The IBSA Podcasts

Dmitry Zapol on Mastering UK Inheritance Tax Strategies and Securing Your Legacy

• Lucie • Season 2 • Episode 5

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Unlock the secrets of navigating UK inheritance tax laws with our illuminating chat featuring international tax advisor Dmitry Zapol. If the mere thought of estate planning sends shivers down your spine, fear not—we’ve got you covered. Together, we dissect the taxing details of owning UK assets and the tax repercussions for those considering making Britain their home. Dmitry's expertise shines as he explains the pivotal role of domicile status and maps out the legislative landscape that's evolving to favour residence-based taxation after a decade of living in the UK. Business owners and investors, pay attention—we also unravel the complexities of business property relief and how recent changes impact offshore entities with property in the UK, not to mention the effect of loans secured on UK properties on your inheritance tax bill.

Strap in as we navigate the labyrinth of mitigating inheritance tax liabilities in the second segment of our discourse. Here's where strategy meets savvy planning, with a tour through the world of excluded assets and trusts. For entrepreneurs, we highlight how holding a UK business through a foreign company could shield you from hefty taxes, though this is a dance with domicile rules. Dmitry expertly guides us through the nuances of excluded property trusts, the potential pitfalls of loans, and the delicate issues with the inheritance tax. Plus, we clarify the often-misunderstood spousal exemption and delve into the seven-year gifting rule that could reconfigure your estate’s tax valuation. Tune in for a masterclass in securing your legacy with precision and foresight.

Speaker 1:

Hello and welcome to this IBSA podcast on the topic of UK inheritance tax for individuals moving to the UK. My name is Roy Saunders, founder and chairman of the IBSA, the International Business Structuring Association, which is a multidisciplinary global association of entrepreneurs and their professional advisors, dedicated to sharing their expertise with each other within a great networking platform. Today, I am joined by Dmitry Zappol, a Russian lawyer with whom I've had the pleasure to work with for over 10 years. Dmitry advises clients, many of whom are from Eastern Europe, on pre-immigration planning when they're considering relocating to the UK. So, dmitry, what are the key points you would like to talk about today?

Speaker 2:

Good morning, roy. Thank you for having me. Today we are going to discuss inheritance tax. People have many wrong ideas about what inheritance tax is all about, about, and my job today is to make sure that these misconceptions go out of the window.

Speaker 1:

Good, okay, so we have inheritance tax in the UK. Quite a lot of countries actually don't have inheritance tax. Nowadays they seem to have abolished it and to some extent I think it's a little bit of an unfair tax, because it's like a double tax really You've been taxed on your income and capital gains and then when you die, you have another 40% swinging tax in the UK. So what assets are included in the inheritance tax scheme?

Speaker 2:

To begin with, all assets which are located in the UK are subject to inheritance tax if a person who owns them dies and also, in certain circumstances, when they transfer them during lifetime. However, there's a catch If you are domiciled in the UK, then your worldwide assets meaning in the UK and outside the UK, will be subject to inheritance tax if something happens to you, whereas if you do not have British domicile, then it is only British assets which may be subject to tax, and this is where we are expecting the largest change in decades, because the incoming governments are thinking of switching liability to inheritance tax from domicile to residence. We don't know yet, however, how this will pan out, and so we just have to wait for the latest announcements. It's been said that domicile will be replaced by 10 years of continuous residence in the UK, but it is still too early to make any planning around this fact.

Speaker 1:

And that domicile. If you're resident for 10 years, it'll be on worldwide assets. For people who haven't been resident for 10 years, and particularly for your potential clients, I guess, who are coming to the UK initially within that 10 year period, it will only be on UK assets. Will it be on all UK assets, I understand? I know that there are exemptions for business property relief, for example, whether or not that stays. Have you heard rumours that that might disappear?

Speaker 2:

As you rightly said, and as I mentioned earlier, it's the UK assets which will suffer the inheritance tax charge. And let's talk about what we actually mean by UK assets. First of all, of course, it's British real estate, residential and non-residential. Then there's money in UK bank accounts, there are securities issued by British companies, there are companies registered in the UK and, if we're talking about exempt assets, there aren't that many. There are certain government bonds which are excluded from inheritance tax, but what is probably most useful for people owning businesses in the UK is the currently existing business property relief existing business property relief.

Speaker 2:

There are indeed talks about abolishing the business property relief or perhaps limiting the exempt amount, but we don't know this yet. Business property relief operates by excluding shares in British trading companies, as well as certain shares in AIM listed companies, from inheritance tax as long as you broadly owned the shares for over two years. The problem with private businesses is that the company must be trading or must be existing with the view to start trading, and what can happen occasionally is that the company may have substantial cash reserves and unless these cash reserves are earmarked for future trading activity, the company will be considered not trading but investment, in which case, it may reduce the availability of the relief.

Speaker 1:

Yeah, I mean I remember when business property relief was first introduced it was introduced only at 50% of the level of. The remaining 50% were subject to inheritance tax. I mean, I guess that is something that could be brought in by a future Labour government. You mentioned UK real estate. Up till fairly recently, if you have shares in a foreign company, for example, which owns UK real estate, then the foreign company is foreign company situs asset and therefore outside of the scope of inheritance tax. But perhaps you'd like to comment on the recent introduction of the extension of inheritance tax to those assets.

