The headline-grabbing inheritance tax (IHT) news from last week’s Budget was the introduction, from April 2017, of an additional nil rate band when a residence is passed on death to direct descendants. However this is only one part of the changes that were announced in relation to IHT and residential property, as significant changes were also announced in relation to UK residential property held by foreign domiciled persons.
UK Residential Property Held by Foreign Domiciled Persons
From April 2017, all UK residential property held directly or indirectly by foreign domiciled persons will be brought into charge for UK inheritance tax (IHT) purposes. This will be the case even when the property is owned through an indirect structure such as an offshore company, partnership or trust.
UK domiciled Individuals are subject to IHT on all their worldwide assets (subject to various reliefs and exemptions). Individuals who are neither UK domiciled nor deemed domiciled (often referred to as “non-doms”) for IHT purposes are, until April 2017, only subject to IHT on their UK assets (whereas their foreign assets are excluded from the scope of IHT). In relation to UK property, this means that if a non-dom dies owning UK property directly, their personal representatives or the beneficiaries of their estate would be liable to IHT at 40% on the value of the UK property (subject to the usual exemptions, including the £325,000 nil rate threshold). Non-doms can however remove UK property from the UK IHT net by “enveloping” the property in an offshore vehicle, for example by transferring the property to an offshore company, with the individual owning the shares in the company. The shares held by the individual would constitute “excluded property” for IHT purposes, outside the scope of IHT.
Once a non-dom becomes UK domiciled or deemed domiciled for IHT purposes, their worldwide assets are subject to IHT unless they have been settled into an “excluded property trust” prior to the individual becoming domiciled or deemed domiciled here. As a result, the shares in the offshore property-owning company would usually be transferred to an excluded property trust prior to the non-dom becoming UK domiciled or deemed domiciled.
This will no longer be the case from April 2017 because the Government has announced that it will amend the rules on excluded property so that trusts or individuals owning UK residential property through an offshore company, partnership or other opaque vehicle, will pay IHT on the value of such UK property in the same way as UK domiciled individuals. The intention is that the measure will apply to all UK residential property whether it is occupied or let and regardless of value. The rules will remain the same in relation to UK assets other than residential property or for non-UK assets. This announced change in the law is a further indication of the Government’s intention to ensure that UK residential property comes within the UK tax net (following the extension in April 2015 of UK CGT to UK residential property, irrespective of its value). A consultation document will be published some time this summer in relation to the proposal on UK property held by non-doms and the draft legislation will most likely form part of the 2017 Finance Bill.
Non-Dom Status Restricted
The Government also announced another change that will be relevant to non-doms and IHT: non dom status will be restricted for long-term residents, across all taxes (including inheritance tax). From April 2017, those who have been resident in the UK for more than 15 out of the past 20 tax years will be treated as deemed UK domiciled for all tax purposes. This will mean that they will no longer be able to use the remittance basis and they will be deemed domiciled for inheritance tax purposes.
Passing Residences to Direct Descendants
The announcement that got the headlines was the forecast change to the rules on IHT and residential property, which will be beneficial to taxpayers: an additional nil rate band, when a residence is passed on death to direct descendants, will be introduced for deaths on or after 6 April 2017. The additional band will apply in addition to the existing £325,000 nil rate band and any unused part of the additional band will be able to be transferred to a surviving spouse or civil partner (in the same way as for the existing £325,000 nil rate band). The additional band will be
- £100,000 in 2017-18,
- £125,000 in 2018-19,
- £150,000 in 2019-20, and
- £175,000 in 2020-21.
It will then increase in line with CPI from 2021-22 onwards. It will also be available when a person downsizes or ceases to own a home on or after 8 July 2015 and assets of an equivalent value, up to the value of the additional nil-rate band, are passed on death to direct descendants. There will be a tapered withdrawal of the additional nil-rate band for estates with a net value of more than £2 million (at a rate of £1 for every £2 over this threshold).