Changes to Inheritance Tax on UK residential properties
Currently, individuals who are non-domiciled in the UK currently enjoy a significant advantage over other individuals for inheritance tax purposes. UK domiciled individuals are liable to inheritance tax on their worldwide property. However, those who are non-UK domiciled 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.
Any residential property in the UK owned by a non-domiciled individual directly will be within the charge of inheritance tax. However, it is common 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 inheritance tax. This is known as ‘enveloping’ the UK property and the effect is that the property is taken outside the scope of tax.
Enveloping properties in this way only provides a tax advantage to individuals who are domiciled outside the UK. It is not available for any other individual, either those who are domiciled in the UK under general law or those who are deemed to be so domiciled under statutory rules because they have been resident in the UK for a long period.
The UK government plans to bring residential properties in the UK within the charge to inheritance tax 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.
Charging inheritance tax on UK residential property
To implement the extended inheritance tax charge, the government proposes to remove UK residential properties owned indirectly through offshore structures from the current definitions of excluded property currently provided by the Inheritance Act. The effect will be that such UK residential properties will no longer be excluded from the charge to inheritance tax. 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 to the extent that, 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.
Similarly, where a non-domiciled individual is a member of an overseas partnership which holds a residential property in the UK, such properties will no longer be treated as excluded property for the purposes of inheritance tax.
No change will be made to the taxation of UK property which is held by corporate or other structures which are owned by UK domiciled individuals or by trusts made by UK domiciled individuals.
The change will be effective for all chargeable events which take place after 5 April 2017. For these purposes, the definition of a chargeable event will follow existing inheritance tax rules and will include:
- the death of an individual holding shares in an overseas close company which owns UK residential property
- the redistribution of the share capital of an overseas close company which owns UK residential property
- the death of a donor making a gift of shares in a close company which owns UK residential property where that gift was made within 7 years of death
- a gift made by a non-domiciled individual of shares in a close company owning UK residential property
- the death of a donor or settlor who benefits from a gift of UK residential property or of shares in a close company which owned such property within 7 years of death
- any ten-year anniversary of a trust holding UK property through an offshore company
- the death of a life tenant with a pre-March 2006 qualifying interest in possession in a trust from which they have an entitlement to income
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