In this article we revisit the new inheritance tax (IHT) charge following publication on 5 December 2016 of the government’s responses to its August consultation document and further draft legislation.  In doing so we discover the government have reinvented some of the proposed rules in such a way that they will require more than just non doms who own UK residential properties via offshore structures to review arrangements before 6 April 2017.

What we already knew

  • From 6 April 2017 residential properties in the UK will be brought within the charge to IHT where they are held within an overseas structure, including a company. The charge will apply both to non doms and to trusts with settlors or beneficiaries who are non dom to the extent they have a ‘UK residential property interest’.
  • A residential property for the purpose of the new IHT charge will follow the same definition used for Non-Resident Capital Gains Tax. The new charge will not therefore apply to interests in non-residential property or property with a communal use, such as boarding schools and nursing homes nor purpose built and converted student accommodation

What we now know

  • The government have now confirmed that the new IHT charge is to take account of any debt used to acquire or maintain the property, including ‘connected’ party borrowing (which was previously to be ignored) but as we explain below, creditors of certain loans are now set to be within the scope of the new charge.
  • In a further change the government has identified four categories of interest in UK residential property for the purposes of the new charge:

1. Interests in ‘close’ companies

The government has confirmed that interests (i.e. shares or loans) of participators in ‘close’ offshore companies (i.e. companies owned by five or fewer participants) which derive their value directly or indirectly from UK residential property will be subject to IHT.  By implication, an interest in a widely held company (for example, a real estate fund) will not be subject to IHT.

2. Partnerships

Interests of partners in a partnership will be subject to IHT to the extent its value is directly or indirectly attributable to UK residential property.  Unlike companies though, it does not make any difference as to how many partners there are and whether or not they are connected with each other.

3. Relevant Loans

As we noted above, the new IHT charge is to take account of any debt used to acquire or maintain the property, including ‘connected’ party borrowing. In return the government is now proposing that the benefit of loans from individuals, trusts or partnerships which are used by the borrower either to acquire, maintain or enhance an interest in a UK residential property; or to acquire an interest in a close company or partnership that acquires, maintains or enhances an interest in a UK residential property (so called ‘Relevant Loans’) will instead be subject to IHT. This change therefore widens the scope of the IHT charge to bring creditors of such loans within the scope of IHT, when previously they were not.

The charge is set to extend even further to assets used as collateral or as security for a Relevant Loan to impose an IHT charge on the value of the assets; not just the value of the loan. If we take the example of a £10m loan obtained from a bank to purchase a UK residential property and a £20m portfolio is put up as security for the loan, the full value of the share portfolio could then be subject to IHT. Quite whether the government intended to extend the scope of IHT to this extent is not clear. We will be making representations to the government against this rule as part of our responses its formal consultation on the draft leglislation.

4. Other property

In a further change a new ‘look back’ provision is to be introduced.  Property that is no longer an interest in UK residential property will be within the scope of the new charge in the following circumstances:

(a) In the event an individual receives consideration following the disposal of a UK residential property interest, that consideration will be subject to the new charge if the disposal takes place within two years of a chargeable event (i.e. death) for IHT purposes.

(b) If a trust disposes of a UK residential property interest and the consideration received is paid outside the UK, or it is received in the UK but subsequently taken abroad (without time limit), there will be an ‘exit’ charge for IHT purposes.  The draft legislation in relation to this rule is not clear but we believe this is the essence of what the government is proposing.  An exit charge is calculated as a proportion of a ten yearly charge which is charged on ‘relevant property’ trusts every ten years at a maximum rate of 6%.

  • The government has also confirmed that the new IHT charge will be imposed regardless of any ‘treaty protection’ which might otherwise be available.  Certain estate tax treaties the UK has with other countries (including India and Pakistan) operate to give the taxing rights in relation to non-UK situated property (i.e. shares in an overseas company owning UK residential property) to that other jurisdiction. Under the new rules, these rights will be overridden unless the other country charges IHT or a similar tax and there is some tax to pay (however small) in that country.

Comment

The government’s reinvention of its proposed IHT charge cannot be underestimated and will go beyond the original aim of introducing an IHT charge on UK residential property held via offshore companies.  What we now have, through the development of the concept of ‘Relevant Loans’, is a far more wider reaching IHT charge which will bring not just creditors of these loans within the scope of IHT but the full value of other assets used as collateral or security.  Quite whether the government intended to create such a broad taxing measure, and whether the rules as they currently appear will be scaled back, is not clear but existing arrangements will now need to be reviewed on the assumption that the rules, as drafted, are to come into force from next April.