KEY POINTS
Due to the imposition of IHT on all enveloped structures holding UK residential property of any value from April 2017 an urgent review is required of any such holding structures.
INTRODUCTION
The Government confirmed in the consultation document published on 19 August 2016 that all UK residential property held in foreign companies or partnerships will come within the scope of UK IHT from 6 April 2017. The draft legislation setting out how this policy will be implemented was released on 5th December 2016.
BACKGROUND TO THE REFORMS
If a UK asset is held directly by a trust or an individual then IHT is already payable under the current legislation irrespective of where the individual or trust is domiciled or resident. The rate is broadly 40% on the death of an individual and 6% every ten years for UK assets held directly by trusts. In some cases a double IHT charge can arise if the asset is held in a trust from which the individual settlor can benefit, resulting in 40% on death and 6% every ten years.
In order to avoid IHT it has been common for foreign domiciliaries including non UK residents to hold UK assets such as pictures and houses through wholly owned foreign companies. This is often called “enveloping”. As the individual or trust then holds foreign situated property rather than the UK property no IHT is payable; it effectively becomes “excluded property” in that it is excluded from IHT by the Inheritance Act 1984 (IHTA) s6 and s48.
While enveloping still works for assets such as commercial property and pictures, from April 2017 such enveloping will no longer provide any IHT protection for UK residential property and indeed there may be positive disadvantages in enveloping such UK residential property.
The IHT changes are part of the Government’s ongoing attempts since 2013 to put the taxation of UK residential property between residents and non-residents on a more level playing field. The first shot in the bows was the introduction of Annual Tax on Enveloped Dwellings (“ATED”) in April 2013 which imposed an annual charge on any high value property (over £2m) owned through a company. The ATED charge has since been extended to any property worth £500,000 or more although it is not imposed on let property. The annual rates are high – over £23,000 pa for property worth more than £2m in April 2012 or at the date of acquisition if later. The next revaluation date will be April 2017 and some properties will fall into a new higher band then. On any disposal of such properties by the company a special CGT charge is imposed at 28% on the increase in value since 2013. However, the IHT protection afforded to enveloped structures meant that in many cases people were prepared to pay ATED to save IHT particularly where the owner was elderly and more likely to die. With the loss of IHT protection, ATED and ATED-related CGT has now become merely an additional cost without any offsetting benefits and makes the case for keeping enveloped structures much less compelling.
The second change in relation to UK residential property came in 2015 with the introduction of non-resident CGT: this applies to disposals of residential property by all non UK residents but only in respect of increases in value accruing since April 2015. The third change now is IHT: there will be IHT due at 40% on the death of an individual owning enveloped residential property after April 2017 irrespective of when the property was acquired. There are no transitional reliefs. That individual will be still entitled to the same reliefs and exemptions as a UK domiciliary or UK resident such as exemption on transfers between spouses. Trusts will also be subject to ten year charges at 6% on the value of their residential property going forward. Any transfers of enveloped property into trust will be taxed at up to 20% immediately and transfers of enveloped property out of trusts will be taxed at up to 6%.
Many advisers had hoped for some kind of de-enveloping relief to aid individuals in unravelling what are now tax inefficient structures but the Government has rejected the prospect of any such relief. As it stands therefore there may be a significant cost (mainly capital gains tax or SDLT) in extracting residential properties from the company especially for UK resident shareholders or where the property is subject to borrowing.
This note considers briefly the scope of the new legislation. Tread very carefully is the key message – the tax rules in this area are complex and navigation of these rules is not to be undertaken lightly. The legislation is only draft and is clearly likely to be amended and expanded before it finally becomes law but the broad shape of the proposal is now clear.
THE NEW IHT LEGISLATION
Clause 42 and Schedule 13 of the draft Finance Bill 2017 operate to amend the definition of excluded property in section 6 and section 48 IHTA to charge IHT on residential properties situated in the UK if held through foreign structures such as companies and partnerships. IHT is now imposed on the shareholder or loan creditor of the company or the partner of the foreign partnership that holds such UK residential property as if the company or partnership was UK situated. The charge only applies to companies that are closely held i.e. under the control of five or fewer participators.
