UK Tax Changes and their impact on UK Real Estate Structures

Briefing note

January 2, 2018

The UK’s November 2017 Budget announced a number of proposals that will affect the taxation of inward investment into UK real estate. The changes announced are due be implemented with effect from 1 April 2019 with draft legislation pencilled in for publication in the summer of 2018. The details (but not the substance) of the proposals are open to consultation – and comments to the UK government should be submitted by 16 February 2018. This briefing note is designed to provide some general background on the proposals especially in regard to those investors who may be invested via a Jersey vehicle and should not be taken as any form of advice.

Non-resident investors to be taxed on gains made from UK commercial property

Historically, the UK had a policy of not taxing non-residents on their UK property gains.  This began to change in 2013 with the introduction of ATED for corporate owners of UK residential properties, which was widened in 2015 to capture all direct owners of residential properties.  Currently, non-residents are not taxed on gains upon disposals of commercial property, where the purchase was made for investment rather than trade. This relatively favourable tax policy has meant that the UK’s commercial property sector has traditionally been seen as attractive to foreign investors. However, it now seems that from April 2019, gains made on the disposal of UK commercial property by non-resident individuals and entities (that don’t have diverse ownership) will become chargeable to UK tax. 

There is some welcome relief in that properties will be allowed to be rebased to market value as at April 2019 so that only the gains from the date of the rebasing will be chargeable. From that point (with some limited exemptions for entities such as pension funds that are exempt from Corporation Tax), these gains will be taxed at either the capital gains tax rate for individuals or the corporation tax rate for companies (which is expected to fall to 17% by 2020).

 

Non-resident landlords taxed under Corporation Tax from April 2020

The Spring 2017 Budget announcement that the UK proposed to bring non-resident companies currently chargeable to income tax on rental profits into the corporation tax regime has now been confirmed and this proposal will be implemented (subject to consultation) with effect from April 2020. This will mean that from April 2020 such companies will benefit from the lower rate of corporation tax - 17% against the current rate of 20% paid under the non-resident landlord scheme (“NRLS”).

The possible downside to this change is that the rental profits of such companies will be calculated using corporation tax principles as opposed to income tax principles. This will mean, for example, that restrictions on the use of brought forward losses will apply and deductions for interest charges will be capped at, broadly, 30% of EBITDA. In addition, the UK corporation tax regime contains rules to counteract advantages that may arise from the use of hybrid structures and/or transactions. Therefore, taxable rental profits may, for some companies, be higher under the corporation tax regime than they would have been under the income tax rules and the completion of the returns is likely to become more complicated.

 

Non-resident investors – gains on indirect disposals of properties

It is possible for UK properties to be disposed of via a sale of the shares in any corporate entity owning a property rather than through a sale of the property itself. Presently, where non-resident investors dispose of properties in this manner, the transfer of the corporate entity does not generally fall within the charge to UK tax. However, during the 2017 Autumn Budget the Chancellor announced the proposal to charge tax on any gains non-UK residents make on the disposal of shares that derive their value from UK property, where certain conditions are met. Broadly, the conditions are that: 

  1. the entity being disposed of must be 'property rich'; and 
  2. the non-resident must have owned at least a 25% interest in the entity during the previous five years.

 

Register of beneficial ownership of UK property

In addition to the new tax proposals is the UK’s plan to introduce a public register of the beneficial owners of 'overseas entities' that own UK real estate. This was first announced in 2016 with an update issued in December 2017 stating that a draft bill would be published in 2018 setting out how the register would be created and what information would be publically available. It now appears likely that the proposals would require overseas entities that wish to register UK property ownership on the Land Register to first register their own beneficial ownership information at Companies House.

Our thoughts

The changes are still in consultation and will no doubt be subject to some serious lobbying, but it seems likely that the main principles (especially that of taxing the capital gain of non-residents) will come into force. Therefore, the emphasis for each investor now must be on taking advice and understanding how the changes are likely to impact their structuring from 2019. 

Capital Gains Tax Changes

Put simply, the aim of the changes is to ensure that any gain made by a non-resident on a disposal of UK immovable property will be chargeable to UK tax as is the case for UK residents. The Chancellor was at pains to point out that this will simply bring the UK into line with most other major jurisdictions who already tax residents and non-residents in the same way in relation to this profit. This clearly seems fair, but there may be a risk for an already Brexit-volatile market in that investment in the UK’s commercial property sector will fall. Equally, if the measures have an effect on market pricing, there may be opportunities for new investment despite the increased tax burden.

Non-resident UK commercial property owners should take advice now on how the changes will affect them as there may be actions that they should consider immediately. For example, where it is known now that a property may be subject to an exceptional increase in value post the April 2019 rebasing date (e.g. in the event of a restrictive covenant ending), consideration should be given as to whether that gain can be crystallised earlier.

There is suggestion that some foreign investors may now benefit from utilisation of UK REIT structures for the purposes of holding UK real estate, but this requires some clarification and it may well be worth waiting for the results of the consultation process before committing to an approach.  

Corporation Tax Changes

As described above those non-resident investors currently within the NRLS will be paying a higher 20% rate of tax for the next three years relative to the Corporation Tax rate of 19% (reducing to 17% in 2020). The flip side of this is that the various BEPS-related provisions of the Corporate Tax regime will not apply to these tax payers for an additional three years. Existing investors should be looking at their existing internal lending arrangements now to ensure that compliance with the provisions in 2020 will not come as a surprise. 

Indirect Disposals 

It is important to note that, when calculating the gain, the cost of the shares can be rebased to the market value at April 2019. It is also important to note that anti-forestalling measures are expected to take effect from 22 November 2017, so that attempts to circumnavigate the charge prior to April 2019 (e.g. by restructuring to seek protection under a beneficial tax treaty) will likely be invalidated.

Register of beneficial ownership 

This proposal, with the laudable aim of increasing transparency, forms part of the UK government’s National Anti-Corruption Strategy. However, there must be a balance to be struck between transparency and administrative burden that discourages investment. The details of how the register will work are still to be disclosed by the UK government, but well-regulated and transparent jurisdictions such as Jersey that already disclose beneficial ownership privately to their Registrar will be best placed to comply with relevant requirements.

Where can I obtain more information: 

Our team would be happy to assist with further information or introductions as necessary. In addition, the UK Government website contains all relevant information including the above referenced consultation on taxing capital gains can be found here.

Author(s)
Terry Northcott
Terry Northcott
Associate Director - Corporate Services
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