Inheritance Tax changes for non-UK residents | Impact & Changes
Our 3rd newsletter focuses on the impact of the forthcoming changes to the UK’s tax regime, which will radically affect the traditional structures adopted by non-UK residents who hold significant investments in UK prime residential real estate. The benefit of these corporate structures or ‘envelopes’ have meant that non-UK residents could hold property without any liability for inheritance tax. However, UK tax authorities have decided to disregard such structures and apply inheritance tax on such property after April 5th 2017. This newsletter is meant to bring this to your attention and to encourage you to seek specialist advice if you are directly affected by these changes.
We look forward to your feedback and enquiries. Enjoy the read!
“TO DE-ENVELOPE OR NOT TO DE-ENVELOPE”
UK Residential properties held in corporate structures are subject to IHT from April 5, 2017
It has been common practice for persons who are not domiciled or resident in the UK to own UK residential property through a corporate structure or a trust registered offshore. The purpose of such structure was historically to provide protection from a range of UK taxes e.g. Capital Gains Tax (CGT); Stamp Duty Land Tax (SDLT) and Inheritance Tax (IHT). However, through a series of changes in the UK tax regime since 2013, such structures (and the properties they hold) have become subject to these taxes, as well as the newly introduced ATED (Annual Tax on Enveloped Dwelling). The final “nail in the coffin” for these structures is the recent announcement that UK residential properties held in such structures would become subject to IHT from 5th April 2017. This removes altogether the final tax advantage of such structures.
What is De-Enveloping?
Dismantling or “De-enveloping” of Corporate structures would be advisable in many cases – Before 5th April!
The term “de-enveloping” was coined by the UK tax authorities (commonly referred to as ‘HMRC’). In order to ensure that the new tax regulations would not only refer companies, HMRC came up with the term “corporate envelopes” to include all the forms of holding structures used for residential properties. In most cases however, the corporate envelope will be either:
A non-UK company - with the shares held by a non-resident or non-domiciled person – owning UK residential property
A non-UK company - with shares held by an offshore trust – owning UK residential property
It is clear from the upcoming changes to the UK tax regime which take effect on 5th April 2017, that residential property holding structures will be disadvantaged going forward, at least for tax purposes. Even other advantages like confidentiality and asset protection are becoming limited.
The dismantling of such property holding structures (whether companies or trusts) is referred to as “de-enveloping”. This is an exercise in re-structuring which, though possible after 5th April 2017, will most certainly be easier and less costly if done before that date.
Planning and implementation should start now, if not already in process, as completion prior to April 2017 may be impossible.
No Tax Relief
The UK Government has declined to offer any tax relief for de-enveloping of structures which have already been subject to other taxes in the interim, such as ATED or SDLT; therefore the choice to be made is for the ‘least bad alternative’. There is no cheap or easy fix.
To De-Envelope or Not To De-Envelope?
In making the decision whether or not to de-envelope, you should consider the following questions:
Question 1: Is the property Commercial or Residential?
Commercial property is not subjected to the forthcoming IHT changes
Property is defined as ‘Commercial’ (and therefore not subject to the forthcoming IHT changes) only if it is not a place for someone to live. Even if residential property is let out on a commercial basis, it is still residential for these purposes. However, you should take specialist advice if the property is institutionally residential e.g. student accommodation, nursing home etc.
Commercial property is not subjected to the forthcoming IHT changes.
Question 2: Is the property occupied by family members or as a holiday home (and is it held in a company or trust)?
Care should be taken not to trigger a “gift with reservation of benefit” – if property is gifted to family members
If the property is occupied by a family member and held only by a non-UK company, it may be advisable to just liquidate the company, as it will no longer provide IHT protection after 5th April 2017. This will also eliminate any burdensome ATED charge which applies to such property.
