The Government has confirmed its intention to make UK residential property held indirectly by non-doms through an offshore structure chargeable to UK Inheritance Tax (IHT). As planned, this will begin on 6 April 2017.
Although the proposal was first announced as far back as July 2015, draft legislation effecting this change was only published on 5 December 2016 – and it contains some surprises.
Main features of the draft legislation
Main features of the draft legislation
Affected structures clarified
Owners of interests in partnerships and closely held companies whose value is derived, directly or indirectly, from UK residential property, are the key targets.
A close company broadly means one owned by five or fewer participators (essentially anyone who has an interest in the company, not just shareholders), or owned only by directors, who together control the company.
Debt in the structure
The Government’s 18 August Consultation envisaged that debt funding provided by connected parties would be ignored when valuing an interest for the purposes of these changes.
This proposal has been shelved. Instead, any person providing a loan, or offering money or money’s worth by way of security, collateral or guarantee, to an individual, a partnership or a trust where the funds are used to finance the acquisition, maintenance or enhancement of UK residential property will be treated as having an asset that is within the charge to IHT. Funds used to invest in close companies or partnerships who carry out the acquisition etc. instead are also caught.
However, any such loan can be deducted (unless otherwise disallowed under existing IHT legislation) when valuing the close company or partnership interest.
It does not matter when the loan or collateral etc. was provided, making this element of the legislation retrospective. The entire value of the collateral or guarantee will be subject to IHT, regardless of the value of the UK residential property that it relates to.
If the close company has liabilities and owns a number of assets, in addition to UK residential property, the liabilities are to be attributed to all the property rateably (regardless of the actual position).
Two year tail
After 6 April 2017, for owners of qualifying company or partnership interests or who have lent funds or provided collateral or a guarantee, IHT exposure will continue for two years after ownership of the qualifying interest or the other arrangement ceases.
Secondary IHT liability for company directors dropped
The Government had planned to make directors of affected close companies liable in certain situations to any IHT that may arise under the new rules, if the company was the legal owner of the UK residential property. However in the Autumn Statement, the Government announced that it would consider alternative approaches to enforcement.
A widely worded Targeted Anti-Avoidance Rule will apply to counteract any arrangements whose purpose, or main purpose, is to secure a tax advantage by avoiding or minimising the effects of the new look-through rules.
The changes will be of concern to individual owners of close company and partnership interests, and trustees, who must now get to grips with the IHT relevant property regime and its periodic charges to IHT. Here are some points for consideration:
- As the definition of a participator in a close company is very wide, it may be worth checking whether all companies within the structure are really closely held. Ownership of UK residential property through unit trusts or widely held companies will act as a block against these provisions.
- The proposed two year tail provides another major incentive to de-envelope before 6 April 2017 for those who have decided that it is the right course of action for them. The Government confirmed in its consultation response that no de-envelopment relief will be provided.
- Structures must now be reviewed for the existence of loans, security, collateral or guarantees so that the IHT implications for the providers of those assets can be assessed and consideration given to changing the finance structure if possible and desirable.
- If a close company with liabilities contains a mixture of assets including UK residential property, consider moving the non-UK residential property out of the company so that the value of the close company shares under the new IHT rules will be reduced by the liabilities as much as possible.
- The introduction of the TAAR will make contrived avoidance of the new rules risky. The difficulty will be determining when the line is crossed.