Holding UK Property Through An Offshore Trust: Is The Tide Coming In?

Alan Pink points out a worrying trend in the taxation of UK property held in offshore trusts.

Until very recently it was pretty much a ‘no-brainer’, if you or key members of your family were non-UK resident or non-UK domiciled, to hold a substantial portfolio of UK real property through the medium of an offshore trust, provided the values were great enough to justify the annual cost. 

Whether accidentally or deliberately (and I suspect deliberately), the rules favoured such individuals investing in the UK. Whilst there was the potential to use such a structure to save income tax (using ‘back to back’ loan arrangements), what I’d like to concentrate on here is the very substantial potential benefits from the point of view of capital gains tax (CGT) and inheritance tax (IHT). On the back of these capital taxes advantages, a massive offshore holding industry built up, from which the economies of islands like Jersey, Guernsey, and the Isle of Man have particularly benefited. 

A trust with non-UK resident or non-UK domiciled beneficiaries, and with non-UK resident trustees, was given a highly privileged position from the point of view of CGT, to start with. If you compare the position of, say, two UK resident but non-domiciled brothers whose parents acquired a UK property portfolio for them, and who decided to hold that portfolio through a non-resident trust, with the position of the same two individuals owning the property direct, you’ll notice that there’s one simple but massive difference. Because the trustees are non-UK resident, they would have been able to realise gains on selling UK property completely tax-free. Quite simply, this is because non-residents, whether owning direct or as trustees, were outside the scope of CGT (there was a technical exception to this rule, which it was very easy to make sure your situation avoided). All the time the proceeds were kept within the trust, no question of UK tax arose. 

Turning to IHT, a straightforward trust situation wasn’t automatically favoured in the same way. IHT applies not just to the assets of individuals who are domiciled in the UK, but also to the UK sited assets of any individuals, whether they are domiciled in the UK or not. In the trust sphere, the way these rules work is that if the ‘settlor’ of the trust (i.e. broadly the person who provided the wealth for the trust) was UK domiciled, the whole trust is within the IHT net. If, on the other hand, the settlor of the trust is non-UK domiciled, it’s generally only UK property which is within the IHT net.

So, the way an offshore trust structure has typically been set up to get around this rule is to interpose a non-UK limited company between the trustees and the UK property. If the asset which is being put into the trust is the shares in a non-UK company, this asset will be ‘excluded property’ – excluded, that is, from the IHT net. This applies, crucially, even if the non-UK company has as its sole or main asset UK-based real property. In a way, it was a simple question of ‘wrapping up’ a UK property in a non-UK company, so as to take advantage of the IHT rules. 

All in all, it could be regarded as surprising that the CGT and IHT rules in the UK have been so easy for non-resident trustees to get around. I think that those who can see further than a few inches from their noses will infer from this that policymakers, albeit unofficially, wished to encourage wealthy foreigners to invest in the UK. This wish seems to have completely evaporated, and no doubt we will pay the price of this, as a country, in due course. However, whether it is just naivety on the part of those making the rules (all of them nominally ‘Conservative’ politically), or actually comprises deliberate policy, we’ve seen a staged series of punitive measures. 

The first of these came in 2015 when George Osborne imposed CGT on UK residential property owned by non-residents. Any sale of such a property after 5 April 2015 is within the scope of CGT. Rather than impose what is effectively retrospective taxation on such investors, however, the rules provide that UK residential properties could be rebased to the start date of the regime, which is 6 April 2015. So, it only gains in value over the value of properties at that date which are within the CGT net. 

After a brief pause, our legislators then turned their attention to IHT, and the immemorial practice of non-UK domiciliaries holding UK property through the medium of an offshore trust owning an offshore company, which owns the UK property. With effect from 6 April 2017, the shares in the holding company will no longer be ‘excluded property’ if their value derives from UK residential property. 

Again, the focus of the attack is on UK residential property rather than commercial property. As things currently stand, there is a highly punitive regime for residential property as compared with commercial property. No doubt the simplistic thinking of the politicians behind these changes is to try to cool down what could be seen as an ‘overheating’ residential property market in the UK. Whatever the reason, an offshore trust, which now includes offshore companies owning UK residential property, will have to consider its position with regard to the IHT ‘ten-year charge’. This applies to trusts which hold assets of more than the nil band (currently £325,000), and imposes a tax charge of broadly up to 6% on the value of the excess.

The change in rules also has a radical effect on non-domiciled individuals owning UK residential property directly through a company, rather than through the medium of a trust, and the death of an individual such as this could have very significant tax implications for the first time under the new regime.

If the UK residential property market is overheating, the same could probably not be said for the commercial property market. Nevertheless, the above provisions, apparently aimed at dampening the UK residential market (and there is evidence that they have been successful in doing this) are now proposed to be extended to commercial property as well, at least as far as CGT is concerned. 

The Autumn Statement at the end of 2017 introduced a ‘consultation’ under which UK based commercial property will be brought into the CGT net similarly to residential property. Despite the reference to ‘consultation’, the Budget notes relating to this proposal are written from the standpoint of somebody who knows that the changes will come in, with effect for individuals from 6 April 2019.

So, the position we now have, or seem likely to have, is that CGT will apply to both residential and commercial property owned by offshore trusts. IHT will apply to residential property owned by offshore trusts, but not, so far, to commercial property. Those who run offshore trusts in places like the Channel Islands are obviously very concerned, however, because it seems like an almost inevitable development, in the evolution of UK tax, that we will see the extension of IHT to UK commercial property as well before too long. 

If you are, or act for, a non-UK domiciled individual who owns commercial property in the UK, be on the alert for the likely need to move this into an offshore trust if the commercial property portfolio would otherwise be brought within the UK IHT net. This is the sort of situation where prompt action might save a huge IHT bill at 40%. Of course, if and when this happens, and whether there will be a window of opportunity, depends on what the government, in their wisdom, decide to do.