In last year’s budget, the Government announced that it would change the tax regime for people who have a foreign domicile (‘non-doms’). These changes will bring an end to permanent non-dom status for tax purposes and mean that non-doms can no longer escape a UK inheritance tax (IHT) charge on UK residential property through use of an offshore structure like a company or a trust.
Those who are not domiciled in the UK currently enjoy a significant advantage over other individuals for IHT purposes. Whereas UK domiciled individuals are liable to IHT on their worldwide property, non-doms are only liable on the property which is situated in the UK. This is the case both for individuals who are resident in the UK and those who are resident elsewhere, bearing in mind that there are technical differences between residence and domicile.
Any residential property in the UK owned by a non-domiciled individual directly will be within the charge of IHT. However, it is standard practice for such individuals to hold UK residential properties through an overseas company or similar vehicle. Where this is the case, the property of the individual consists of overseas shares which will be situated outside the UK and are therefore excluded from IHT. This is known as ‘enveloping’ the UK property and the effect is that the property is taken outside the scope of tax.
The Government plans to bring residential properties in the UK within the charge where they are held within an overseas structure. This charge will apply both to individuals who are domiciled outside the UK and to trusts with settlors or beneficiaries who are non-domiciled. These changes will come into effect from 6 April 2017 and will be legislated as part of the 2017 Finance Act.
To implement the extended IHT charge, the Government proposes to remove UK residential properties owned indirectly through offshore structures from the current definitions of excluded property currently provided by sections 6 and 48 of the Inheritance Act (IHTA) 1984. The effect will be that such UK residential properties will no longer be excluded from the charge to IHT. This will apply whether the overseas structure is owned by an individual or a trust.
Once the legislation comes into effect, shares in offshore close companies and similar entities will no longer be excluded property if, and as far as, the value of any interest in the entity is derived, directly or indirectly, from residential property in the UK. There will be no change to the treatment of companies other than close companies and similar entities. Generally, a company is a close company where five or fewer participators have control of the company.
The Government has advised that the legislation will need to define the types of property which will become liable to IHT but introducing a wholly new definition for IHT purposes could risk creating unnecessary complexity and uncertainty. The Government therefore intends that the new charge should be based as far as possible on other definitions of residential property which currently exist within tax legislation, and is now consulting on the new model to be used, asking the question “Do you agree that the definition of a dwelling introduced for the purposes of non-resident Capital Gains Tax (CGT) would provide the most suitable basis for the extended IHT charge?”
This possible model is based on the definition of a dwelling which was introduced in Finance Act 2015 for the purposes of capital gains tax (CGT) on disposals by non-residents of residential property in the UK. This definition can be found in paragraph 4 of Schedule B1 to the Taxation of the Capital Gains Act (TGCA) 1992 and includes:
- any building which is used or suitable to be used as a dwelling
- any building which is in the process of being constructed or adapted for use as a dwelling
- the grounds in which such a building is situated
One type of property which is specifically excluded from this definition of a dwelling is a hotel or inn or similar establishment.
An alternative approach would be to follow the definition of a dwelling for the purposes of the annual tax on enveloped dwellings (ATED) in section 112 of Finance Act 2013.
ATED applies to high-value UK residential properties which are owned by a company, a partnership with a corporate member or a collective investment vehicle. For the purposes of ATED, the definition of a dwelling excludes hotels, guesthouses, hospitals, student halls of residence, boarding schools, care homes and prisons.
However it should be noted that the Government’s opinion is that the scope of the IHT charge will be significantly wider than that of ATED and adopting its definition of residential property will need more extensive amendment than would that used for the purposes of non-resident CGT. The Government is therefore more attracted to using the non-resident CGT definition as the basis for the extended IHT charge.