On 13 July 2017, the government confirmed that all policies originally announced to start from April 2017 will be effective from that date, including the extension of inheritance tax (IHT) to offshore structures holding UK residential properties. Revised draft legislation was also published. Whilst the legislation is still only draft, this provides much needed certainty, which has been lacking since the General Election was announced. Below we summarise the changes.
Interests in foreign entities which hold UK residential property
Individuals who are not domiciled or deemed to be domiciled in the UK (non-doms) and trusts which are settled by such non-doms are only within the scope of IHT to the extent that they hold UK assets; non-UK situs assets are ‘excluded property’ and are outside the scope of IHT.
The new rules extend the scope of IHT to interests in foreign entities which hold UK residential property, either directly or indirectly. Such interests, to the extent that their value is attributable to UK residential property, are no longer excluded property.
Definition of residential property
The definition of a residential property for the purposes of these rules is based on the definition of a dwelling used for the purposes of the charge to capital gains tax for non-UK residents.
Entities which will be within the scope of the rules
An interest in a non-UK entity will only be within the scope of IHT where it is an interest in a close company or partnership (or equivalent entity).
An interest will be disregarded if the interest is less than 5% of the total interests in the close company or partnership. For the purposes of considering whether the 5% threshold is met, the interests of connected persons will be taken into account. Connected persons include spouses, ancestors, descendants, brothers, sisters, trusts set up by such relatives and companies owned by relatives or such trusts.
A debt interest in a close company may also be an interest in a close company and therefore may be within the scope of IHT itself.
Valuing the interest
The rules do not look through entities holding UK residential property, instead they treat the interest in the entity itself as a chargeable asset (eg the company’s shares). It will therefore be necessary to value that asset and then determine how much of that value is attributable to UK residential property. Such a valuation will need to take into account all relevant circumstances. For example, in the case of company shares, it may be appropriate for the shares of minority shareholders to be discounted.
Where a close company owns both UK residential property and other assets, liabilities of the companywill be attributed to all of the company’s property ‘rateably’. Debts will not be deductible based on what they were used for, but purely based on the balance sheet of the company at the relevant date.
Loans use to purchase UK residential property
The new rules also extend IHT to the rights of a creditor in respect of a loan to an individual, trust or partnership used to purchase (directly or indirectly) UK residential property. Such loans are known as ‘relevant loans’.
These rules will also apply to assets used as collateral for relevant loans or an interest in a close company or partnership which is a creditor or guarantor. This will mean that although the borrower may receive a deduction for IHT purposes, the lender may be within the scope of UK IHT instead.
In addition, there may be double tax charges arising where:
- A tax charge arises for both the lender and the guarantor; or
- A tax charge arises for the lender but the borrower does not get a deduction for the loan.
It will therefore be necessary to review structures with loans to identity entities where an IHT charge may arise and if double tax charges may arise.
Where an interest in an entity holding UK residential property has been sold or a relevant loan repaid, the proceeds of sale or loan repayment will be within the scope of IHT for the two years following the disposal.
Time apportionment for trust charges
The usual time apportionment rules will apply, so that 10-year charges and exit charges will be proportionately reduced where assets have become relevant property on 6 April 2017 as a result of the new rules.
Double tax relief
As the asset subject to IHT may be the shares in a non-UK company or a loan, the terms of some treaties may exempt such an asset from a charge to UK IHT. However, no such exemption will be available if no IHT (or similar) is charged under the law of the other jurisdiction or the effective rate of IHT charged is 0%.
This means that the UK/India treaty (for example) will not provide any exemption from the new IHT rules, as no IHT is charged in India.
What to do now?
- Consider whether it would be appropriate to de-envelope structures holding UK residential property which did not de-envelope before 5 April 2017.
- Individuals, trustees and company directors should review loans used to acquire UK residential property.
- Settlors who have retained an interest in a trust created by them should consider whether those trusts hold any property which may now be within the scope of IHT and treated as within their estates under the gift with reservation of benefit rules.
For more information regarding any of the issues raised here, please speak to your usual Saffery Champness partner, or contact Clare Cromwell.