Offshore companies holding UK residential property will no longer be opaque for UK Inheritance Tax (IHT) purposes from 6 April 2017. The change is being achieved, courtesy of the Finance Bill 2017 as currently drafted, by removing IHT ‘excluded property’ status from an interest in a closely held company (see the 15 December 2016 blog for a brief definition) which derives its value, directly or indirectly, from UK residential property. In plain English, that means that anyone owning a right or interest in such a company will have an asset that will be taxable to 40% IHT if the person owns that interest on death. The same situation applies if instead the person is a partner in a partnership invested in UK residential property.
From the introduction of the Annual Tax on Enveloped Dwellings (ATED) in 2013, using a company to hold a UK residential property came with an annual ATED tax bill, if the property was simply used as a family residence, but as the company structure prevented the UK property from being exposed to IHT, this was an annual price that many non-UK domiciled families were willing to consider paying. However, now that the IHT protection of the company is being lost, as a result of the Finance Bill 2017 changes, a key reason for keeping a UK residential property in an offshore corporate structure is about to be lost. Not surprisingly, therefore, removing the residential property from the corporate structure into personal ownership is becoming more prevalent.
For many non-domiciled families with UK residential property interests, this will be their first brush with IHT. Two key planning points will be of interest to non-dom families faced with this new predicament.
Firstly, a tax deferred is potentially a tax mitigated. Married couples jointly owning UK residential property in their personal capacities should ensure that they make UK Wills leaving their UK residential property outright to each other on death or, if that is not desired, in a certain sort of trust written into the Will instead, which gives the surviving spouse a life interest in the property. If a Sharia compliant distribution will be required on death, a suitably flexible life interest will trust may still offer an acceptable solution. Structuring matters this way will ensure that, on the death of the first spouse, their interest in the UK property will attract the benefit of the generous, 100% IHT spouse exemption, so that no IHT will be payable on the first spouse’s death. The deferral will give the surviving spouse the opportunity to sell the UK residential property and take the sale proceeds out of the UK before the surviving spouse’s death. As long as the survivor does not own UK residential property at their death, there will be no IHT provided the sale proceeds are abroad. For some families, this simple estate plan will suffice. In short, making a UK Will in the correct format secures a complete IHT exemption for non-dom married couples on the first death.
If the corporate structure owning the UK residential property interest is to be retained notwithstanding these changes, the owner of the interest in the company should ensure that their interest is left to their spouse in a way that attracts the IHT spouse exemption. As the company will invariably be a non-UK company, advice should be sought in the jurisdiction in which the company is registered as to whether making a Will in that jurisdiction will be the best means of transferring the interest in the company to the surviving spouse on death. An English tax adviser can confirm whether the terms of any foreign Will will secure the IHT spouse exemption.
Secondly - be wary of the potential IHT consequences of lifetime gifts of personally held UK residential property. The IHT legislation prevents lifetime gifts of assets being effective for IHT purposes if, at any later stage, the gifted property is not enjoyed to the virtue entire exclusion of the giver. These are referred to as gifts with reservation of benefit. According to HMRC, that means that if parents give their occasional London residence to, say, their children and continue to occupy that residence in the absence of the children for more than two weeks each year thereafter, the residence will still be taxed to IHT on a parent’s death, even if the parent had made a Will in the format above. There are a couple of statutory let outs to the reservation of benefit rules for gifts involving residences but, in general, gifts with reservation of benefit are to be avoided at all costs.