Non-dom taxation: inheritance tax treatment of residential property held in offshore structures from 6 April 2017.
A series of meetings have been held between interested stakeholders, HM Revenue and Customs (HMRC) and HM Treasury following the issue of the recent consultation document and draft legislation around the planned changes to the taxation of non-UK domiciled individuals from April 2017. A key area of these proposals relates to the future taxation of UK residential property held within offshore structures. We consider the latest proposals in this area.
One of the more far reaching of the planned changes to the taxation of non-UK domiciliaries (non-doms) concerns the taxation of UK residential property held within offshore structures. The consultation document, published in August earlier this year, reaffirms the government's plans to bring residential properties in the UK within the charge to inheritance tax (IHT) where they are held within overseas structures.
In this respect it is important to appreciate that the residence and domicile status of the ultimate owner of the property held in the structure has no bearing on whether a charge to tax should apply. Equally this is the case as regards the tax status of the settlor of any non-resident trust that acts as the ultimate owner of the property concerned.
Whilst it is understood that a number of questions are yet to be resolved, it is still proposed to bring the changes in as of 6 April 2017. This means that time is short, and steps may need to be taken relatively quickly to improve the tax position going forward before the changes become law.
Draft legislation is expected to be published on 5 December 2016 which means that it will be important to have completed any strategic reviews prior to this date, as well as sketched out any possible course of action. This suggests that outline discussions with banks over possible refinancing options should be considered sooner rather than later.
Although the draft legislation suggests that the definition of property for these purposes will be taken from the legislation relating to the annual tax on enveloped dwellings (ATED), the consultation documents suggests that the definition will be drawn from the capital gains tax rules.
All UK residential property falls within the ambit of the charge to tax, even if let out on a commercial basis. However, commercial property will stand outside of these rules, so no immediate action is required where such property is held in offshore wrappers except where there is a prospect that such property might be converted to residential use in the relatively near future.
Where a non-residential property has been previously used as a residence, it is proposed that the property will be within the IHT regime where the property has been residential property within the two years before the chargeable event. This will mean that rules will need to be introduced to address the situation where non-residential property is purchased that would otherwise be caught.
What is proposed?
The government proposes to treat UK residential property held in offshore envelopes, such as non-resident companies and partnerships, as being UK sited property for IHT purposes.
In addition, the aim is to look through the offshore entity and tax the ultimate owner of the shares or partnership interest as the owner of the property and subject to tax. The intention is to legislate the change in such a way that double tax treaties (such as the India and Pakistan estate agreements) offer no protection from the charge.
This would mean that a gift of shares in a foreign company owning UK residential property after 5 April 2017 would be treated as a potentially exempt gift if made to another individual such as an adult son, but this would be an immediately chargeable transfer if made to a trust for example. Similarly, UK residential property that could be traced through to a discretionary trust would suffer exit and ten yearly charges.
Under current proposals, the gift with reservation of benefit rules could also apply where a donor had retained an interest in the property concerned, so that its entire capital value was taxable irrespective of the amount of debt charged on the property concerned. This means that existing offshore structures should be reviewed with care.
Valuing interests held by companies
The new approach poses a number of challenges, such as the basis of valuing the property interest. Recent indications suggest that the intention is to base the value of the property subject to tax taking into account the size of the shareholding or partnership interest held. This suggests that minority discounts should be allowed, subject to the introduction of safeguards to protect the tax position against abuse.
Debt charged on the property
The tax consequences of charging debt on property held within a corporate structure, or where a partnership is involved, is relatively complex. This is all the more so as the consultation document proposes that debt will only be deductible where it relates to the value of the residential property concerned, and does not involve a loan between connected parties.
Where loans are between connected parties, the debt will be disregarded. Practically this means that any planned refinance of property held within a structure should take such considerations into account. However, it would be prudent to delay any refinancing until after the publication of the draft legislation in early December at the very least.
The position as regards the possibility of introducing de-enveloping relief has remained unchanged. There appears to be no realistic likelihood of introducing such a relief. The Stamp Duty Land Tax implications of de-enveloping can be complex, so it is important to take professional advice at an early stage.
Enforcing the charge to tax
As suggested by the consultation document itself, serious consideration is being given to how the liability to tax will be enforced should a charge to tax arise in the future. The consultation document suggests that HMRC should have an expanded power to impose the IHT charge on indirectly–held residential property so that the property cannot be sold until any IHT liability has been paid. The document also proposes that liability for the IHT due can be extended to the legal owners, including the directors of the company owning the property.
Summary and further information
These wide ranging changes to the UK's tax regime will need to be considered by non-resident trustees and shareholders of nonresident companies holding UK residential property. In particular, offshore trustees will need to have a good knowledge of the way that such property has been financed. Professional advice on the options for unwinding structure or the consequences of retaining them will be crucial to ensure that any unnecessary tax exposures are mitigated for property owners.
For more information, please contact Andrew Cockman, Director – National Tax Office.