Double trouble when winding down unwanted offshore property structures

It used to be common practice for non-domiciled individuals to hold UK residential property through an offshore company. That way, a UK asset (property) was converted to a foreign asset (offshore company shares) so that inheritance tax (IHT) was avoided.

The issue

Rules were introduced in 2017 which brought such indirectly held residential property within the scope of UK IHT. Although the rules are complex, broadly they treat a certain value of the offshore company shares as if they are UK situs assets and the quantum of this value is driven by the value of underlying residential property within the structure. With no IHT benefit, and often high administration costs to these structures, we are often asked about how they can be wound up.

A key consideration here is the potential double layer of non-resident capital gains tax which can arise:

• On disposal of the property by the company when it is distributed in specie to the shareholder on liquidation (the direct disposal), and
• On disposal of the property rich company shares on liquidation (the indirect disposal). This relates to rules that were brought in in 2019 to bring "property rich companies" within the charge of UK tax.

Any non-UK resident shareholder faced with this situation will want to know whether it can be avoided.

Example

Carlita is resident and domiciled outside of the UK. She is the sole shareholder of Island Ltd, a Jersey resident company, which owns a buy to let in Manchester currently worth £500,000. The company purchased the house in 2000 for £100,000, and it was valued at £200,000 on 5 April 2015.

At 6 April 2019, the company had made historic profits and the value of the company shares comprising these profits and the value of the property less debt was £300,000. Today it is worth £675,000.

Carlita wishes to dissolve Island Ltd and hold the property personally because she resents having to pay the ongoing costs of an offshore structure without the prospect of a tax advantage.

Under a standard liquidation, Carlita would be taxed twice. First, Island Ltd would pay corporation tax at 25% on the gain on the UK residential property of £300,000 since 5 April 2015 (the direct disposal where the base cost is uplifted to the value on 5 April 2015). This results in corporation tax payable of £75,000. This can be paid out of existing retained profits, reducing the company’s value at the date of liquidation to £600,000.

Additionally, Carlita would be personally subject to capital gains tax on her disposal of shares in a property rich company (the indirect disposal with the uplifted base cost on 6 April 2019). With the company worth £600,000 on liquidation, the gain on the shares would be £300,000 (£600,000 - £300,000), giving rise to capital gains tax on Carlita at 20% of £60,000.

The total tax cost on the liquidation is therefore £135,000.

Is there a better option?

Provided the company has sufficient distributable reserves, it could pay up the £500,000 property by way of a dividend in specie prior to liquidation. As a non-resident, Carlita would not be liable to UK income tax on this foreign dividend.

The company will remain subject to a corporation tax charge of £75,000 on the disposal of the property, but the company will cease to be a property rich company once the dividend has been paid and so there will be no capital gains tax on the disposal of the shares (and there would be unlikely to be a gain anyway). This will save Carlita £60,000 of tax, provided that she does not face tax on the dividend in the jurisdiction in which she is subject to tax.

Hamilton Rose's view

In the above example, a dividend in specie will result in only one layer of UK taxation and save the individual UK capital gains tax (as well as the administrative burden of completing a 60-day capital gains tax return in respect of the liquidation).

Generally, for a company to make a dividend in specie, it must have sufficient distributable reserves to do so. Usually these will need to equate to the net book value of the property which may be quite a low figure. In some jurisdictions, it can also be possible for distributions to be made out of capital.

A key caveat to the effectiveness of this planning is that the shareholder will have to reside in a jurisdiction where they will not be subject to income tax on the dividend and of course the wider tax implications of their jurisdiction will need to be considered generally.

Finally, targeted anti-avoidance rules are in place to invoke the indirect property rich capital gains tax rules where arrangements have been entered into to avoid this tax. HMRC’s view in their manuals is that these can apply where the assets have been ‘manipulated’ so that the company was not property rich at the date of disposal. However, our view is that these anti-avoidance rules should not impact the relatively simple planning which is outlined above.