Changes to non-UK domicile inheritance tax regulations

The rules and regulations covering non-UK domiciled individuals (non-doms), and excluded property trusts, have seen some major changes which may have a significant impact on future tax liabilities. In July 2015 the UK government published new inheritance tax (IHT) regulations regarding residential property held by non-doms. These changes came into force in April 2017 and IHT is now applicable on UK residential property held directly/indirectly through trusts, offshore companies and partnerships.

Property assets and IHT

Those who are domiciled in the UK are subject to IHT on their worldwide assets while non-doms are only subject to IHT on their UK assets. The exact level of IHT for both parties will depend upon various reliefs and exemptions. Foreign assets held by non-doms are excluded from the reach of IHT and are referred to as “excluded property”. The new regulations have no impact on non-UK based excluded property but they do impact UK residential property held directly or indirectly through an trust or offshore vehicle.

Individual ownership of UK residential property

As an individual, all UK residential property assets directly held by a non-dom will upon death fall under the UK IHT regulations. The personal representatives/beneficiaries of the estate will be liable to IHT at the standard rate of 40% subject to the usual exemptions. Whether or not the deceased was resident in the UK at the time is irrelevant when it comes to IHT.

Enveloping property

The term “enveloping” relates to the purchase/transfer of a UK-based residential property into an offshore vehicle in which the non-dom hold shares. The idea is simple, the offshore vehicle (such as a company) will be deemed to be an overseas asset and as a consequence outside the reach of UK IHT. In years gone by this was a very popular means of shielding family homes and other UK assets from IHT liability in the future.

Trust ownership of UK residential property

At the time a non-dom is deemed to be domiciled in the UK their worldwide assets would be subject to UK IHT. However, assets which had been settled into an “excluded property trust” prior to the change in domicile would fall out with the reach of UK IHT. As a consequence, no IHT would be charged on foreign assets held or purchased at a later date within the trust, providing it was funded before the change in the individual’s domicile. There is also a restriction dictating the trust is not allowed to directly own UK residential property.

In order to protect UK residential property assets within the “excluded property trust” structure, UK property was often held through an offshore company. The “excluded property trust” would hold shares in the offshore company as opposed to direct ownership of the UK property. The offshore company was deemed as a “foreign investment” and protected under the excluded property trust regulations. Until recently there was no provision to review the assets held by these offshore companies with regards to UK residential property exposure and potential IHT.

New IHT rules

The new IHT rules have effectively closed the loophole which allowed trusts and individuals to own UK residential property through offshore companies or similar opaque vehicles. As a consequence, the share of UK residential property indirectly held through offshore companies will be considered part of the individual’s estate for IHT purposes. It is important to note the new IHT regulations will only impact UK residential property assets held by non-doms/connected trusts. It is also irrelevant whether the residential properties are occupied or let, they will still be classed as part of the IHT estate.

One potential quirk of the new IHT regulations in relation to offshore companies is the apportionment of company debt. Depending upon the way in which the company was structured this could be beneficial or fairly costly. If we consider the following example:-

  • An offshore company holds £10 million worth of property assets of which £2 million are UK-based
  • The total company debt is £2 million

If the £2 million debt was secured against the UK property then you may assume the net contribution to IHT was zero (the debt equalled the value of the asset). Unfortunately, this is not the way in which the new IHT regulations will work. The debt is deemed to be spread across all company assets and therefore only 20% could be apportioned to the UK property asset. As a consequence, this would result in a net asset value for the UK residential property of £1.6 million (£2 million less £400,000 of apportioned debt).

Alternatively, if the debt was secured against the foreign assets held by the company this would be beneficial to the tune of £400,000 when calculating the net value of the UK residential asset.

Summary

The rules and regulations regarding UK domicile/non-doms and potential IHT and CGT liabilities are relatively complex and often subject to change. It is very important to take professional advice before undertaking any chargeable event which could impact future tax liabilities. Over the last few years we have seen a number of changes to the non-dom status which has impacted both IHT and CGT liabilities.

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