Understanding the Changes for Non-UK Domiciliaries
Nobody likes to think about inheritance tax, for obvious reasons. However, those not domiciled in the UK should consider their overall tax position so that there are no surprises for them or for the beneficiaries of their estate. Indeed, with planning it is possible to minimise the amount of UK inheritance tax (IHT) an individual is liable to. For more information on domicile and UK taxation generally please see our article, Domicile and UK taxation – the Basics.
It is worth noting that UK IHT is not just confined to charges on death – there are potential tax implications to gifting assets to other individuals, or settling assets into trust. There have also been some changes to the UK IHT rules for non-domiciled individuals which we outline below. However, it is always worth seeking specific advice before undertaking a certain transaction to ensure that the UK tax implications have been considered and accounted for.
UK IHT – General Principles
The general rule is that IHT is charged to individuals where the value of their estate decreases by virtue of a “chargeable transfer”. The most obvious example of a charge is on death, when the whole value of an individual’s chargeable estate is charged to IHT. A gift of assets could also result in an immediate charge to IHT, with the most common example being a settlement of assets into trust. However, where a gift of assets is made to another individual, there is a potential charge to IHT only if the donor dies within seven years of making the gift.
UK Doms and UK IHT
UK domiciled individuals are charged to UK IHT on their worldwide estate, meaning that overseas holiday homes and shares in foreign companies are within the scope of the tax. All individuals (wherever domiciled) are entitled to the Nil Rate Band (NRB), which is currently set at £325,000. This means that the first £325,000 of a chargeable transfer is charged to UK IHT at 0%. However, note that the NRB refreshes every seven years, meaning that if an individual makes a chargeable transfer and uses up their NRB, they will not have a new £325,000 NRB available to them until seven yearshave passed.
There are reliefs and exemptions from UK IHT. The main exemption is the spousal exemption – meaning that all transfers between spouses or civil partners are exempt from UK IHT. In the common situation where on the first of a couple to die, all assets are left to the second spouse / civil partner, the second individual can benefit from any remaining NRB of the first partner. This could give the second individual an available NRB of up to £650,000.
Non-Doms and UK IHT
Non UK domiciled individuals are charged to UK IHT only on UK “situs” assets. This means that from an IHT perspective, there is considerable advantage to being considered a “non-dom” and not surprisingly many have sought to establish themselves as not domiciled in the UK (with mixed success).
Whether an individual is not UK domiciled is not in itself a tax question, but a question of general law. That said, a non-dom who has lived in the UK for an extended period of time may in fact be considered domiciled in the UK under general law, or by application of specific tax law.
From 6 April 2017, a non-UK domiciled individual who has been resident in the UK for 15 out of the previous 20 tax years will be considered UK domiciled for IHT purposes and therefore charged to UK IHT on their worldwide estate. Before 6 April 2017, the test was whether an individual had been resident in the UK for 17 out of the 20 tax years (including the year of assessment). If you fall into this category of individual, the only way for non-UK assets to fall outside UK IHT is to become not UK tax resident. After four complete tax years, you will no longer be considered UK domiciled for IHT purposes, although you will need to remain outside the UK for six complete tax years before you can return to the UK as a non-domiciled individual for UK IHT purposes.
Individuals who have not yet been in the UK for 15 years, or who are considering an investment into UK assets (such as shares in a UK company or a UK rental property) should consider the UK IHT implications and the best options for mitigating any future liabilities.
For those who already live in the UK, it is possible to secure the favourable IHT treatment on non-UK assets for the long term by settling such assets into an overseas trust before becoming deemed domiciled in the UK. HMRC recognise this practice and consider it to be one of the incentives to attract and retain talented individuals in the UK. A trust retains the domicile status of the settlor at the date the trust is settled. This means that the trust will remain non-UK domiciled even after the settlor becomes deemed UK domiciled for IHT purposes. The trust is generally located outside the UK to retain UK income tax and capital gains tax advantages, and it is important not to settle further assets into the trust once the settlor has become deemed domiciled.
