Advice is often sought about how a resident but foreign domiciled client should hold residential property in the UK. The property is invariably valuable, and because it is situated in the UK it will be vulnerable to inheritance tax in the client’s hands. Even foreign domiciled individuals are liable to inheritance tax on assets situated in the UK. The value of a comparatively modest house in central London can create an inheritance tax exposure of millions of pounds, which most non-dom clients find undesirable.
A traditional answer here is to ensure that the UK property is purchased by an offshore company. The individual then owns shares in the offshore company, which is foreign property for inheritance tax purposes and excluded from the scope of inheritance tax. Simple. Problem solved.
However, it is not quite as simple as that. There are some other issues arising which need to be considered.
One issue would be the possibility of a charge to income tax under the benefits in kind legislation on the basis that the client is an employee who is receiving the benefit of living accommodation and is liable to income tax on the annual value in the normal way plus the supplementary benefit calculated at 4% of the cost of the property over £75,000. This will make your eyes water. The argument for HMRC is deceptively simple. The client is a person in accordance with whose instructions or directions the real directors are accustomed to act. He is therefore a shadow director; a shadow director is the same as any other director, so he is an employee and has had living accommodation provided for him by the company, which by definition is provided by reason of his employment. All the building blocks are in place for the benefit in kind charge to arise. It is therefore necessary to ensure that the purchase is structured so as to eliminate this charge.
There is also the question of the company’s residence. It will be readily appreciated how easily HMRC might argue that the company is resident in the UK because of the overwhelming influence of the UK-based client on its operations, so that the central management and control of the company would take place where the client is resident. Accordingly, in the event of a sale the capital gain made on the property would be fully chargeable to corporation tax. No private residence relief would be available because the property would be owned by the company and not by the individual personally.
For all these reasons the client is likely to establish a non-resident trust to purchase the property and for the trustees to arrange for the property to be held by an offshore company under their control. (The trustees would no doubt want to do so as it would protect the trust fund from an unnecessary charge to inheritance tax.) This is likely to be extremely helpful with both the benefit in kind and the residence arguments.
However, there is still one fly in the ointment. The resident non-dom client may be protected from inheritance tax and possibly from any benefit in kind charge, but he is now exposed to a charge to capital gains tax when the property is sold. If the company makes a gain, that gain is attributable to the trustees and is taxed on him to the extent that he has received benefits from the trust − which of course he has because he has occupied the property for many years. The full gain might not be chargeable of course − it depends on the length of time for which he has occupied the property and the precise calculation of the benefit he has enjoyed from the trust property, but a substantial charge will still arise. If his family members also occupy the property, they could have part of the capital gain attributed to them as well.
One might ask why, with this serious capital gains tax disadvantage, has it been traditional for this structure to be used − and the answer is that until 5 April 2008 trust established by a foreign domiciled individual did not give rise to any capital gains being attributed to the beneficiaries if it was established by a foreign domiciled settlor. Unfortunately that exemption has been removed and the beneficiaries are liable to capital gains tax by reference to capital payments under Section 87 in the traditional way. The foreign domiciled beneficiary can still be advantaged by the remittance basis so that benefits received outside the UK and not remitted to the UK are protected, but in these circumstances the benefit is received in the UK and therefore the individual derives no advantage by reason of his foreign domicile. Companies have no equivalent of Section 225 TCGA 1992 whereby trustees can be allowed the main residence exemption if the property is occupied as the main residence of a beneficiary.
Although a company is the clear answer to the inheritance tax problems and the implications regarding the other taxes can perhaps be happily managed, one does have to ask why are we doing all this? Which is the real problem here. It is of course inheritance tax − but how real is that liability, and is it worth all these complications and costs, which can last for decades?
Of course, it may not be a problem at all because the client may simply leave the property to his spouse on his death and the full spouse exemption would be available. She would have the rest of her life to decide what to do with the property having regard to her own tax position. In many cases, the property is sold, being too large for the widow in her new circumstances. The problem therefore disappears.
The risk here is, of course, that if both spouses die in some accident and there is no spouse exemption, the full value becomes immediately chargeable. However, depending upon the age of the client, that is a matter which can perhaps most simply and effectively (and cheaply) be covered by insurance which pays out on the second death.