In the July 2015 Budget George Osborne announced that all beneficial owners of UK residential property would be brought within the charge to inheritance tax, regardless of how that property was held.
With the publication of the draft Finance Bill on 5 December 2016, the detail of how these rules will operate from 6 April 2017 is now available. While in many respects the rules will operate as previously announced, the rules in relation to loans are significantly wider than anticipated and will bring many structures into charge that had previously looked as if they would fall outside these rules.
What is taxable?
- Company shares - the ultimate (individual or trustee) shareholders of closely held non-UK companies that own UK residential property will be treated as if the shares in those companies were UK situs and therefore liable to inheritance tax.
- Partnerships - partners in partnerships will also be treated as if they own UK situs property directly, rather than an interest in the partnership.
- Reservations of benefit - particular care needs to be taken with arrangements where a property has been gifted (in particular into trust), but the donor/settlor retains the use of the property or is not completely excluded from the trust, as both the individual and trust inheritance tax charges can arise.
- Exemptions - widely held companies (broadly ones not under the control of five or fewer persons) are exempt from these rules, as are companies or partnerships where UK residential property makes up less than 1% of that entity's total assets.
How much is the tax?
- Valuation - in each case, it is the value of the shares/partnership interest that is taxable, rather than the value of the property itself, so discounts may be applied to minority holdings. Liabilities such as loans/mortgages will be deductible in determining the value subject to inheritance tax. More details are set out in this regard below.
- Individuals - inheritance tax is charged at up to 40% on UK property that is held at death or by a trust from which the settlor can benefit or was given away in the previous seven years (but after 6 April 2017). Exemptions are available for gifts and legacies to spouses and some charities.
- Trusts - inheritance tax is charged on the value of UK residential property at a rate of up to 6% on each tenth anniversary of the establishment of the trust, or on the property being distributed to a beneficiary.
How are loans treated?
- Deductibility - as set out above, loans and mortgages will be deductible in calculating the value subject to inheritance tax, subject to various restrictions that already apply to directly held property:
- Loans are generally only deductible if they have been used to acquire (or enhance) the interest in the UK residential property. Additional financing taken out after the purchase is complete for other purposes will not be deductible.
- Loans other than from commercial third parties may need to be repaid after death before a deduction to be claimed.
- Liability to inheritance tax - in an unexpected move, the value attributable to the right of repayment of any loan taken out to acquire, maintain or enhance a UK dwelling or acquire a company owning a UK dwelling will also be subject to inheritance tax in the same way as a direct interest in a property. Further the value attributable to any security, collateral or guarantee given by a borrower, or a third party in connection with such a loan will similarly be subject to inheritance tax.
This means that wherever funds have been (i) lent to finance the purchase or enhancement of a property, or (ii) made available to support a purchase or enhancement those funds will be subject to inheritance tax. This will apply to the following arrangements:
- any additional security given by a borrower for a mortgage;
- any security given by a borrower under 'Lombard' loans or similar arrangements;
- 'bank of Mum and Dad' loans to children;
- loans from trusts to beneficiaries; and
- guarantees from family members, companies or trusts.
There is no restriction on the amount liable to tax under these arrangements and while the capital right to repayment of a loan is fixed, the value of security given may considerably exceed the value of the property purchased and give rise to a larger inheritance tax exposure. The value of a guarantee could potentially be unlimited. It is also possible that double charges to inheritance tax could arise in relation to the same property.
What happens when I sell?
- The liability to inheritance tax does not cease on a sale, the repayment of a loan or the release of a security/guarantee and the proceeds of sale, repayment or released security remain subject to inheritance tax for a further two years.
What about Double Tax Treaties?
- For residents of countries with which the UK has IHT treaties (France, India, Ireland, Italy, Netherlands, Pakistan, South Africa, Sweden, Switzerland, USA) they will only be subject to this charge if there is no inheritance tax on the same taxable event in their home country.
- Currently India, Pakistan and Sweden do not apply inheritance tax and their residents will therefore be taxable in the UK, but residents of the other countries may escape the charge to UK tax.
So what should I do now?
- As anticipated, all UK residential property ownership structures need to be reviewed and the liability to tax assessed urgently so that any remedial action can be taken before 6 April 2017.
- In addition, any loan or security arrangements put in place to assist with the purchase of UK residential property also need to be assessed urgently so that any remedial action can be taken before 6 April 2017.
- If any ownership changes are required, such as gifts between family members or distributions from trusts, these need to be completed before 6 April 2017.
- Reservations of benefit in particular need to be identified and assessed before 6 April 2017, so that double charges to tax do not arise.
- Finally, all corporate holding structures should be reviewed.
Following the introduction of the ATED in 2013, 'owner-occupied' residential properties have been subject to an annual charge (up to £220,350). Some of these structures were maintained because of the inheritance tax protection they afforded and the cost of 'de-enveloping'. From 6 April 2017, these structures will no longer offer any inheritance tax protection. Further, with capital gains tax at a rate of 20%, probably a long-term low and the property market in something of a slump, and now is likely to be the best time to de-envelope.