For non-UK resident individuals considering an investment in UK property, the UK IHT position should be considered to ensure tax efficient planning. UK IHT is generally charged on the net value of an asset so, for example, if a house was purchased for £1m as a rental property using a mortgage of £800,000 there would be no UK IHT on death provided that the owner had the full NRB available and did not hold any other UK assets (providing that the mortgage was used to purchase the property and not taken out at a later date).
Care should be taken for existing residential properties owned by non-UK residents, because new anti-avoidance rules mean that where debt is subsequently taken out on the property and used such that the funds released are not chargeable to UK IHT, the debt will not be allowed as a deduction when calculating the IHT position. For example, if Mr A purchased a UK property for £1m using cash, but subsequently remortgaged the property to buy a house in Spain, the full £1m would be charged to UK IHT, with no deduction for the mortgage against the property.
Care should also be taken where debt is provided by a “connected party” such as the settlor of a trust, or where overseas assets are used as collateral for a loan to purchase UK property, as in both these situations there could be unexpectedly high IHT bills (in some cases, charging tax on more than the value of the property in question!) and advice should be sought.
Corporate Ownership of UK Residential Property
Before 6 April 2017, a common planning tool for non-UK domiciled investors into UK real estate was to purchase the UK property in a non-UK company. The investor would then hold shares in a non-UK company which was considered as non-UK situs property for UK IHT purposes and not charged to UK IHT on death. Indeed, settling such a company into trust before becoming deemed UK domiciled meant that the UK family home would be protected from UK IHT indefinitely.
However, from 6 April 2017, the rules for such companies (or partnerships) holding UK residential property have changed and the holdings in the company / partnership could now be charged to UK IHT. This is a significant change and means that individuals with such structures will need to revisit any planning to consider their likely exposure to UK IHT and the benefit of changing their arrangements. Note that only UK residential property is caught – if an offshore company holds UK commercial property there is no change to the UK IHT position for the shareholder / partner.
To give a concrete example, Mrs B is not UK resident or domiciled, and holds a rental property in London in her BVI company. Historically, there would be no charge to UK IHT if Mrs B were to die, or to settle the shares into Trust. However, from 6 April 2017, the value of those shares attributable to the UK residential property will be chargeable to UK IHT (i.e. the value of the property less any debt). As ever, the detailed rules are more complicated and Mrs B should seek advice to determine her overall position.
One quirk of the new rules is that debt within the company is apportioned across all company assets, even if it is secured against one particular property. This can give some surprising results, as shown below:
Ms C is not UK resident or domiciled, but holds shares in a BVI company. This company holds rental properties in the UK and around the world. UK properties total £2m with debt of £1.7m secured against the properties. However, other properties around the world are valued at £8m with no debt against the properties. Ms C would expect the net value of the UK property to be £300k, but with the allocation of debt rules, only 20% of the debt would be allocated against the UK properties:
£2m/(£2m + £8m) * £1.7m = £340k. The UK taxable element would therefore be £2m - £340k giving rise to a significantly higher exposure to UK IHT.
It is also worth noting that there have been a number of changes to UK tax law around the ownership of UK residential property by non-residents, companies or partnerships, including higher Stamp Duty Land Tax charges, an annual charge to tax on certain properties owned by a “non-natural person” and capital gains tax charges on non-UK residents disposing of UK residential property. We will be covering this topic in a future article.
How can We Help?
The UK IHT rules are complex and advice should always be sought before action is taken. We have extensive experience in assisting individuals and trustees with tax advice and implementation, advising on the UK tax impacts of assets and whether there are more tax efficient ways to hold such assets.
We are always happy to have an initial telephone consultation or meeting, at no cost to you, to see how we can help.
The information provided by Charter Tax Consulting Limited is general in nature and does not constitute specific tax advice. Professional advice should be sought before deciding on a course of action, or refraining from a certain action, arising from the above information. Tax legislation changes regularly and information contained herein is provided based on legislation as at 20 November 2017
Taxation planning concerns the application of complex statute and case law to future events. Accordingly, however expert the opinion given, it is always possible that the Courts will take a different view of the application of the law. We undertake to apply reasonable care and skill in the provision of advice. We do not guarantee that tax planning steps will in all circumstances achieve a certain legal effect.