To the extent that shares (or other interests, including loans) in non-UK close companies and interests in overseas partnerships derive their value from UK residential property, from 6 April 2017 that value will be within the scope of UK inheritance tax (IHT). Offshore ownership structures which have previously shielded the value of UK residential property ultimately owned by non-UK domiciled individuals (non-doms) from IHT, will be liable to the tax for the first time. IHT charges will potentially arise on the death of and following certain gifts made by non-domsas well as during the life of certain trusts established by them (‘ten year anniversary’ and ‘exit’ charges). This will be the case regardless of whether the individual is UK resident or non-UK resident. The legislation makes it clear that the new rules will override all double tax treaties.
The following assets will be subject to IHT to the extent that their value is attributable to UK residential property:
Where the UK property is held indirectly via underlying companies and/or a partnership, interests whose value is less than 1 percent of the total value of an underlying company or partnership will be disregarded and the chain of indirect ownership broken.
Where an IHT charge arises on shares etc. under the new rules, the IHT liability will be calculated on the open market value of the shares (or other interest) to the extent that their value is attributable to UK residential property. In determining the value of an interest in a close company, the liabilities of the close company will be attributed to all of its property pro rata. The liabilities attributable to the residential property will be deductible in determining the value within the scope of IHT.
Under the original proposals, debts that related exclusively to the property were to be deductible when calculating the value for IHT purposes, unless the borrowing was from a connected party. In response to concerns that this could result in a double IHT charge, the Government’s solution contained in the legislation and other documentation published on 5 December 2016 is to treat any debt used to finance the acquisition, maintenance or repair of UK residential property as an asset subject to IHT in the hands of the lender, with look through provisions where the lender is itself a non-UK close company or partnership. Similarly, any security or collateral for such a debt will be within the scope of IHT in the estate of the provider of the security. Whilst this removes the potential for double counting, it would appear to defeat certain IHT mitigation options which the Government previously appeared to accept when the provisions relating to debts were revised in 2013. The application of these rules to debts, whenever created, seems unduly harsh and a restriction to debts created after 19 August 2016 (when an iteration of the provision was first announced), if not to commencement date, would be welcomed.
The rules will apply where the shares’ (or other interest’s) value is attributable to any UK residential property, whether that property is occupied or let and whatever the property’s value (subject to limited exceptions such as care homes). A property which is being constructed or adapted for residential use will be treated as UK residential property. The rules will not apply to the extent that the asset’s value is derived from commercial property.
It is to be welcomed that previous proposals to include a property which had had a residential use at any time in the last two years have been dropped. Rather, it will simply be the use of the property at the time that the IHT charge arises that will be relevant. Legislation is still awaited for properties used for both residential and non-residential purposes.
Newly included in the 5 December 2016 draft legislation are provisions such that following sale of close company shares or partnership interests which would have been within the scope of the new IHT rules, or indeed repayment of a lender’s loan, the consideration received (or anything which represents it) will continue to be subject to IHT for a two year period following the sale or repayment. This appears to be a provision introduced to combat specific anticipated avoidance. However it will, as drafted, have a wider effect and give rise to an IHT charge in normal commercial situations even where UK residential property is no longer held.
Any arrangements whose whole or main purpose is to avoid or reduce the IHT charge on UK residential property will be disregarded. This anti-avoidance provision is extremely widely drawn.
Proposals to impose a liability for any outstanding IHT charge onto the directors of a company which holds a UK residential property have been dropped following consultation. The Government is continuing to consider how to effectively enforce the extended IHT charge. It is difficult to see how this can be fully achieved.
There are no reliefs from other taxes, notably capital gains tax and Stamp Duty Land Tax, where existing property structures are unwound. Those considering alternative ownership options in light of the changes will need to fully understand the tax implications of so-called ‘de-enveloping’.
The new rules will apply to IHT chargeable events on or after 6 April 2017. Certain gifts made before that date may become liable to IHT where the donor dies on or after 6 April 2017.
We understand and support the Government’s aim to ensure parity of all residential property owners in terms of their exposure to IHT. However, the rules are widely drawn, encompass what previously appeared to be accepted planning and provide no relief to help people simplify complex property ownership structures. The Government’s approach appears to be one of all sticks with no carrots.
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If you would like KPMG to assist in considering any of the issues that could arise for you from the new rules for inheritance tax on UK residential property and/or on taxation of non-domiciled individuals, please contact a KPMG Private Client specialists.