George Osbornes Assault on UK property investors

If you're non domiciled and have been building a residential property portfolio in the UK as a nest egg for the future, perhaps using an offshore company or trust, set up in a low tax or zero tax jurisdiction, such as BVI or Panama, you're heirs are about to lose up to 40% of the value of that portfolio, with George Osborne's new inheritance tax rules coming into force in April next year.

What is surprising, is how speaking to a variety of people who are likely to be affected by this change in Inheritance Tax , being non domiciled high net worth individuals and ultra high net worths, with billions of pounds invested in the UK property market, together with their banks, lawyers and estate agents who advise them, in the most part, seem blissfully unaware of the impact of these new rules.

This proposed amendment to the IHT rules, comes on the back of a suite of other amendments to the UK’s taxing of residential property, particularly property owned by offshore companies, demonstrating a clear policy decision by George Osborne and this current government to tackle two issues: one; the overheated property market in London and two; the growing demand for greater transparency and fairness in our taxing of High Net Worth individuals, particular in their use of off shore companies.

These issues pre-date the “Panama papers”, which leaked the names of more than 214,000 offshore corporations, with links in some cases to some high profile beneficiaries. The proliferation and the use of such companies and trusts to legally avoid taxes, has been well known for some time, resulting in an increased pressure on the government to act. The magazine, Private Eye, published an article in 2015 revealing graphically the full extent of the overseas property ownership with reference to land registry data. As you will see from the map contained in the article, ownership of property in London by such offshore entities has saturated prime Central London postcodes. (See Article Here )

Investment in the UK residential property market using non domiciled companies has exploded over the course of the last 5 years, with current levels of investment in the UK estimated to be in the region of £170 billion, much of which is invested in London.

Whilst one can argue that this investment has been fuelled by the strength of the UK property market, which it has, it is also very clear that it has also been promoted through the ease, by which non-domiciled individuals, investing through off shore companies and trusts, have been able to protect property gains from HMRC, whilst at the same time maintaining their anonymity.

The effect of this massive investment by overseas buyers in London, has together with other factors, resulted in rampant house price inflation, which has only aggravated the under supply of available properties, for an ever increasing population.

The government now seems determined to slow down that rate of overseas investment by taxing the beneficiaries of such offshore vehicles. In fact the policy extends not just to overseas buyers and investors, but also to UK domiciled investors, as has been seen by the recent increasing of stamp duty (SDLT) on second homes by 3% from this April and the withdrawal of interest rate relief on second homes with mortgages, available to such investors, which will be phased out from next year.

Whilst the aforesaid changes were targeted at the buy to let market, both domestic and overseas buyers, the further following changes introduced by the Chancellor are more directly aimed at the wealthy and overseas investors;

In 2013, ATED ( Annual Tax on Enveloped Dwellings) was introduced, being the so called “Mansion Tax”. The legislation is designed to charge an annual fee to companies (incorporated anywhere in the world) holding UK property for the benefit and the use of individuals. Reliefs are available for companies carrying on genuine commercial activities (such as letting the property), but ATED is chargeable, even if there is no commercial purpose.

Amounts payable can reach up to £218,200 per annum for properties valued at more than £20m. Whilst this tax applies to all companies, not just non resident companies, allowing for some exceptions, it could be argued that the thrust of the new tax was primarily targeted at those individuals holding UK properties through off shore companies and using the property for occasional personal use. The ATED is payable in circumstances where the beneficial owner of the company or his immediate family stays in the property for just one night a year.

The threshold at which this tax now applies has been lowered from £2 million to £500,000 as from April of this year, making it less a “Mansion Tax" and more akin to a “Pied de Terre Tax” in Central London.

In April 2015, the government further introduced a new non resident capital gains tax on both non uk individuals, as well as certain offshore close companies and trusts. Gains accruing after April last year will now attract CGT of 28%.

There have also been changes to Stamp Duty (SDLT), with a new rate introduced in 2014 for companies, partnerships, collective investment schemes (onshore or offshore) of 15%, as well as the already mentioned 3% increase in current SDLT rates for any second properties, held by individuals or corporates (onshore or offshore) which was brought into force in April of this year.

Arguably, the most significant changes to the tax regime for overseas companies and individuals is now the introduction of new rules regarding Inheritance Tax, which will take effect from the 6th April 2017 and the proposed introduction of a register of beneficial ownership of such companies

Up to this date, individuals who are neither domiciled nor deemed domiciled for IHT purposes, and trusts settled by such individuals, are subject to IHT, but only on assets they own directly in the UK. From April 2017, UK residential property held indirectly by non-doms will be subject to IHT, i.e. property held through offshore companies or other opaque entities used by an individual or a trust.

The changes were first tabled in the March 2015 Budget, will give the HMRC a “look-through” with regard to the beneficiaries of offshore vehicles, in most cases SPVs (special purpose vehicles or off the shelf companies set up for the purchase of one particular asset) and most types of offshore trusts holding UK properties.

