UK Residential Property Tax Reforms Increase IHT Liabilities

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Overview


The UK Government has published a consultation document and draft legislation relating to the reforms of UK residential property taxation that are due to take effect from 6 April 2017. The new rules mean that most UK residential property will become subject to UK Inheritance Tax, on top of the Annual Tax on Enveloped Dwellings, regardless of how it is held.

In Depth


The UK Government has published a consultation document and draft legislation relating to the reforms of UK residential property taxation that are due to take effect from 6 April 2017. The new rules will effectively mean most UK residential property becomes subject to UK Inheritance Tax (IHT), regardless of how it is held. In many cases the IHT charge will be in addition to the Annual Tax on Enveloped Dwellings (ATED).

Summary of Proposed Changes

Currently, non-UK domiciliaries can shelter UK assets from IHT by holding them through foreign entities, normally in a company that is often owned by a trust. For IHT purposes, the individual or trustee is treated as owning the shares in the foreign company, which are “excluded property” and therefore outside the scope of IHT, rather than owning the underlying UK asset. Since 2013, many of the structures which provide this IHT protection for UK residential property have been subject to ATED and to tax on capital gains.

The government proposes to amend the current definition of “excluded property” in the IHT legislation. The purpose is to bring shares in these offshore companies and similar entities within the scope of IHT if, and to the extent that, the value of any interest in the entity is derived from UK residential property. Other types of UK asset will not be affected by this change.

This means that IHT will be payable in respect of the UK residential property on the occasion of a “chargeable event”. Chargeable events include the death of the individual shareholder (where the company shares are owned directly), or the death of the settlor of a trust in certain circumstances (charges at 40 per cent), and the ten year charge for trusts (charges up to 6 per cent).

Debts will be taken into account when determining the value of the UK residential property at the time of the chargeable event, but only to the extent that they relate “exclusively to the property”, e.g., as amounts outstanding on a mortgage used to acquire the property. Any loans made between connected parties will be disregarded for valuation purposes.

The government originally suggested it may offer some form of relief from potential Capital Gains Tax and Stamp Duty Land Tax charges which may arise as a result of “de-enveloping” properties held by entities subject to ATED. However, the latest consultation document indicated that the government has decided not to offer any relief.

Next Steps

It will be extremely important to consider the impact of these changes on each UK residential property structure in advance of the new rules taking effect. From 6 April 2017, existing structures may be subject to both ATED and IHT charges and any debt planning may no longer be effective.

Individuals with UK residential property structures should consider whether there are any benefits to retaining their structures, or whether it will be most tax and cost-efficient to hold residential property directly, with the protection of life insurance if appropriate. Existing loans should be reviewed to determine whether or not they would be deductible under the revised rules.

If you think you are affected by these changes, you should take advice well in advance of April 2017.