Overseas holiday homes and the expected April 2025 IHT changes
9 May 2024
Much has been written over the last month about the changes announced during the Spring Budget and the Labour party’s potential counterproposals (see our articles here and here). Regardless of the result of the next general election, it seems a racing certainty that the Inheritance Tax (IHT) rules affecting non-domiciliaries will be drastically different in 12 months’ time.
In preparation for the expected changes, we are advising clients to review their existing overseas structures, and these reviews have started to uncover some unusual issues, particularly with overseas entities that don’t have a direct UK equivalent.
Usufructs and overseas properties
Usufructs are features of many continental European legal systems, including those in France, Germany, Spain, Portugal and Switzerland. HMRC define a usufruct as, “the right of one individual to use and enjoy property that is vested in another, provided the property concerned is neither impaired nor altered.”
Usufructs are often used in relation to real estate. For example, it is not uncommon for owners of French property to gift the ‘bare ownership’ of the property to their children but retain a usufruct to allow them to continue to use it during their lifetime. Several European states also impose usufructs over property following the death of the owner under local inheritance rules (e.g. Spain).
As usufructs are not a feature of the English legal system, the correct UK tax treatment is uncertain and can differ depending upon which tax is being considered. For IHT purposes, HMRC view usufructs as settlements akin to life interest trusts. However, this approach is not universally accepted and conflicts with HMRC’s Capital Gains Tax (CGT) treatment, often leading to unexpected CGT charges. Whether or not a usufruct is an IHT settlement will have increased importance following 6 April 2025.
The proposed April 2025 changes
If HMRC are correct that a usufruct is an IHT settlement, then:
- Any usufruct arrangements set up by a taxpayer within the scope of IHT after 6 April 2025 will be subject to an immediate tax charge of up to 20% followed by ongoing charges of up to 6% every ten years.
- If the “Gift with Reservation of Benefit” rules apply (i.e. if the holder of the usufruct is treated as having reserved an interest in the property), a 40% tax charge may be triggered on their death on the overall value of the property.
- Under the Government’s proposals, any usufructs set up by non-domiciliaries before April 2025 would be treated as “excluded property trusts” and would remain permanently outside of the scope of IHT. However, under Labour’s proposals, there would be no grandfathering of existing structures.
By contrast, if HMRC are incorrect and a usufruct is not an IHT settlement, the rights retained by a usufruct holder would be subject to IHT on their death in the same way as any other personally owned asset, but the arrangement would not incur any ongoing IHT charges.
What should clients be doing?
The uncertainty over whether existing structures will be grandfathered under the new rules, and the lack of draft legislation puts clients in a difficult position. We recommend that all such structures are reviewed before next April and that advice is taken before any new overseas entities are established since there are often alternative structures available that are less problematic from a UK tax perspective.
Usufructs are just one of many types of overseas entity where the UK tax status is in doubt. The same types of issues could arise with Foundations, Stiftungs, Fideicomisos and a host of other entities and arrangements that are alien to the UK. Anybody who is concerned about the impact of the proposed rules on their overseas entities should contact the International Private Client Team at Birketts who will be delighted to assist.
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Alex Hunt
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Tobias Gleed-Owen
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Deborah Carrivick
Services
The content of this article is for general information only. It is not, and should not be taken as, legal advice. If you require any further information in relation to this article please contact the author in the first instance. Law covered as at May 2024.