26 March 2018
March 2019 will introduce a sea-change which results from Brexit. Less well-known are the tax proposals that will start to come into effect in April 2019, with further changes in 2020. Whilst they are less well known, they will potentially have a serious impact on foreign investment in the UK real estate market, and in particular the commercial investment market. It has long been held that foreign investment in UK commercial real estate should be made an attractive proposition in order to encourage inward investment into the UK – certainly since 1965.
The tax proposals as set out in summary form below are likely to quash this notion entirely, although the political thinking behind this is far from clear.
The consultation period on the proposed changes ended very recently. It seems likely that any comments made during this period will merely tinker around the edges of the proposals. Similar laws in other jurisdictions often run to a couple of paragraphs. Almost inevitably UK law will introduce a substantial chapters devoted to this new tax.
In broad terms, gains made after April 2019 by non-residents of commercial properties, or the shares of the companies that hold such real estate, will be liable to UK tax. Gains made after April 2020 by companies will be subject to UK Corporation Tax.
Action to be taken now: If you are non-UK resident and are considering the sale of any UK commercial property, you may wish to bring forward that action and sell before April 2019. Non-resident owners need to be aware that vendors are already looking at selling their UK commercial real estate portfolios, and the effect of this may be depressing market values.
If clients are looking to hold on to their commercial properties then it is important that they seek to instruct valuations be undertaken as at April 2019, as this will be a key rebasing date.
How are foreign investors currently taxed on real estate investments?
The sale of commercial properties held for investment purposes by non-UK residents are currently completely exempt from UK taxation, as are the shares of any company that is used to hold such properties. In broad terms, there is currently no tax on sale of UK sited land that is held for investment purposes such as offices, factories, warehouses, shops, hotels, leisure facilities, and agricultural land.
Property business generally
As a further matter, commercial and residential properties held for letting purposes are currently subject to the UK Income Tax rules and form part of the Non-Resident Landlord Scheme. Income Tax is applied at 20% to net taxable rental profits of a property rental business, and as a general rule loan interest relief is also given as it accrues to the business. Losses of the rental business can be carried forward without restriction and set off against property rental business profits.
Non-Resident Capital Gains Tax (NRCGT):
At present, a foreign investor holding UK real estate for investment purposes is subject to tax on the sale of residential property held (amongst other things) for a genuine rental business. The tax regime that applies is NRCGT, and the rate that applies is 20%. The NRCGT regime was introduced in 2015, and the rules permit the disponer to choose to substitute the value as at April 2015; or to use historic cost and to time-apportion the gain such that only the gain accruing from April 2015 to the date of sale will come into charge.
There is no tax charge on the sale of the shares of a company that holds the UK property.
Annual Tax on Enveloped Dwellings (ATED):
At present, if a foreign investor holds residential property via a wrapper, for example a non-UK company, and the UK real estate is used for personal use, then ATED will apply on the sale of the real estate and in broad terms the tax liability will be 28% of the gain. The ATED rules were introduced in 2013, and again, these contain some step-up and or time apportionment options.
In this scenario there is again no tax charge on the sale of the shares of the company that is used to hold the residential property.
What are the proposed new changes in the tax rules and what is their impact on foreign investors?
A non-UK resident owner of UK commercial real estate held for investment purposes will be subject to UK tax on the sale of the UK commercial real estate; or on the sale of any company that owns it (the latter is known as an indirect share disposal).
In short, an indirect share disposal will apply and give rise to a Capital Gains Tax (CGT) liability where the entity is ‘property rich’. To be property rich involves two legs: broadly, this is where 75% or more of its gross asset value at disposal is represented by UK real estate; and where the shareholder holds 25% or more over a five year period.
Where the asset target is owned by a non-resident individual, the disposal will fall within the UK Capital Gains Tax rules.
Gains will be calculated by reference to the difference between proceeds and the revaluation as at April 2019. No other option would appear to be available at present.
Points to address as soon as possible:
- Accelerate any plans to sell the commercial real estate if already on the cards
- Book a valuation as at April 2019 if considering retaining the real estate
- Look at the structure which holds the property. It may be the case that the Treaty will give all taxing rights in respect of the shares or the real estate to the jurisdiction in which the non-UK resident is Treaty resident
- Look at the structure to see who owns the shares/property. Certain owners will continue to be exempt including pension funds, sovereign funds, or be able to claim the substantial shareholding exemption, such as life assurance businesses, charities etc.
- Consider the scope for migrating the ownership structure to the UK
- Consider introducing non-UK situs real estate into the company that holds the UK real estate as a means of avoiding the property rich rules concerning UK real estate values
Non-residents will be subject to Capital Gains Tax on the sale of residential properties or the shares held in the residential properties. The ATED regime is under discussion.
- The timing of Brexit and the new rules is likely to have a devaluing effect on land and real estate values in April 2019
- Indexation for Corporation Tax purposes is not going to assist as this has now been frozen
- The sale of property rich shares will leave that company with a latent gain in respect of the UK real estate that it continues to hold, and which will then pass onto the buyer. The buyer will want to know the 2019 valuation of the property, and will also seek to negotiate a discount on the value of the property held by the property rich company
- The base cost of the property may differ from the base cost for tax purposes of the real estate
- Changing the Treaty residence of the ownership structure to a more favourable location, or take other restructuring measures to avoid the new rules could be self-defeating as HMRC introduced anti-forestalling rules on 22 November 2017 to stop investors from avoiding the new tax
Very briefly, it is worth mentioning the second instalment of the real estate tax changes. It is unclear why the two lots of changes cannot be introduced at the same time.
Property businesses owned by non-UK resident companies will be brought within the Corporation Tax regime effective 1 April 2020. There could be some good things (subject to seeing the new rules) and some bad things about this:
1. The tax rate may fall from 20% as paid under the non-resident landlord scheme, to 17%
2. Groups may be able to group relief their losses and profits
3. Some flexibility may be available as regards the use of profits and losses from different income streams generated by the company
The more problematic points are as follows:
4. An interest restriction will be imposed where net interest expense is £2.5m or more in the year
5. Loss carried forward restrictions will be imposed which may prevent a company from using all of its losses brought forward against profits arising in a particular year
6. All loans will fall under the corporate loan relationship rules, making all loans UK source interest when considering the obligation to withhold UK tax at source from interest paid overseas
The above is merely a summary of the potential effects of the proposed changes – only the basic framework of the new rules has been published. We will of course keep you updated once more information is available.
It is strongly recommended that all non-resident clients holding UK real estate seek urgent advice from their UHY tax adviser well in advance of the new legislation coming into force. Alternatively, if you have any questions about the proposed real estate tax changes, fill out our contact form here.