In the Summer 2015 Budget, the UK Government announced that all interests in UK residential property would be subject to UK inheritance tax (IHT). From April 2017, shareholdings in offshore close companies or interests held in trust structures holding UK residential property will no longer be excluded property and the ultimate beneficial owners will either face a charge to IHT on their deaths
or a charge within the trust.
This represents a further assault on the tax efficiency of owning interests in UK residential property as a ‘nondom’ following a number of measures introduced to tax those investing in UK residential property through overseas companies and trusts.
The UK Government now proposes that any debt used to fund or improve UK residential property will form part of the UK estate of the creditor, wherever domiciled, and be taxed as if the debt was an interest in UK residential property. This article discusses this latest widening of the IHT net.
The current position
Currently, nonUK domiciled individuals and overseas trusts pay IHT only on their UK situs assets. This includes items such as land situated in the UK, money in UK bank accounts and shares in UK companies. Other assets, such as cash situated outside the UK in a nonUK bank account, are ‘excluded property’ and do not fall into the UK IHT net if owned by a non UK domiciled individual or overseas trust or close company. Shares in offshore close companies are themselves currently excluded property but this will no longer be the case from 5 April 2017 where the value of the shares is attributable to UK residential property, either directly or indirectly.
August 2016 proposals
Ordinarily, a debt secured on a property would be deductible for IHT purposes in recognition of the fact that the debt will have to be paid back at some point in the future. Such deductions occur on the death of the owner of that property or on a ten year anniversary if the property is held by a trust.
The UK Government had proposed in its August 2016 consultation that loans made between connected parties used to fund UK residential property should be disregarded as a debt of the owner of the property when calculating the IHT position. The purpose of the proposal was to ensure that overseas funding could not be used to decrease the value of the UK property which would be subject to IHT.
December 2016 changes
Following critical feedback in response to the August consultation, the Government abandoned this policy and, on 5 December 2016, proposed instead that from 5 April 2017 the benefit of any loan used to purchase or improve UK residential property will form part of the UK estate of the lender.
For those domiciled in the UK who have lent money, this represents no change. Money owing to a UK domiciled individual or UK resident trust will always be an asset of that individual’s estate or the trust for IHT purposes.
However, this proposal now brings into the IHT net funds that have been lent by nondomiciled individuals or offshore trusts and close companies to anybody that uses those funds to purchase or improve UK residential property.
Moreover, the Government has proposed that this will apply to all loans which represent an interest in UK residential property and not just those made between connected parties. This is achieved in the draft legislation by excluding ‘chargeable interests’ connected to UK residential property from the definition of excluded property.
A widely drafted antiavoidance provision in the draft legislation is likely to defeat complex structuring which previously allowed nondomiciled individuals to lend to those buying UK residential property, such as nondomiciled parents helping their children onto the UK property ladder, through the use of overseas companies and trusts without the loan being treated as a UK asset.
The profession’s response
Criticism from the industry has been levelled at the potential double taxation that may be caused by treating the benefit of a debt as nonexcluded property. The draft legislation sets out that if the property is sold or the loan is repaid, the proceeds of sale will still be treated as nonexcluded property for a further two years.
There could be potential for double taxation if a lender and debtor both die within the two year period. Similarly, if the debt is repaid to an offshore trust within two years of an upcoming ten year anniversary, the sum will still be nonexcluded property on the ten year anniversary date and therefore chargeable. Others have said that double taxation is likely where deductible debts are
prorated, for example, where an offshore close company holds debts relating to UK residential property together with other assets, but the benefit of the loan held by the creditor is taxed in full.
It has also been noted that collateral will also be subject to IHT, for example, if an offshore portfolio has been pledged as security for a debt, and the value of such collateral may be worth far more than the value of the residential property itself.
What should affected individuals do going forward?
The UK Government is yet to respond to these criticisms and unless further changes are made, the amendment to the definition of excluded property will be effective from April 2017. Nondomiciled individuals and overseas trusts and companies will need to act with caution before lending money that may be used to fund UK residential property, even if this is done on commercial terms. Offshore structures that hold UK residential properties will also need to be reviewed, although any planning will need to take account of the wide antiavoidance provision. The IHT net is now wider than ever.
The full article is available to read online, first published by ePrivate Client on the 31 January 2017: The net widens