08 April 2023
For historic inheritance tax (IHT) planning reasons, many non-UK residents and non-UK domiciled individuals hold UK residential property within an offshore company that is either directly owned by the individuals or via an offshore trust. Following changes introduced with effect from 6 April 2017, all UK residential property interests are now within the charge to UK IHT, regardless of how their ownership is structured. As a result, many offshore trustees who hold UK residential property interests via underlying company structures are within the UK tax net.
As a brief reminder, a residential property interest for this purpose includes:
the value of shares in a non-UK close company which is attributable to UK residential property; and
the value of loans used to purchase or maintain UK residential property.
Potential IHT charges
One consequence of holding UK residential property through a trust is a potential IHT charge on the occasion of each 10-year anniversary of the creation of the trust. Some trusts that have been in place for a long time may not realise that an IHT charge is due because the value of the residential property interest was not within the scope of IHT before 6 April 2017. Trustees, especially those who have taken over an existing investment ownership structure, need to check when the trust was first established to determine when the 10-year anniversary will fall. IHT charges may also arise on the distribution of assets from the trust. When calculating the IHT charge, relief is available for the period when the trust assets would have been excluded property under the pre 6 April 2017 rules, on a time apportionment basis.
Trustees can also be exposed to IHT where the trust holds shares in a company and makes loans to the company, or an underlying entity, for the purpose of acquiring or maintaining UK residential property. The receivables in respect of the loans are treated as UK situated assets of the trustees for IHT purposes, both while the loan is outstanding and for two years afterwards.
In addition, any assets given as security, such as collateral or as a guarantee, for such a loan are within the scope of IHT in the estate of the provider of that security, up to a maximum of the value of the debt.
The position can be particularly complex where the company holds foreign assets, which remain excluded property, in addition to UK residential property, or where there is a loan used to purchase or maintain UK residential property. In these circumstances, an apportionment, on a just and reasonable basis, of the value of the company’s shares is required to reflect the amount attributable to excluded and non-excluded assets. Any valuation should also take into account other factors, such as inherent liabilities to the annual tax on enveloped dwellings (ATED) and an appropriate discount for minority interests.
Care is required, even after the disposal of UK residential property. For example, where a company owning such property is sold, the sales consideration continues to be treated as relevant property for the next two years where the proceeds are held offshore and would otherwise be treated as excluded property. The additional two-year period does not apply, however, if the property itself is sold. Lastly, it is important to remember that the rules do not apply to commercial property. Where a trust holds shares in a company which in turn owns a portfolio of properties in the UK, it is important to review the use of these properties to determine whether it may have changed or could be changed in the future and affect the IHT position.
Recommendations for trustees
Trustees should undertake a review of any trust which directly or indirectly owns UK residential property interests to determine the IHT position. In particular, they should consider the purpose of any loans, whether outstanding or recently repaid, that have been made by the trust or associated companies. It is not unusual for trustees to make loans to beneficiaries rather than distributions, with a view to mitigating the beneficiaries’ UK income tax and capital gains tax exposure. As a result, it may be tricky to identify, over time, whether a loan was partly or wholly used to maintain or enhance UK residential property. Records that could be checked to identify the relevant facts include notes in the trust accounts (if prepared) and trustee minutes, but it may be necessary to talk to the beneficiary involved. Keeping accurate records, documenting the purpose of loans and carrying out detailed due diligence when taking over an existing trust structure are all essential actions that trustees should undertake to ensure compliance with any potential IHT reporting obligations and to correctly identify IHT liabilities.
For more information, please get in touch with Anne Perrotin or your usual RSM contact.