KPMG’s Justine Howard considers the extension to the IHT rules for UK residential property
On 19 August 2016, the UK Government published another consultation document drip-feeding us a few more details about the proposed new rules that will fundamentally change the inheritance tax (IHT) treatment of UK residential property held via foreign companies. The draft Finance Bill 2017 published on 5 December 2016 now gives us a little more insight as to how these new rules will work. However, it doesn’t leave much time to do something about them!
At present, it is relatively easy for a non-UK domiciled individual (non-dom) to shelter UK residential property from IHT. As non-doms are only charged IHT on UK assets, if UK property is held through say an Isle of Man company (IOMCo), then the asset owned for IHT purposes is the shares in IOMCo and not the underlying UK property.
From 6 April 2017 this will no longer be the case. The value of the shares in the foreign company will be chargeable to IHT to the extent that their value is “derived (directly or indirectly) from UK residential property” (meaning a “dwelling”). The new rules apply only to UK residential property held via a foreign close company, ie a company controlled by five or fewer persons or by its directors.
In simple terms, if IOMCo holds a UK property worth £1m and other assets worth £2m, the value of the shares attributable to the UK property would be £1m. It is this amount that would be brought within the scope of IHT under the new rules after taking into account any allowable debt.
However, it seems that a debt should be allowable whether it relates to a loan used to purchase the property OR shares in IOMCo. The flip side is that this debt – whenever created and regardless of the residence/domicile status of the lender – will itself be within the scope of IHT if the lender dies.
It is also worth noting that consideration (or anything that represents it) received on a potential sale of IOMCo, or repayment of a lender’s loan, which was previously caught by the new IHT rules will continue to be subject to IHT for a further two years! This will therefore not only apply to normal commercial situations but also to a sale of IOMCo within two years prior to death.
The definition of a dwelling for these purposes will be modelled closely on the Non-Resident CGT (NRCGT) definition which came into effect on 6 April 2015 and will therefore apply to dwellings under construction off-plan as well as existing properties. There will be no exemptions for properties occupied as a main residence, or for properties used in a rental business.
The proposal to impose a liability for any outstanding IHT charge on the directors of a company which holds UK residential property has, thankfully, been dropped following consultation. However, whether the UK Government will try to introduce some other mechanism to enforce the extended IHT charge remains to be seen.
There will be no “de-enveloping” relief from other tax charges, such as Stamp Duty Land Tax (SDLT) and NRCGT, for those wishing to unwind structures falling within the new IHT charge. So those who adopted a “wait and see” approach may want to start reviewing their position and considering any restructuring opportunities available to them.
The draft legislation makes it clear that the new rules will override all double tax treaties, eg those the UK has with India and Pakistan, unless tax is payable in the other country. These treaties specifically exempt any charge to IHT arising on death in certain circumstances, with the taxing rights retained by the country of domicile.
Finally, a Targeted Anti-Avoidance Rule (TAAR), which is extremely widely drawn, will be applied where arrangements whose whole or main purpose is to avoid or reduce the IHT charge are put in place.
One might then ask whether there is now any benefit to holding UK residential property in a foreign company and the answer is: it depends! Foreign companies may still benefit from lower rates of income tax on UK rental income whilst also avoiding the Annual Tax on Enveloped Dwellings (ATED) if the appropriate ATED relief is being claimed.
But it is probably safe to say that if the property is going to be personally occupied by the beneficial owner and/or his/her family, there may be some merit in holding the property directly, now there are no capital gains tax or inheritance tax benefits of holding the property in a foreign company. Whether an existing structure should be “de-enveloped” may depend on whether it can be done in such a way as to avoid immediate SDLT and CGT charges.
There is also still planning to be done going forward. For example, a residential property purchase can be funded with qualifying debt so as to reduce its net value for IHT purposes, insurance can be taken out to cover any potential IHT liability that may arise and the ownership of a property may be spread between family members in order benefit from several nil rate bands in the event of death.
Finally, it’s worth remembering that the new IHT rules only apply to UK residential property. Non-doms can still benefit from holding other non-UK assets and UK commercial property in a foreign company so perhaps all is not lost - yet!
© 2019 KPMG LLC, an Isle of Man Limited Liability Company and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.