Residential property and IHT

Draft legislation has now been released to subject non domiciled individuals and offshore trusts which hold UK residential property in offshore companies and partnerships to inheritance tax (IHT). The legislation will apply from 6 April 2017.

Current rules

Currently, an individual domiciled outside the UK or a non UK resident trust is generally only subject to UK IHT on directly held UK assets. To avoid a charge, it is common to hold UK sited assets through an offshore company.

Proposed changes

From 6 April 2017, shares in an offshore company will be subject to IHT to the extent they derive value from UK residential property. This could bring offshore investors into the scope of UK IHT for the first time.

The current rate of IHT is 40 per cent for individuals. Some exemptions exist where a spouse inherits. In this regards wills may need to be reviewed.

Offshore trusts are subject to IHT at a rate of up to 6 per cent every 10 years. The ten year anniversary is normally based on the date of settlement.

Debt will generally be allowed to reduce the value of the residential property. However these loans will be included in the estate of the lender. Non UK domiciled individuals and non UK resident trusts will need to assess their exposure to UK IHT when they indirectly hold or finance UK residential property.

The definition used for “residential property” has been borrowed from that used in the capital gains code. This should mean that shares and loans in widely held structures should avoid the charge.

The draft legislation also treats proceeds from the sale of UK residential property in the same way as the property itself for two years following the disposal. Where a sale is being considered, exposure to IHT could be avoided if the property is sold prior to April 2017.

It was originally proposed that a restriction on the sale of UK property on which there is an outstanding IHT charge would apply. The government accepts this would be impractical and is instead considering alternative approaches.

Example

Mr X, an individual who is neither resident nor domiciled in the UK acquires a portfolio of UK residential properties for £20 million. It is wholly funded through a loan from another company owned by Mr X.

Were Mr X to die prior to April 2017, no IHT would arise. However if he were to die after April 2017 his estate would be subject an IHT charge of c£8m.

If Mr X were married and his spouse were to inherit, the IHT charge may be avoided through the IHT spousal exemption.

What action to consider

Acting prior to April 2017 may reduce the impact of these new rules. Consideration should be given to:

  • gifting property or shares;
  • selling property or shares;
  • settling shares into offshore trust structures;
  • distributing out of trusts; and
  • ensuring wills are up to date.

The appropriate action will depend on the facts of each situation. However given the impending deadline, action needs to be taken soon as the legal and commercial implications of altering a structure can be costly and time consuming.