Every week, Mansion Global poses a tax question to real estate tax attorneys. Here is this week’s question.
Q: I've recently read about tax changes on properties for U.K. residents who are not domiciled. I fall under this category; can you explain what I need to know?
Starting next week, all U.K. residential property will be subject to the country’s inheritance tax (IHT), no matter how it’s held, said Daniel Simon, senior partner at Collyer Bristow, a London law firm.
Under current law, non-domiciled individuals (so-called "non-doms") could hold property via offshore structures or trusts without it being subject to inheritance tax, said Andrew Godfrey, partner at Russell-Cooke law firm, also in London.
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"That way, for IHT purposes, it became foreign property, which for non-domiciled individuals could fall outside the IHT net," he said. This made such structures attractive for investors. A structure is generally a trust owning a company which owns the property, he explained.
But the new rules that go into effect on April 6 "seem to finally be the death knell" for skirting inheritance tax in this way, he said. "There will be no IHT benefit from that point on," Mr. Godfrey said.
U.K. inheritance tax is 40% and charged on the part of the estate that exceeds the £325,000 threshold. But when assets are held by a trust, matters could become complicated and could lead to inheritance taxes being applied not once but on several occasions, he said. The 40% hit could be sizable. For instance, property worth £8 million will generate about £3 million in inheritance tax upon the death of the person who funded the trust if they are also a beneficiary, Mr. Godfrey said. The property also could be subject to a periodic inheritance tax charge of about £500,000 every 10 years, in addition to other taxes that can apply to properties in such structures, he said.
Under the new measure, non-doms will also be deemed or considered a U.K. domicile for tax purposes if, as of April 6, they have been a U.K. resident for 15 of the previous 20 tax years or were born in the U.K. and return to the country after having been a domicile elsewhere.
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"There could be IHT to pay on death, on transfers to trusts, or on property held in a trust, where currently there would be none," Mr. Simon said.
Also, money loaned and collateral offered to secure a loan to buy or maintain U.K. residential property will be subject to inheritance tax,, Mr. Simon said.
If the loan is repaid after April 5, 2017, the loan amount may be subject to inheritance tax for two years after the sale. The same applies to the proceeds when a non-U.K. company that owns U.K. residential property is sold, Mr. Simon said. Whether this two-year rule will apply to sales or distributions that occurred in the two years before April 2017 is unknown.
But the IHT rules will leave some people "in an unenviable position," Mr. Godfrey said.
Mr. Simon suggests that investors who have loans related to U.K. residential properties review their arrangements. As for current non-doms who own U.K. residential property in offshore structures, they should "consider drawing up tax-efficient wills (for example, by leaving assets to your spouse to ensure that there will be no IHT to pay on the first death) or making timely lifetime gifts to the next generation," he said.
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Individuals may just want to remove the structures to simplify matters, but removing them isn’t necessarily simple, Mr. Godfrey said. Doing so could trigger an immediate tax hike because the value of property has increased in recent years.
"When [property] comes out of the structure, there will be a gain that can be taxed on trustees or beneficiaries," he said. Plus, because they hadn’t owned the property directly, they wouldn’t be entitled to an important relief on those capital gains, he added. However, some reliefs may be available to limit or remove the tax liabilities.
Thus far, it looks unlikely that leaving it in the structures will help matters, Mr. Godfrey said. "The medicine may be unpalatable, but taking it early will generally be the best way to limit further tax and professional costs," he said. "If people are still trying to find loopholes, they should be prepared for potential penalties, lengthy litigation and unsympathetic public sentiment."
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