Writing for Taxation magazine’s Readers’ Forum, BKL tax consultant Terry Jordan responds to a reader’s query about inheritance tax (IHT) and the ten year anniversary charge in relation to offshore trusts.
‘My client has two unrelated separate overseas trusts settled by unconnected non-UK domiciled individuals. One trust has a tenth anniversary and the other has a twentieth anniversary coming up.
Both have a similar setup, with overseas bank accounts, overseas assets and liabilities and ownership of overseas registered companies. In trust 1, company A contains no UK residential property but company B’s value is derived from a loan given to a beneficiary of the trust which was then used to purchase a UK residential property. In trust 2, company C also contains a UK residential property and some overseas assets and liabilities that do not fall under UK inheritance tax.
Does the change in inheritance tax rules in 2017 mean that company B in trust 1 falls under the ten-year anniversary rules as the company derives its value from a loan in connection with a UK residential property? If company B does fall under UK inheritance tax, then how is the inheritance tax value for trust 1 calculated and reported to HMRC? For company C in trust 2, how is the value attributable to UK inheritance tax worked out? Again, would we need to look at the value of property in isolation or do we factor in the other assets and liabilities contained within the company and the trust and use a pro rata method?
We would be grateful for any pointers from readers on this.’ Query 19,936 – Maid Marian.
Terry Jordan’s reply: If the company is wholly owned by the trustees, HMRC is unlikely to allow a discount to the value of the loan when valuing the shares.
‘Inheritance tax is charged by reference to a person’s domicile. For those domiciled within the UK at general law or deemed domiciled under what is now the 15 out of 20 tax year of residence rule, the charge extends to their worldwide assets and, conversely, for those domiciled outside the UK the charge is limited to UK situs assets. Since October 2002 holdings in authorised unit trusts and shares in open-ended investment companies are also excluded property and outside the scope of inheritance tax for non-UK domiciles. Similar rules apply to assets held in trust settled by non-UK domiciles and in those cases the acquisition of a domicile within the UK by the settlor does not affect the inheritance tax treatment going forward: IHTA 1984, ss 48 (3) and (3A).
Prior to 6 April 2017 it was possible to shift the situs of UK residential property by having it ‘enveloped’ in a non-UK company the shares in which were owned by the trustees. As part of the 2017 changes it was decided that UK residential property should always be within the scope of inheritance tax and the relevant provisions are in Schedule A1 IHTA. As Emma Chamberlain explained in British Tax Review Issue 5, 2017 the legislation needed to deal with borrowing taken out to purchase UK property. It was decided that debt should be brought into the scope of IHT so it can be deducted against the value of UK residential property but in the hands of the lender such loans can be chargeable under paragraphs 3 and 4 of Schedule A1.
Turning to Maid Marian’s queries, company B in trust 1 does fall under the ten-year anniversary rules and the trustees will need to submit an IHT 100 and related forms. If the company is wholly owned by the trustees HMRC is unlikely to allow a discount to the value of the loan when valuing the shares. In trust 2 the taxable value of the shares in company C is the value referable to the UK residential property interest and the liabilities of the company are attributed rateably to all of its assets even if secured on the UK property: paragraph 2 (5) Schedule A1, see IHTM 04312. Reference could also usefully be made to ICAEW Tax guide 11/20 prepared in conjunction with STEP, CIOT and the Law Society.’
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