Speaker 2:

Indeed, until fairly recently, it was most common practice to own UK residential property through an offshore company and then through an offshore trust. First they introduced ATED annual taxed on developed dwellings, which made it too expensive to own UK properties through companies. Then they introduced rules under which, no matter how many layers you have above the company including trusts, including companies, et cetera if the owner or the beneficiary of the structure dies, then there's inheritance tax to pay, and there are very few ways around it. It goes even deeper If you receive a loan from someone abroad and this loan is secured by UK property or it is used to purchase UK residential property, if that person dies, their estate will suffer inheritance tax by reference to the value of the loan outstanding. But interesting though that it's not the same for non-residential property, it is still possible to own non-residential buildings via foreign registered company, which would make it an excluded asset, and then you're fully outside the scope of inheritance tax under the current rules.

Speaker 1:

You talk about excluded asset and then you are fully outside the scope of inheritance tax under the current rules. You talk about excluded asset and you mentioned earlier on about business property relief for companies. It might be that the ownership of those trading operations through a non-UK company, albeit tax residents in the UK, might be of benefit to some of these people when they're thinking about inheritance tax planning 90%.

Speaker 2:

This is a very often overlooked planning strategy, as you've rightly said. If your British business is owned by a company which is tax resident in the UK but which is registered abroad, then it becomes excluded property. Of course there's a cash. Not all people can benefit from this. You must be non-domiciled at the moment or you must be in the UK fewer than the number of years that the government is going to set. Also, a company will have to file probably twice the amount of reporting back in the country where it is registered and in the UK. But if we're talking about substantial inheritance tax saving, this may be a small price to pay.

Speaker 1:

And perhaps you can comment on other excluded property, and particularly excluded property trusts, I guess, and what's likely to happen to them.

Speaker 2:

One kind of excluded property which is not often known is the following If you are not resident in the UK not tax resident and you're not domiciled in the UK and you're on a British bank account with non-stealing currency in it, then if you pass away there are no inheritance tax consequences. But if we want to discuss excluded property trusts, basically it is an offshore trust with offshore trustees which is settled by a person who is not domiciled in the UK at a time when the trust is settled Broadly assets which are in such trusts. They are outside the scope of inheritance tax. Of course there are various catches on the way to transferring property in the trust. For example, if you're settling UK property on trust, there's a lifetime charge of 20% payable immediately, and also further 20% if you die within seven years. Also, if you transfer UK residential property into such trust, then you have also lifetime charge.

Speaker 2:

Another thing to be concerned about is that if UK property and not just UK residential property, but if any UK situated property is in the trust directly, without the interposition of a holding company, there are what we call 10th anniversary charges, which equals 6% of the net asset value, and also there are exit charges etc. So unless you are putting UK residential real estate in the offshore trust, you must use a foreign company or a foreign holding vehicle to hold such UK assets, whose shares are then transferred into the offshore trust. I have a client who had a collection of art in the UK and what we suggested to them was to take the art outside the UK to the overseas bonded warehouse and then make the transfer of the property of the art to the overseas trust while it was outside the UK. This would normally constitute settlement of trust of a non-UK property.

Speaker 1:

OK, one of the key things that I think have been misunderstood or planning is difficult with these is whether these loans to anybody would be considered UK loans or non-UK loans. If they're offshore loans, you know, if a company is resident in the UK and borrows money from somebody else, is that UK asset always, or can it be an overseas asset?

Speaker 2:

If you are a foreign lender and you're lending to the UK company, then it would be UK situate assets and if you pass away, this would be subject to inheritance tax. So you should be careful about it.

Speaker 1:

Yeah, so UK loans might be difficult. So if, for example, you have a very wealthy parent that lends you money and he dies, then that could be an issue that may not be understood that well. What other exemptions are there for inheritance tax? Obviously, I know that transferring assets to a spouse would be exempt, but how else would you recommend people plan for inheritance tax when there is definite liability because of the type of asset it is?

Speaker 2:

Well, actually, let's spend a bit of time talking about spouse exemption, because it is often overlooked. If two persons are married, it doesn't matter where they are married, as long as they are married and the marriage is registered somewhere. When they pass assets between each other on death or during lifetime, there are no inheritance tax consequences. However, difficulties arise when the so-called domicile mismatch. It happens when two spouses have different domiciles.

Speaker 2:

Typically, if one spouse has British domicile for example, they were born and bred in the UK and their spouse has come from abroad the amount of wealth they can transfer from the domiciled spouse to the non-domiciled spouse is broadly equal to twice the amount of nil weight band, which is around 650,000 pounds. And people should bear this in mind, especially if, say, half of the family moved to the UK to stay with the kids and they have been deemed UK domiciled after living in the UK for 15 years, whereas the other half of the family, for example the itinerant father who comes and goes to and from the UK and earns money abroad, has not been yet deemed domiciled. If they own property in the UK, then such property, which belongs to the UK domiciled spouse, will not be able to be transferred to the non-domicile spouse without having to pay tax. So this is a common overlooked mistake. It is possible to elect to be domiciled for these purposes together, but I don't think many people would take this option.

