Helping overseas investors pay less tax on UK property investment
Tax should be a four-letter word. If you don’t plan for it, a tax can severely damage your wealth. Like cigarettes, they could come with a government warning. Now, while I don’t think that tax should be the reason to invest (and if you pay tax, then it should show that your best property investments are profitable), I’m a firm believer that there is no point in paying tax when you don’t have to.
The government, however, want you to pay as much tax as they can get away with charging you. So, they constantly change tax rules, hoping to draw even more property investment profits into the tax net. Naturally, you’ll want to avoid as much tax as possible. It’s like a game of cat and mouse. The only way you can win is by knowing the rules.
Non-domiciled property investors will find themselves subject to new rules come April 2017. In this article, I’ll discuss the effect of the new regulations on inheritance tax for non-doms so that you can shape your UK residential investment property portfolio to minimise the impact.
What is a non-dom?
When discussing your tax position and legal status, you’ll have three identifiers. These are a residence, nationality, and domicile. For most people, all three will be the same:
- Nationality is usually determined by where you were born
- Residence is determined by where you live
- Domicile is determined by where you intend to live permanently
Other people have mixed nationalities, residencies, and domiciles. For example, a mate of mine is British with an Australian wife. They currently live in Spain, but intend to move to Australia and make that their permanent home. His nationality is British, he’s a resident of Spain, but his intended domicile is Australia. Currently, he’s domiciled in the UK, which means he can vote there.
The key thing about domicile is that it determines a lot of the taxes you pay. In particular, inheritance tax.
What is inheritance tax (IHT)?
It’s not enough that the government taxes you on your property investment income and any profit you make on sales of investment properties. When you die, they’ll want to take a slice of the value of your estate.
If you’re UK domiciled, IHT will be charged on all your property, wherever it is. So, if you own, say, a £10 million property portfolio in Asia, when you die your estate will have to pay IHT. Some IHT allowances reduce the tax you pay – for example, the first £325,000 of your estate is IHT free, and your primary residence (when passed down to a direct descendant) also benefits from an additional nil-rate band.
The rules for non-doms are different, but they are changing.
What IHT do non-doms pay?
At the moment, non-doms only pay IHT on property that they own directly in the UK. What this means is that non-doms have been able to take advantage of UK property investment opportunities, and if investing in them through an offshore structure such as an offshore trust, they haven’t been subject to IHT. It is about to change.
The government published its original proposals back in 2015. It’s recently finished the last round of consultations, but it looks unlikely that there will be any significant changes to its proposals. Once the new rules are confirmed, there may only be a small window of opportunity for non-doms to prepare and position their investment property portfolio for IHT purposes.
How will the new IHT rules affect non-doms?
From April 6th, 2017, if you’re a non-dom but have been resident in the UK for 15 of the last 20 years, you’ll be treated as domiciled in the UK. (This used to be 17 years.) This means that all of your UK investment properties, whether held directly or via an offshore structure, will be IHT liable.
If you die, you could find that your beneficiaries have to stump up 40% of the value of your UK property portfolio as in IHT payments (after any IHT allowances available have been applied).
Will grandfathering be allowed?
Grandfathering is a term used to describe the handing down of the old rules into a new regulatory structure. For example, if the government were to allow grandfathering of current offshore UK property investment holdings, then the new rules on domicile would have no effect. Unsurprisingly, there will be no grandfathering.
Gifting your estate before you die
If you gift property more than three years before your death, there will be taper relief (which helps to reduce your IHT liability). However, the new IHT rules for non-doms will also cover any ‘chargeable event’. Chargeable events include:
- The death of an individual who held shares in an overseas close company that holds UK residential property.
- The death of a donor making a gift of shares in a close company that holds UK residential property, where that gift was made within seven years of death.
- Any ten-year anniversary of a trust holding UK residential property through an offshore company.
Exemptions to the new rules
The new rules cover UK property. However, it is held. However, there are some exemptions:
- Commercial property is not included. The new rules only capture UK residential property.
- Property funds will also be exempt. However, the fund must be diversified as to ownership (in their words, lots of owners that are unconnected persons).
- If the investment property has been bought with the aid of a mortgage, only the net value of the property will be liable to IHT. However, the mortgage must have been put in place when the property was originally bought.
Should you unwind your offshore investment vehicle?
If you’re a non-dom who could be affected by these rule changes, you may be considering unwinding your offshore property investment vehicle. Before you do so, you should seek specialist tax advice. The government has said that it won’t provide any leniency to investors taking this route to avoid tax under the new rules. By unwinding an investment vehicle, you could create other tax liabilities (such as capital gains tax) and have your transactions counted as chargeable events.
How will the government enforce the new rules?
HMRC will be given extended powers under the new rules. It will give them the ability to charge IHT in all UK residential investment property that is captured by the new rules. Its powers will stop you from any property being sold until the due IHT is paid.
In addition to this, it will make owners of the investment property personally liable for the IHT. The ownership rules will be extended to include the directors of any company that holds the UK residential investment property.
What should property investors do now?
A lot of our property investor clients are likely to remain largely unaffected by these property tax rule changes. Their investments have been concentrated in the growing private rented sector, leveraging purchases in some the best places to invest in property UK. Offshore investment vehicles are pretty expensive to set up and run, so fewer of our non-dom investors have invested indirectly in this manner.
If you’re a non-dom who holds UK investment properties as part of your investment portfolio, or you’re considering investing in UK residential property, you’ll need to assess your individual position as soon as possible. The quicker you act, the more time you’ll have to take the action that’s needed to keep your property investment both profitable and tax efficient. The longer you leave it, the more likely it is that you’ll end up paying more tax than necessary.
Contact our team on +44 (0)207 923 6100 to take advantage of an investment planning session, in which you can discover how property investment could help you realise your financial objectives.