The effect of this latest proposed legislation will be that the beneficial owners of those SPVs will become liable to UK Inheritance Tax on those property assets in the event of their death – effectively, subjecting their UK property assets to a 40% tax charge, even though those assets are held within a structure, in many cases set up specifically to avoid UK IHT. This will apply to all UK residential property of any value whether it is owner occupied or let.

The definition of chargeable event also extends to the gift of the shares into a trust; the ten year anniversary of a trust; the distribution of shares out of a trust and the death within 7 years of someone who has made a gift of the shares to an individual.

For banks, lending to non domiciled individuals or companies on UK property, there will have to be a fundamental shift in their risk analysis, in order to take account of the IHT changes, otherwise they will be exposed to potential losses if their clients pass away without adequate ilife insurance being in place or if the exposure has not been planned away using other structures.

An example of how in practical terms it will affect banks lending to clients domiciled overseas for UK property assets, is that quite simply if a bank makes a loan of £5 million to a non domiciled company buying a UK residential property, who is buying for a price of £10 million, the risk ratio after April next year will have changed dramatically, increasing the LTV from 50% to 83%. In the wider context, the effect of the changes in IHT might very well lead to a contraction of available funding for overseas buyers and a slowing down of the inward investment into the UK residential property market.

This may very well be the political imperative, in terms of their commitment to greater transparency and putting a break on an overheated property market, especially in London.

The IHT provisions as to transparency when it comes to offshore resident companies, is to a large extent already being addressed by the anti money laundering legislation, requiring a greater due diligence on the part of estate agents and lawyers when dealing with property acquisitions and disposals.

The government acknowledges that “property can provide a convenient vehicle for hiding the proceeds of crime” and that “high values of property in London in particular, presents an opportunity for criminals to launder considerable sums of money in one transaction”. So it also proposes to make transparency a condition of property ownership in the UK, as suggested by the Eye and others, “requiring foreign companies to provide information on their beneficial ownership before they are able to buy land/property in England or Wales”.”and it seems very likely, in view of recent events, that such a list will be become more of a priority leading up to the 2017 IHT deadline.

The leak of private data from the law firm Mossack Fonseca,- “The Panama Papers” has only heightened the need for greater scrutiny and will, in all likelihood ,consolidate political pressure to end the use of such off shore tax havens.

The government has intimidated that they may possibly introduce certain reliefs to encourage non dom’s to unwind their off shore structures, but it is too early to see

how these overseas investors will respond to the requirement for greater transparency, the loss of anonymity and the increased tax burden on owning or investing in UK property?

For many overseas investors in the UK, the IHT changes are the last straw, coming on the back of the changes already outlined and is prompting investors to sell large swathes of their residential portfolios.

However, it is likely that many will continue to invest, on the basis that the UK and particularly London is a “safe haven”, whilst many I’m sure will look to invest and re-acquire their anonymity using other offshore structures.

Bespoke tax planning is delivering some alternative solutions, one such structure, gaining traction amongst overseas buyers and investors is the use of overseas pension planning vehicles such as a QNUP (Qualifying Non UK Pension) linked to an EPUT (Exempt Property Unit Trusts) which is used as the onshore vehicle for the purchase of the property.

An EPUT is HMRC approved and a QNUP is HMRC recognised, although the validity of the latter is only tested on the death of one of its contributors, so it is important that the QNUP is bona fide and properly used as a pension vehicle, not just as a tax reducing scheme. If valid, the distribution from the pension is free of inheritance tax and if the beneficiary is non domiciled in a tax free haven, any pension payments will ultimately be tax free.

The structure works as follows: the beneficiary of the QNUP makes contributions, which are used to purchase units in the EPUT, which in turn purchases the UK property. Any gains made by the EPUT, whether by way of sale of the property or rent, are remitted back to the overseas pension, and such gains made by the EPUT are exempt from capital gains, ATED and overseas landlords withholding tax. In addition any “look through” provisions are for the present time, not applicable to QNUP beneficiaries.

Whilst this structuring is part of a bespoke planning process, only time will tell as to whether HMRC will look to close this possible loop hole for property ownership in the UK or whether it will proliferate to the same extent as offshore companies have done in the past.

What is clear, is that any current tax planning advice will have to recognise that this present government seems determined to raise the veil of corporate property ownership in this country and concurrently to put a brake on property inflation fuelled by overseas investors. A comprehensive list of beneficial ownership at the land registry, seems almost a certainty, with the same rules extending to other off shore jurisdictions.

Any one who is affected by these taxes is no doubt already in contact with their tax advisers, but not every adviser is aware of the benefits of using pension planning to mitigate the effects of some or all of these taxes. I have been working with a firm of very reputable tax advisers and wealth specialists who are providing a bespoke and innovative tax structure which can be very effective.

Please don't hesitate to get in contact if you wish to discuss further by emailing me at lee@ullgerchambers.com

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