Speaker 1:

Obviously, that might change with changes in the rules on domicile, but I understand that. What about? I know the seven-year period of giving gifts to children and so on all about.

Speaker 2:

let me explain this to you. When a person dies, their estate for inheritance tax purposes includes their assets that they owned at the time of death and also gifts that they made within seven years of dying. There's what we call taper relief. This means that the more time passes between the gift and the death, the less tax you have to pay on those assets, but I will not dwell too much on it. So if you gift something to your children and then you pass away within seven years, this property that you gifted will be considered within your estate. So the advice that we give gift it to your children and then survive for seven years. If you have reservations about surviving for so long, take out inheritance tax insurance.

Speaker 2:

Often clients ask me hey, I'm living in the UK. My parents, who live abroad, wherever I may come from, are going to gift me a property, wherever they live. What if they die within seven years? Am I going to pay tax? If they die within seven years, am I going to pay tax? This is when I have to explain to them that, no, you do not need to pay tax as the person who is receiving the gift. It is them who may be subject to tax liability. But because they're not UK resident, they're not UK domiciled and the property that they gifted you is outside the UK, the seven-year period will not apply.

Speaker 2:

But coming back to the original plan giving everything to kids during lifetime another mistake that some parents may make is gifting, say, the house to them and continuing living in it as if they have not gifted it. In essence, you would not. If you gave me the property, I would not allow you to live in your property, would I? But people continue doing this. This is called a gift with reservation of benefit. As long as you continue using the property as you had used it before the gift, the seven-year period will not start. What do you have to do? Well, either stop using it or just visit your old home as a guest, or pay rent to your children. There's a little known exemption which allows children to move in with their elderly parents and to share expenses connected with running of the house, and in this case the seven year period starts running. But this is quite narrowly defined and requires professional analysis.

Speaker 1:

OK. So we don't know yet. I think it's going to be in July when we hear some further news about the non-dom changes. But of course, with the new government potentially being a Labour government, we won't know for some period of time as to the changes, further changes that they may make. What's your anticipation as regards particularly excluded property trusts? What do you think is likely to happen with those?

Speaker 2:

It's not looking good, roy. From what we heard, labour are planning to abolish the preferential treatment of excluded property trusts. From what I recall, the Tory governments have a thinking of allowing the continuing treatment of excluded property trusts as long as they were settled, before the reforms, by non-domiciled individuals, or else the protection would be gone for everyone under the Labour government. You would think it's unfair and it messes up plans of people who entered into these arrangements back in 2017, when they reformed the taxation of properties and trust in the UK, etc. But if you think about it back until 2012, 2015, nobody thought that properties in the UK that belonged to offshore companies would be subject to tax one day. But this is exactly what happened. They've completely changed the regime over well pretty much overnight. So I don't think there's anything stopping the government from changing the existing treatment and I don't think European Convention of Human Rights has any effect on them. Yes, it's unfair, but this is life.

Speaker 1:

Well, the US has the concept of grantor and non-grantor trusts, and it seems as though the foreign non-grantor trust rules are similar to our excluded property trust rules. There doesn't seem to be much emphasis in the US on changing these rules, so it would be interesting to see what's happened in the UK, whether or not there's perhaps a rebasing of assets for inheritance tax so that only future income and gains would fall within the trap. But let's leave that one open. What about wills? Anything that people should leave in their wills that might be of interest that we should be thinking about.

Speaker 2:

I always say to my clients that a bad or a short will is better than no will at all. What I mean by a short will is a will drafted with respect to British assets only and under which one spouse wills everything they own to their spouse and vice versa. Why? Because without the will, there will be intestacy rules and under intestacy rules a spouse gets a certain fixed share of the assets and the rest of the assets are divided equally between the same spouse and the children, and the assets which go to children will be subject to inheritance tax, whereas the will replaces the intestacy rules and one spouse can receive 100% of the property and benefit from the spouse exemption. It is, I think, possible to do what we call post-death variation and agree on asset distribution etc. But we always have to think about whether the heirs and children can do this when the owner of the assets dies and, to be honest, nobody wants to do it. So it's better to do something while you're living.

Speaker 1:

Okay. Well, that's really interesting. I think there's a lot of still we don't know about. You know, the current domicile rules mean that you have to be out of the country for more than six years to become non-domiciled, if you like, and the same thing probably is going to come into play for residents, I guess, yeah, indeed, yeah, okay. So thank you very much. I mean fascinating, uh, particularly since we don't really know, um, what's going to happen under the potential labor government. But, uh, dmitry, thanks very much for joining me today. It was really informative, um, so that concludes today's podcast, and I'd like to thank our listeners for joining us today, thank you, thank you very much for joining me today. It was really informative. So that concludes today's podcast, and I'd like to thank our listeners for joining us today.

Speaker 2:

Thank you. Thank you very much. Have a good day, roy. Goodbye, thank you.