Tax changes affecting residential property in offshore structures

Historically individuals may have opted to hold UK residential property within an offshore trust or company to mitigate their liabilities to UK capital gains tax, income tax on rents and/or inheritance tax.

These structures came under attack in 2008 when the taxation of non-UK domiciliaries was amended, bringing many beneficiaries and settlors into the charge to income tax or capital gains tax unless they elected to pay an annual remittance based charge. Despite this, offshore structures currently remain favourable to hold UK residential property for the benefit of non-UK domiciliaries.

From 1 April 2013 the government will introduce a number of changes to tackle what they see as ‘the avoidance of tax on high value residential property’. These new regulations are currently in the consultation period but the proposals look to threaten the use of offshore structures for properties that exceed £2m in value, by imposing annual charges and capital gains tax charges on new and existing structures.

The intention of the legislation is to encourage the removal of UK residential properties from the offshore structures so that in the future ‘a fair share of tax is paid on these properties’. This paper looks at how the charges may be imposed and reviews whether the offshore structures can still offer some tax advantage. Unfortunately it is not possible at this stage to offer any solutions to avoid these charges as the extent of the legislation and how it will be applied is not yet known.

Current taxation position

Inheritance tax

Typically an offshore company has been used by non-UK domiciliaries as a wrapper around UK property; converting the asset held from UK situs property to offshore company shares. This removes the property from the UK inheritance tax net for such individuals, saving tax at 40% on the value of the asset. This tax advantage does not seem to be affected by the proposed new legislation.

Capital gains tax

Currently offshore companies and the non-resident trustees of an offshore trust are not liable to UK capital gains tax on gains realised on assets, wherever they are situated. For this reason such trusts are often seen as an offshore tax-free roll up vehicle.

Even if the gains are distributed to UK resident but non-UK domiciled beneficiaries, there is no charge on the recipient, provided they do not remit the gains to the UK. Very often the funds will be transferred into a foreign account for the beneficiary, to be used outside the UK. If the recipient of funds has been resident in the UK for more than seven out of nine years they must pay a remittance charge of at least £30,000 to attract this favourable treatment. However, as the remittance charge only needs to be paid in the year in which a distribution is made, it is possible to plan ahead to minimize the charges and taxation.

New charges to be introduced

The government intend to introduce measures to ensure that individuals and companies pay ‘a fair share of tax on residential property transactions and to tackle avoidance’. They intend to do this by imposing the following charges from April 2013 on properties worth more than £2m:

  • An annual charge on residential property owned by ‘non-natural persons’;
  • Capital gains tax on disposals of properties by ‘non-natural persons’.

They have already imposed a new Stamp Duty Land Tax (‘SDLT’) charge at a rate of 15% on the acquisition of residential dwellings exceeding £2m by ‘non-natural persons’. This was introduced from 21 March 2012.

Extent of the charge

This paper concentrates on the annual charge and the potential to capital gains tax as these affect existing structures where there are properties held that exceed £2m in value. In cases where an existing structure holds property that is likely to exceed £2m in value in the near future, there will be a need to look at restructuring to try to mitigate the ongoing charges.

Entities it applies to

The definition of non-natural person differs for the two charges but in both cases includes:

  • Offshore companies and other bodies corporate;
  • Collective investment vehicles;
  • Partnerships which include an offshore company or a collective investment as a partner.

The definition is further extended for the capital gains tax charge to include offshore trustees.

As offshore trusts are not subject to the annual charge, in some cases it may be worthwhile transferring the property from an offshore company to an offshore trust. The property will still be liable to the new capital gains tax charge, however, and may not achieve the same objective as a company.

Valuation

The charges depend upon the property exceeding a £2m valuation. This is obviously subjective but will rely on a professional valuation report being submitted with the annual charge tax return. The property must be re-valued every five years.

As with most new legislation the government intends to include anti-avoidance measures to bring the property back into tax if any artificial measures attempt to devalue the property to below the £2m threshold. For example the freehold and leasehold interest in a property will be aggregated to ascertain the value of the property if the interests are held by connected persons.

It is clear that this applies only to residential property, so commercial property will not be subject to the charge or to capital gains tax. It also appears that the £2m valuation threshold applies only to individual properties and not portfolios.

Annual charge

The annual charge will increase in accordance with the valuation of the property; starting at £15,000 per annum for properties valued between £2m – £5m, with the highest intended charge of £140,000 per annum for properties exceeding £20m. It has not yet been decided who will be liable for the charge as very often the offshore entities are single purpose vehicles with no cash to fund annual charges.

The payment on an annual charge may mean that the offshore structure is no longer cost efficient but this will depend upon the circumstances of the beneficiary. For example, if the beneficiary is elderly, retaining the property in an offshore wrapper that remains outside his estate for UK inheritance tax may still be more cost effective. The inheritance tax liability that would arise on direct ownership may exceed the likely total annual charges, based on life expectancy.

Capital gains tax charge

The consultation document comments that this measure brings the UK more in line with other countries that impose a capital gains tax on  non-residents’ gains. The legislation attempts to align the tax treatment of gains on disposals of UK residential properties so that a non-UK resident does not have an advantage over a UK resident.

The scope for the persons chargeable is much wider than under the annual charge simply because it catches offshore trusts, personal representatives of an estate and other similar structures that exist in other jurisdictions e.g. usufructs in Germany.

However, there are more reliefs against the capital gains tax charge than the annual charge. It is intended that reliefs available to the UK resident versions of the entities caught, should also be available to the non-UK resident. For example, if a beneficiary of a life interest trust occupies a residential property held in trust as his main residence, the Principal Private Residence Relief that exempts the gain from tax should be available to the non-UK resident trustees.

There will be no apportioning of any gain on disposal between the period before and after April 2013, hence the capital gains tax charge will apply to the total gain if the proceeds exceed £2m.

Conclusion

Following the end of the consultation period we will review the draft legislation to advise on possible restructuring before April 2013. There is unlikely to be a ‘catch-all’ solution and it will be necessary to understand the original reasons for the offshore structure before providing solutions. In the meantime please feel free to contact us to discuss this or any other tax matter further.

 

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