding 20 tax years, or were born in the UK with a UK domicile of origin and return to the UK after having left and acquired a non-UK domicile by choice.

This also applies to individuals under the age of 18.

For those who are deemed UK domiciled under the new rules, the deemed UK domicile status would fall away where they leave the UK for at least 6 consecutive tax years.

If you have any queries with regards to Inheritance Tax, please contact Vikki Elliott at vikki@pd-tax.co.uk.

Contact us today to discuss your tax requirements.
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