Property purchases in the UK can be a sound fiscal investment for non-UK domiciled persons. This note provides an outline of the options available to these clients. It is not intended to cover all aspects in detail, and clients should seek advice tailored to their individual needs both in the UK and in their country of domicile. We would be happy to assist in this respect.
The most common methods used by non-UK domiciled individuals to hold property are:
- personal ownership;
- via an off-shore company (where the non-domiciled person is the owner of the company);
- through an offshore discretionary trust whereby the trustees hold the property either directly or
- through an underlying offshore company.
Careful consideration should be given to the choice of method as whilst transferring from one method to another at a later date is an option, this could be complex (particularly if loans and guarantees are involved) and both Stamp Duty Land Tax, and Capital Gains Tax (“CGT”) liabilities may arise in the event of the non-domiciled individual being tax-resident in the UK.
Income tax liability applies to the four purchase methods in the same way. It will be levied where the property is rented out. Where this is the case, the tenant must withhold tax at the basic rate from his rent payments and the sum withheld must then be paid to the Inland Revenue. The owner has the option of making an application to have the rent paid gross but will then be obliged to make a UK tax return and pay the tax due. Any mortgage payments can be deducted from the rents received.
1. Personal Ownership
This is the most common way of holding property. CGT is not payable by non-UK tax resident individuals. Where the owner is deemed to be UK resident, CGT will be payable on any gain made on the disposal of the property unless it is their main residence. If they have more than one property, they should choose one of these as their main residence and claim relief accordingly.
The property will be subject to Inheritance Tax (“IHT”) on the owner’s death. IHT is charged on lifetime gifts and gifts made on death currently at a fixed rate of 40% above the IHT threshold of £285,000. If the property is held at the death of the individual a UK grant of probate may also be necessary.
Liability may be lessened by:
(i) joint-ownership, as both owners will be able to take advantage of both of their nil-rate bands. If they are a married couple, or in a civil partnership property passing between them may be exempt from IHT and they may not need to obtain grant of probate on the first of their deaths (although an IHT return may be required);
(ii) mortgaging the property (but weigh the benefit of such an arrangement against the cost);
(iii) by purchasing an insurance policy to cover the potential tax liability.
However, the second and third measures may require money to be sent to the UK to fund them which may give rise in itself to a tax liability.
2. Holding the property through an offshore company owned by the non-UK domiciled individual
This method of holding property was considered the most favourable for non-UK domiciled individuals as the property is not owned directly by them, but by a company instead.
The individual owns shares in the owner-company. These shares are not liable to inheritance tax (unless the client is deemed domiciled in the UK for IHT purposes by having been resident in the UK for 17 of the last 20 tax years).
However, the advantages of such arrangements have been reduced by the Inland Revenue, which has extended the scope of the legislation applying to benefits in kind. Where the owner-company allows a person to occupy the property rent-free, that person may be regarded as an ‘employee’ or ‘shadow director’ of the company and will be taxed on the benefit (a percentage of the purchase price of the property) of the rent-free accommodation.
Another potential pitfall is that if company decisions are seen to be taken in the UK there is a significant risk that the company will be treated as UK tax resident. If this is the case, CGT may be levied on any chargeable gain made on the sale of the property as the company could be regarded as being managed in the UK and contrary to personal ownership no private residence relief is available.
3. Holding the property through an offshore discretionary trust structure
Off-shore trustees can either hold the property directly or via an underlying company:
(a) Trustees holding the property directly
The Finance Act 2006 only received Royal Assent on 19 July 2006 and the true implications for the area of trusts will take time to implement not least as there are substantial and complicated transitional provisions for existing trusts.
However if property is held by the trustees directly and retained until the tenth anniversary of the trust, the property will become ‘relevant property.’ IHT at a rate of 6% will be levied on every tenth anniversary of the date the trust came into existence. Therefore if the property is being purchased as a long-term investment, this method is less suitable than 3b.
Any gain realised on the sale of the property will not be subject to tax unless the anti-avoidance provisions apply. These provisions provide that if the settlor (the non-UK domiciled individual) or a ‘defined person’ (e.g. the settlor’s spouse or child) benefits from the trust then any gains made on the sale of the property will be regarded as accruing to the settlor and CGT shall be levied.
This method is also unlikely to be suitable where the settlor, or his immediate family, or the beneficiaries wish to live in the property. Under this method if the settlor lives in the property the property will be regarded as a ‘gift with a reservation’ and the value of it will be included in the settlor’s estate. The same is true for a beneficiary except this is known as having a ‘life interest in the trust’. The Finance Act will also have implications on the way life interests are taxed to IHT.
If the property is let and the settlor or their spouse, or civil partner is able to benefit from the income, they may be caught under the income tax anti-avoidance rules. Any person able to reside rent-free in the property is also likely to be caught by this net.
(b) Trustees holding the property through an underlying offshore company
Here again, as with option 2 there is the added risk of income tax being levied under the benefits in kind legislation. There is also a risk that if the company is liquidated that there will be liability to CGT on both the sale of the assets and the disposal of shares. As with 3a the CGT anti-avoidance measures may come into play. However, IHT will not be levied on the trust if the property is held in this way.