When acquiring UK residential property, depending on the level of investment, it was common practice for foreign investors to use structures to reduce their tax exposure; initially to stamp duty land tax (SDLT) and ultimately to UK inheritance tax (IHT), which is charged at a rate of 40% on any amount above the ‘nil rate band’ of £325,000. Indirect ownership also offered increased confidentiality by keeping an individual’s name off the UK Land Register.
Typically, a property would be purchased using a vehicle such as an overseas company, partnership or trust, but recent legislation means such structures are generally no longer effective for IHT planning. From 6 April 2017, non-UK domiciles holding UK residential property indirectly through overseas corporate structures were brought within the scope of UK IHT. The new rules apply retroactively to property holding structures set up before the legislation took effect.
The UK government has also brought in a package of measures designed to make it less attractive to hold high-value UK residential property indirectly. Residential property valued at more than £500,000 attracts a higher rate of stamp duty land tax (SDLT) of 15% if acquired by ‘non-natural persons’ and is also then liable to the annual tax on enveloped dwellings (ATED) on an ongoing basis.
The new Economic Crime (Transparency and Enforcement) Act 2022, which was passed in March this year, will further introduce a public register of the beneficial owners of overseas entities (expressly including companies and partnerships) that own property in the UK.
Domicile
Under English common law, every individual is born with a ‘domicile of origin’, which generally follows the domicile of their parents at the time of their birth. Domicile is unrelated to the concept of residence or nationality. It is possible for an individual to be resident in one country, domiciled in a second country and be a national of a third.
As a result, many British expatriates, even those who have resided in another country for decades, still find themselves – often unknowingly – UK-domiciled and therefore subject to IHT on a worldwide basis. The only way to shed a UK domicile of origin is to acquire a ‘domicile of choice’ in a different country, which involves moving to that country, establishing a clear intention to reside there permanently or indefinitely, and adequately severing ties with the UK.
If a person has succeeded in acquiring a domicile of choice in a new country but subsequently abandons their permanent home or indefinite residence there, they will automatically revert to their UK domicile of origin until such time as they have demonstrably acquired another domicile of choice.
For non-UK nationals that own property in the UK, the issues are different. An individual with a non-UK domicile of origin can generally preserve his/her non-UK domiciled (non-dom) status for a long period after becoming UK resident, which means he/she is only subject to IHT in respect of UK assets. However, this tax benefit is removed by the acquisition of ‘deemed domiciled’ status, which is typically acquired at the beginning of the sixteenth tax year of UK residence.
Deemed domiciled status means that the scope of IHT extends from UK assets to all assets on a worldwide basis, but the impact can be greatly reduced by ensuring that non-UK assets are placed into a non-UK resident trust – known as an ‘excluded property settlement’ – before the status is acquired. This will ensure that non-UK assets remain outside the scope of UK IHT.
Disposal by sale or gift
This is generally the only realistic option for British expats who are seeking to shed their UK domicile of origin, because retaining UK residential property may risk undermining any acquisition of a domicile of choice in another country.
It is important to remember that gifts to individuals are considered as ‘potentially exempt transfers’ for UK tax purposes. This means that they will only be tax-free if the donor survives for at least seven years after making the gift (the ‘seven-year rule’). It is also important to remember that if the donor continues to derive benefit from the asset, the gift will be subject to IHT under the ‘Gift with Reservation of Benefit’ rules (GWROB).
Insurance
For those investors who do not wish to sell or gift a UK property, the only remaining viable alternative for protecting against IHT is insurance. In its simplest form, life insurance is a contract that offers the policyholder liquidity in the form of a cash payment when they need it most.
The beneficial owner can take out a ‘permanent’ life insurance policy to cover the full amount of IHT. The beneficiaries can then use the proceeds of the policy to pay any IHT liability that becomes due. This is a tried and tested method of funding a potential IHT liability where other succession planning is not available.
To avoid the proceeds of the policy also incurring IHT, it is essential that the policy should be written into trust. This will ensure that the proceeds can be paid to the beneficiaries outside of the estate for IHT purposes and will also avoid any probate or forced heirship rules that may apply.
Premiums will vary considerably for many reasons, so it is best to use an adviser in the private client space, such as Sovereign Group, to find the best solution to match for your personal circumstances.
For more guidance contact
Sovereign Group on: