As part of the Government's proposed reforms to the taxation of non-domiciliaries which will take effect from 6 April, new IHT charges are to be imposed on lenders and borrowers where loans are made to buy, maintain or enhance UK residential property.
Further amendments were made to the Finance Bill 2017 on 20 March which will alleviate the impact on the new charge on borrowers who pledge foreign assets as security for their borrowing. Under the original proposal which I mentioned in my blog dated 24 January, IHT would have been charged on foreign assets pledged as security without limit (even if the value of the assets pledged exceeded the value of the UK property being purchased with the loan). The updated Finance Bill published on 20 March introduces a cap which means that IHT will now be charged on the value of foreign assets pledged only up to the value of the loan taken out to buy, maintain or enhance UK residential property.
Therefore the new IHT charges, taking account of this change, can be summarised as follows:
- Loans to acquire UK residential property – a charge on the lender
Loans made to a non-UK domiciled borrower to buy, maintain or enhance UK residential property will continue to be deductible by the borrower for IHT purposes but may now give rise to a charge to IHT for the lender if the lender is within the scope of IHT (i.e. where the lender is an individual, partnership or a close company owned by a small number of participants). This charge potentially applies to loans by a lender unconnected to the borrower, including a commercial loan made by a Bank if the Bank is within the scope of IHT.
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Security provided for loans to acquire UK residential property – a charge on the borrower
Assets which a non-UK domiciled borrower makes available as security, collateral or guarantee for a loan to buy, maintain or enhance UK residential property, (which is sometimes known as "back to back lending" and which we refer to here as "Collateral Security") will be treated as property subject to IHT in the hands of the borrower to the extent of the value of the loan. This will bring within the scope of IHT foreign Collateral Security up to the value of the loan (UK assets are already within the scope of IHT).
For example, assume X, a non-domiciled individual, purchases a UK residential property for £1m with the assistance of a £0.5m loan from Bank Y which is secured on the property, and Bank Y requires that X makes his property in Doha (worth £2m) available as additional security for the loan. Here the property in Doha up to the value of the loan (i.e. £0.5m) will become subject to IHT. If the loan is outstanding on X's death and remains secured on the property, X's executors can deduct the value of the loan outstanding from the total value of the UK residential property and the remaining value will be subject to IHT. Therefore X's estate will be liable for IHT at the rate of 40% on assets valued at £1m (being the Doha assets equivalent to the value of the loan (£0.5m) plus the UK property worth £1m less the deductible loan of £0.5m).
Although the recent change places a cap on the value of Collateral Security subject to IHT, there is still scope for a duplication of IHT charges in respect of the same UK residential property so significant IHT charges may arise on the death of the borrower.
What you should do
Borrowers and lenders should review the terms of their loan agreements and consider solutions which may include:
(a) ensuring that the loan is secured on the property so that it is deductible for IHT purposes
(b) amending the loan agreement to limit the value of any foreign Collateral Security so far as possible to limit the scope for a double charge to IHT arising particularly if the loan is not deductible; and
(c) obtaining insurance to cover the IHT risk.
It remains the position that it is what the borrower does with the funds that is relevant, and not the intention of the lender when the loan is made. When loans are made lenders will need to make enquiries about what the borrower intends to use the funds for and to keep this under review, in order to identify any exposure to IHT under the new rules.
If you would like to discuss the implication of these proposed reforms please contact one of the following members of our private client team:
Penny Wotton at penny.wotton@fieldfisher.com
Amanda Gordon-Napier-Tompkinson at Amanda.gordon-napier-tompkinson@fieldfisher.com
Olga Tabenko at olga.tabenko@fieldfisher.com