More than a year after it proposed further restricting tax benefits for non-UK-domiciled individuals, the UK government published a consultation paper on 19 August restating a commitment to introduce new rules from 6 April 2017.
The two fundamental changes are a 15-year limit on UK resident non-domiciled individuals to take advantage of income tax, capital gains tax (CGT) and inheritance tax (IHT) benefits; and IHT charges in respect of non-domiciled individuals’ indirect holdings in UK residential property.
This article will address the second of these changes.
Background reading
Prior to 2013, UK residential property was a very tax-efficient investment for non-UK-domiciled individuals, and the tax regime positively encouraged such individuals to hold property via an offshore corporate vehicle. Holding property in this way offered several benefits:
- there was no CGT on the sale of the property by the company;
- there was no stamp duty land tax if the property company shares were sold rather than the underlying property;
- rental income was taxed at 20%, in comparison with a maximum rate of 45% if held by the individual directly; and
- no IHT if the property company shares were transferred by gift or on the death of the beneficial owner.
In April 2013, the UK government introduced new tax laws to curtail the use of offshore companies for UK property ownership, one of which was the introduction of an annual tax on enveloped dwellings (ATED). Originally aimed at properties valued in excess of £2m, the tax now applies to properties valued at £500,000 and above, and the rates have increased substantially since its introduction (see table below).
Figure 1 – Annual Tax on Enveloped Dwellings
Value of Property
Annual Charge in Tax Year
2013/14 2014/15 2015/16 2016/17
Above £500,000 to £1m – – – £3,500
Above £1m to £2m – – £7,000 £7,000
Above £2m to £5m £15,000 £15,400 £23,350 £23,350
Above £5m to £10m £35,000 £35,900 £54,450 £54,450
Above £10m to £20m £70,000 £71,850 £109,050 £109,050
More than £20m £140,000 £143,750 £218,200 £218,200
Where a property is subject to ATED, any capital gain made on the sale of the property by the company is also subject to CGT, although CGT has now been extended to all non-UK residents selling UK residential property, regardless of whether they are subject to ATED or not.
ATED does not apply to all residential property. Purpose-built student accommodation is exempt, for example, as well as any property that is rented out on a commercial basis to persons not connected to the beneficial owner. In spite of this, the total ATED receipts of £116m have been well in excess of the original HM Revenue & Customs estimate of £65m for the 2014/15 tax year.
Foreign-domiciled individuals have been happy to continue to envelope their properties to date as it creates a shelter from UK IHT on transfer, either by gift or on death of the beneficial owner.
This is because the shares in the company are transferred rather than the property. As the shares are non-UK situs, they are treated as ‘excluded property’ if the beneficial owner is non-UK-domiciled. Without the offshore company, IHT would be levied at 40% on the value of the property, once any available nil-rate band is deducted.
For a property worth £2m, where the full individual nil-rate band (£325,000) is available, that amounts to IHT of £670,000 – not an insignificant amount – hence the incentive to continue to envelop the property.
But this is all about to change, and those affected need to consider their options now.