The definition of residential property is widely drawn and includes any dwelling interest including those existing for off-plan purchase. There is no relief for let properties and it applies to all residential properties, whatever their value. The legislation includes a targeted anti-avoidance provision which disregards any arrangements entered into for the sole or main purpose of avoiding or mitigating the effects of the new legislation. Of interest for individuals who have long benefited from various double tax treaties mitigating the effect of a UK IHT charge, the new rules specifically exclude double tax relief where no such equivalent tax is charged in a home jurisdiction.
If the land changes in character from residential to commercial or vice versa during the course of ownership there is a tax charge only if it is residential at the relevant point of charge. The Government’s original proposal to have a two year clawback if, for example, the land changes in nature from residential to commercial in the two years before death, has been dropped. Where property is owned by a company and used for both commercial and residential purposes e.g. the flat above the shop, then one would assume a just and reasonable apportionment will be made between the commercial and the residential elements as the commercial element is not taxable albeit there is no provision for this in the legislation as drafted.
Any gifts to individuals or trusts should be done before April 2017 to avoid a PET or chargeable transfer for IHT purposes. If the settlor can benefit from any trust that holds enveloped property bear in mind that after April 2017 this property will be subject to a reservation of benefit and charged at 40% on his death so the settlor may need to be excluded or the trust ended prior to this date.
How this charge will be enforced and collected remains uncertain as no legislation has been published on this part of the proposals. It seems likely from comments in the related documentation that some sort of duty of disclosure will be placed on the directors.
PRACTICAL EFFECT
The practical effect of the changes can best be illustrated by way of some examples.
WHY DE-ENVELOPE?
It is gradually being acknowledged that the confidentiality and privacy attractions of these structures have in any event over time been lessened by the global transparency agenda quite apart from the hefty ATED cost of owning such structures. Many countries have now introduced a variant of a register of ultimate beneficial owners and the tendrils of the Common Reporting Standard stretch far and wide. How to tackle security and privacy issues will need to be considered alongside the tax issues. It is possible to hold properties in nominee names without falling foul of ATED charges.
HOW TO DE-ENVELOPE?
There will typically be two common incarnations of these property holding structures. Either the property is held in a non UK company, the shareholder of which is the non dom individual- either UK resident or non UK resident. Unwrapping from here is more straightforward and a liquidation and distribution of the property out to the shareholder, taking account of the capital gains tax position may be all that is required.
In the alternative, the property is held in a non UK company which is in turn held in the trust of the non-UK domiciled, likely UK resident settlor and the tax position on de-enveloping this structure is more complex, particularly where beneficiaries of the trust have been occupying the property, as the capital gains tax triggered on the liquidation and distribution may be significant.
In either scenario, in order to de-envelope, careful consideration of the historical CGT position will be required. The property will need to be valued at 5 April 2013 in relation to any ATED CGT and if the individual is non UK resident, a 5 April 2015 valuation will be required to take into account the gain that has accrued since the introduction of non-residents CGT. A 2008 valuation will also be needed as this may be relate to another transitional issue called trust rebasing.
The extent of the tax at stake will need to be carefully balanced and of course funding any tax charge may be a challenge if an individual needs to remit funds in order to do so. It may be possible to transfer the company shares out to the individual with hold over relief and thereby obtain CGT rebasing on the company shares if the individual becomes deemed domiciled for all tax purposes under the new rules on 6 April 2017.
WHY PUT OFF TO APRIL 2017 WHAT CAN BE DONE TODAY?
Delaying taking action will simply increase the cost of extracting these properties.
Transferring the property out of the trust in advance of April 2017 will avoid any additional IHT 10 yearly and exit charges. In relation to the “gift with reservation of benefit” rules, the settlor ought to be swiftly excluded from benefiting from the trust or the property should be distributed out to him.
Co-ordinating any liquidation/distribution process is a time consuming process which requires significant input from overseas advisers. There may be circumstances where consent is needed from funders and/or landlords which will also take time to navigate. Action sooner rather than later is therefore advisable.
* This is for the following reasons:
On 9 December 2016, the Swiss Federal Council reported that they had decided to extend the freezing of all the assets in Switzerland of President Yanukovych, as well as of other Ukrainian individuals allegedly associated with him. Amongst other things, the report asserted that “assets amounting to approximately CHF 70 million are involved” (without saying precisely to whom this amount might belong).
Joseph Hage Aaronson LLP has written to the Swiss authorities to ask that they withdraw or clarify this statement insofar as it suggests that CHF 70 million of frozen assets are owned by either President Yanukovych or his son, Oleksandr Yanukovych, which is simply not the case. In fact, President Yanukovych and his son contend that they have no bank accounts or money or other assets in Switzerland, other than Oleksandr Yanukovych’s company Mako Trading SA, which has around CHF 1 million in its account in Switzerland; and that account is transparent and audited.