However, if the property is held by a non-UK company the shares of which are settled in an offshore trust, the crucial question is whether the settlor is willing to exclude himself from deriving any benefit from the trust property after 5th April 2017? Where the settlor of the trust is still alive and capable of benefitting, it is not advisable to retain the trust because HMRC will most likely deem there to be a ‘gift with reservation of benefit’ (GROB) and will treat the trust property as still belonging to the settlor for IHT purposes. Therefore, on the death of the settlor (after 5th April 2017), the 40% IHT charge would apply, in addition to the 6% IHT charge which applies every 10 years.
Question 3: Are there any benefits of retaining the ‘envelope’ structure?
The main benefits, which may be of limited value when weighed against the costs of paying IHT and possibly ATED are:
- Protection - especially in the event of litigation
- Confidentiality - though the recently introduced global Common Reporting Standards is likely to erode this
- ‘Buy to let’ property – which is held in a non-UK company will not be liable to ATED and rental income will be taxed at a lower rate than income tax.
Question 4: What Next - after De-Enveloping?
Careful structuring is required to mitigate inheritance tax where possible
After reaching the decision to de-envelope, if indeed it is the best of the ‘least attractive options’ – you will need to carefully consider how to hold the property (after removing it from its corporate envelope), whilst still concerned about mitigating any IHT exposure.
The new ownership structure will most likely involve personal or co-ownership; therefore mitigating Inheritance tax could be done by any of the following methods:
- making a UK Will which leaves the property to a spouse on death (under the spousal exemption rules);
- making a UK Will which utilises your nil rate band of £325,000 (or even £650,000 from both spouses;
- borrowing against the property (leaving only net equity as subject to IHT charge);
- taking out life insurance to pay IHT on death (which is usually written in trust for family members);
- gifting the property to younger family members (subject to the 7 year rule for taper relief) and careful not to be caught out by the ‘gift with benefit in kind’ rule if you continue to have access to the property.
Question 5: Cost of De-Enveloping?
De-enveloping involves a range of parties and can be a complex lengthy process – Seek advice immediately!
De-Enveloping may take several months, involving a range of parties, including the mortgage lender, solicitors, tax advisors, valuers, landlords, trustees etc. Firm plans to de-envelope should be concluded without further delay (if not done already), as the process may take up to three months.
There are a number of transactional costs to be considered when deciding whether or not to de-envelope, the most significant of which is Capital Gains Tax (CGT).
CGT : In order to assess the applicable CGT, a valuation of the property is crucial, whether at the key date of 5th April 2013 (for ATED purposes) or 5th April 2015 (when non-resident CGT started to apply).
SDLT : If a property is subject to a mortgage or any other borrowing, there will be Stamp Duty Land Tax (SDLT) payable on the amount of the debt, when the property is de-enveloped.
Question 6: Is it vital to de-envelope before 5th April 2017?
Doing what is right for you and for your family
Whilst we must bear in mind that the changes after 5th April 2016 will really be effective upon the death of the owner of the residential property (since this is when Inheritance tax arises), this could be of significant impact to the fortunes of his family and beneficiaries and it is therefore advisable to review and restructure assets as soon as possible.
There is no “one size fits all” solution, so specific advice should be obtained before making a decision, to ensure that you are doing what is right for you and for your family.
Whilst de-enveloping is not mandatory before 5th April 2017, it is likely to be more costly if done after that date. For example, where the corporate envelope involves a trust holding shares in a non-UK company, such shares would normally be deemed excluded property before April 2017 and any transfer of such shares to an individual, prior to that date will avoid the 6% IHT exit charge. However, after 5th April 2017, not only will the transfer of the shares attract the 6% exit charge, but the 40% IHT charge would also apply (with applicable taper relief) as subject to the 7 year rule on lifetime gifts.
HOW CAN W8 ADVISORY HELP YOU?
Let us support you to make the right decision
Our team of family office advisors and associated firms provide our clients with a holistic “one stop” service to guide you through understanding the impact of the impending changes to the UK tax regime, support you in making the right decision (about whether or not to de-envelope) and will project manage and co-ordinate the implementation of your decision in a seamless and timely fashion.