END
Enquiries to: Joseph Hage Aaronson LLP, Tel: +44 (0)2078518888
Originally published in Tax Journal on 9 December 2016.
The Court of Appeal handed down its judgment in The Test Claimants in the FII Group Litigation v HMRC on 24 November 2016, finding largely in favour of the taxpayers. The method of computing double tax relief on EU sourced dividends for the period from 1973 to 1999 therefore remains as established by Henderson J. HMRC again raised its various ‘restitutionary’ defences as to why it should not have to repay the unlawful tax, but these were rejected. The court notably allowed the claimants’ cross-appeal regarding the date of discovery, extending the date from which the six-year limitation period began to run from 2001 to 12 December 2006 and bringing all claims in the GLO within time.
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Originally published in Lexis®PSL Tax Analysis on 28 November 2016.
It seems that the proverbial white rabbit was the announcement of the single annual fiscal event. After the Spring Budget next year and the consequent Summer Finance Bill, from Autumn 2017 the Budget and Finance Bill cycle will move to the Autumn. Draft clauses for the next finance bill will be published in the Summer. This should allow longer and better debate before the clauses are enacted. There will still be a Spring Statement (from Spring 2018) in response to the OBR’s Spring forecast but normally the government would not use that Spring Statement to announce tax changes. The Chancellor intends that changes to the tax system should be announced in the Autumn. On balance this looks to be an improvement to the system and the CIOT and the IFS called for this change in an open letter back in September.
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Originally published by Lexis®PSL Private Client on 4 November 2016.
Helen McGhee, senior associate at Joseph Hage Aaronson, gives Lexis®PSL Private Client her predictions for Autumn Statement 2016. Includes Brexit, non dom changes, anti-avoidance, HMRC’s unquenchable thirst for more powers, digital tax, the downturn in the residential property market, pensions, and perhaps an increase in the personal allowance.
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Yesterday, the Court of Appeal delivered its judgment in the FII Group Litigation case confirming Henderson J’s judgment of 18 December 2014. This means that the method of computing double tax relief on EU sourced dividend income in the period 1973-1999 remains as established by the judge:
The only alteration to the judge’s judgment of note is that the Court of Appeal has overturned his finding on the date from which the extended 6 year period for issuing High Court claims runs. The judge had held that High Court claims had to be issued within 6 years of 8 March 2001. The Court of Appeal has amended that date to 12 December 2006.
HMRC’s application to appeal to the Supreme Court is pending.
This article appears in the JHA November 2016 Tax Newsletter, which also features:
The Chancellor has given his first (and last) Autumn Statement to the House of Commons. There were no announcements to accompany the Autumn Statement which affect EU claims. For a summary of the statement otherwise please read on.
It will be his last Autumn Statement because he has announced that with effect from autumn 2017, the Budget/Finance Bill cycle will move to the autumn from the spring. There will continue to be a spring statement each year as the Government is obliged to respond to the Office of Budget Responsibility’s spring forecast. However the Chancellor has said that he intends that, normally, all proposed tax changes will be announced in the Autumn Budget. Draft clauses will normally be published during the summer. This timetable should allow for full discussion of any proposals before the commencement of the tax year in April. On balance this new timetable should be an improvement on what happens at present. However much will probably depend on the publication of draft clauses in the summer rather than after announcement as part of a Budget speech.
The Chancellor announced the usual number of technical fiscal changes but nothing that seems overly dramatic. On the business tax front, the Chancellor has recommitted to the existing business tax roadmap which should lead to a reduction in the CT rate to 17% by 2020. However the ‘roadmap’ also contains plans regarding the implementation of BEPS and the tax transparency agenda. Apart from this the Chancellor announced that the Government is proceeding with plans to legislate to deal with the deductibility of corporate interest charges, the reform of loss relief and the reform of the substantial shareholding exemption. Each of these changes have been the subject of consultation already.
Interestingly the Chancellor announced that the Government is considering bringing the UK income of non-resident companies into the CT regime. As well as putting all companies onto the same footing in terms of the tax rules that apply, the suggestion would also probably serve to mitigate any rate discrimination as the rate of CT decreases. On the personal tax side the Chancellor has said that the Government will examine the taxation of different forms of remuneration. After consultation, it is intended that (with specific exceptions) the tax and NICs advantages of salary sacrifice arrangements will removed. At the same time the Government intends to consider the question of how benefits in kind are valued for tax purposes.
A low key but potentially significant announcement was that NICs are going to be removed from the ambit of the Limitation Act from April 2018 and be aligned with the time limits and recovery processes currently applicable to other taxes. Whilst this change has the obvious attractions of consistency and simplicity it will mean that HMRC will be able to go back up to 20 years in the enforcement of unpaid NICs. It will be interesting to see the commencement rules for the legislation implementing this proposal.
The blitz on avoidance (and evasion) continues. The changes in respect of disguised remuneration schemes used by employers and employees announced at Budget 2016 will now be extended to counter the use of such arrangements by the self-employed. The Government will legislate the much debated proposals for a new penalty for those who enable another to use a tax avoidance arrangement that is subsequently defeated by HMRC. Much of the debate has involved professional advisers who will be the asserted ‘enablers’ but as part of the proposal, those who use the tax arrangements will cease to be able to rely on the fact of having taken much professional advice as a defence of ‘reasonable care’ in relation to a penalty exposure. The ‘requirement to correct’ which has been the subject of consultation will be enacted. Finally the Government has announced a new requirement for intermediaries arranging complex structures for clients holding money offshore to notify HMRC of the structure and the related client lists. It proposes to consult on this proposal.
This article appears in the JHA November 2016 Tax Newsletter, which also features:
On 8 November 2016, the Council agreed on the criteria and guidelines for selecting and screening third countries with a view to establish an EU list of non-cooperative jurisdictions in tax matters. The broader aim of the initiative is to combat tax base erosion and profit shifting (‘BEPS’).
According to the Council Conclusions on the criteria for and process leading to the establishment of the EU list of non-cooperative jurisdictions for tax purposes (available here), the countries selected for screening will be assessed cumulatively under three criteria, namely:
Screening is due to be completed by September 2017, so that the Council can endorse the list of non-cooperative jurisdictions by the end of 2017. Screening is intended to be a continuous and regular process. Discussions with jurisdictions aimed at resolving concerns and agreeing on commitments are expected to take place by the summer of 2017.
This article appears in the JHA November 2016 Tax Newsletter, which also features:
The Belgian tax regime enables undertakings to carry forward losses without limitation to future assessment periods and to claim a deduction for so-called risk capital. This resulted in a situation where certain undertakings paid virtually no tax but still distributed profits.
Case C-68/15 X concerns a preliminary reference ruling on the Belgian “fairness tax” which was introduced to deal with this perceived unfairness. The “fairness tax” is calculated on the basis of the amount by which the company’s distributed profits exceeded its taxable profits and is levied on domestic companies and foreign companies with a permanent establishment in Belgium but not on subsidiaries.
Examining whether the tax was compatible with the freedom of establishment, Advocate General Kokott concluded that the tax regime did not pose an obstacle to non-resident companies by preventing free choice of legal form.
Further, article 49 did not preclude the levying of a tax in such a way that a non-resident company with a permanent establishment in a Member State is subject to it when it distributes profits, even though the permanent establishment’s profits were retained, whereas a resident company that retains profits in full is not.
However, article 4(3) of the Parent-Subsidiary Directive which sets a maximum tax burden, did render the tax offensive because it operates so as to exceed the tax limit when a company distributes a received dividend in a year subsequent to the year in which it received the dividend. Article 4(3) of the directive could not be interpreted so as to apply only to received dividends and not subsequent redistribution.
This article appears in the JHA November 2016 Tax Newsletter, which also features:
Originally printed in Tax Journal on 21 Oct 2016.
Henderson J handed down judgment in Six Continents v HMRC [2016] EWHC 2426 (Ch) on 5 October 2016. The issues concerned what foreign profits should receive credit at the foreign nominal rate in accordance with the ruling of the CJEU in Test Claimants in the FII Group Litigation v HMRC (Case C-35/11). The judgment holds that Six Continents are entitled to a credit at the FNR on the underlying foreign profits which incorporated adjustments to the commercial profits for the revaluation of shareholdings, the release of warranty provisions and exchange rate adjustments which were removed for local tax. It also held that the same credit would apply to capital gains even though exempt under the Dutch participation exemption.
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