The game begins - a strong tower
When I started my career in 1996, advising on how to own UK real estate was relatively straight forward. For those who were not UK resident and/or not UK domiciled, the structure would generally involve a non-UK company because it provided non-tax benefits (e.g. anonymity from tenants or nosey neighbours) as well as significant tax benefits:
Potentially limited the effective Income Tax rate on rental income to 20%; and
Kept the value outside of the UK’s Inheritance Tax (IHT) regime, saving up to 40% IHT.
Non-UK residents were not taxed on any capital profits made on UK assets.
None of this planning was aggressive with both HMRC and successive governments being fully aware that this type of ownership was typical, even for low value real estate.
For various reasons, focus on this type of property ownership has increased since 2012 and has almost gone as far as it can go. The remaining step, explained later, is only a matter of time.
If you already own, directly or indirectly, UK property and haven’t had a recent tax review, we would suggest having one ASAP. If you are interested in acquiring UK property, it has become far more complex than it used to be, but careful planning will ensure that you are set up in the optimum way so you can evaluate your investment decision properly.
To help my analogy below, imagine the following:
The generally understood method of owning UK property is represented by a tower of jenga; and
The UK government are the players removing one brick at a time.
2013 - the first brick removed
Annual Tax on Enveloped Dwellings (ATED)
It all started in 2013 when the ATED was introduced as an annual charge payable by corporate owners of UK residential property worth over £2m. The charge ranged from £15,000 per year to £140,000 per year, depending on the property value.
Since then, the charge has been introduced for properties worth as little as £500,000 while the rate itself has increased dramatically, now peaking at £220,350 per year.
ATED Related Capital Gains Tax
At the same time, properties within the ATED charge were also dragged into the Capital Gains Tax (CGT) regime, so any capital profit that accrued from April 2013 up to the date of sale would be taxed in the UK.
Why? No, really, why?
The ATED charge and the ATED Related CGT charge were apparently introduced because non-UK residents had an advantage over their UK counterparts for two reasons:
Non-UK residents did not suffer CGT; and
It was very simple to fall outside the scope of the IHT charge by owning the property through an overseas company.
However, this reasoning was flawed because non-UK residents who held their property as an investment (i.e. for rental or development) were relieved from both taxes (although they still had to file returns). This meant that these initial changes only really affected those who held UK residential property through non-UK companies, but used them for personal/family use. It therefore didn’t really even up UK and non-UK investors at all, and what about those who invested in commercial property?
Had the government really wanted to make it a more level playing field for all, there were far more graceful options.
One of the biggest problems for those who held property in this way was that this type of ‘wealth tax’ was new for the UK and there was no reason for a non-UK resident owner to be made aware of the change. This unfortunately meant that many owners did not know they had to file a return and, where relevant, pay an annual charge. The sooner this is resolved with a full disclosure, the more chance there is of limiting the penalties to something manageable, perhaps even £0.
At first glance, the ATED charge appeared to be the price for keeping the property’s value outside the UK’s IHT net.
2015 – the second brick removed
Non Residents CGT
New rules were introduced to ensure that all UK residential property would now be subject to CGT, regardless of how it is held or why.
Strangely, the tax rates were set at 20% for companies versus 28% for everyone else. This encouraged corporate ownership, which ensured that all those assets continued to remain outside the IHT net. This was somewhat confusing given that ATED was apparently introduced to stop people using non-UK companies to avoid IHT.
April 2016 - the third brick removed (stable but weakening)
Stamp Duty Land Tax (SDLT)
For residential property acquired either by a company or by someone who already owns another residential property (regardless of where in the world), the SDLT rates were subject to a 3% premium. This meant that when buying a new residential property, SDLT at up to 15% had to be paid on top of the purchase price.
April 2017 – the fourth piece removed...clumsily
Predictably, companies that held UK residential property lost their special status for IHT purposes and so the value of the UK residential property was essentially dragged into the IHT net.
Not just for property owners...
However, this didn’t just affect the owner of the property because rules were also introduced for anyone who has lent funds, or provided security, that relates to UK residential property. Basically, anyone who has lent funds or assets to someone who has then used those funds to acquire/maintain UK residential property, or has granted security over some of their assets in relation to any borrowing used to acquire/maintain UK residential property, is also now subject to IHT on the loan/security.
Rather peculiarly, despite the supposed reason for the ATED charge now no longer being relevant (i.e. to discourage the use of companies to avoid IHT), ATED was not revoked and there were no provisions to allow people to restructure into an ownership structure that the government did find acceptable. We have managed to restructure without any tax charge, but this needs to be done very carefully.
Risks of non-compliance?
We suspect that there is still a significant level of non-compliance under the ATED regime and that this will be magnified for those caught by the IHT changes, especially those who have lent funds or offered security over their assets over the coming years. The risks of non-compliance are substantial, including custodial sentences, even though these rules are exceptionally complex and opaque. Therefore, tax advice from a specialist is essential.
22 November 2017 – the fifth piece removed... the tower wobbles
Taxing Capital Gains on Non-Residential Property
It was not really a surprise to see that from April 2019, capital profits on UK non-residential property will be subject to UK tax, regardless of how held despite the explicit promise by the Government in November 2014: "The government does not intend to broaden the scope of the charge and apply CGT to disposals of interests in non-residential property". This will impact the net present value (NPV) calculations for almost all UK commercial property investments. This is only a consultation at present, but based on how recent consultations have gone, I wouldn’t expect much deviation from the intended result.
In addition, those who sell an indirect interest in UK property will also be affected. This would include an individual, company or trustee who holds (or has held in the last five years) 25%+ of a non-UK company whose gross asset value is broadly derived from UK real estate. If the shares are sold for a profit, they will have to report that disposal in the UK and pay UK tax. In addition, there is an indication that it won’t just be the capital profits that accrue from April 2019. Given that the selling shareholder may have no direct connection to the UK, the government may try to make other parties responsible for the tax reporting (e.g. the tax adviser). It will be interesting to see how this develops.
The future – final tower collapse?
From April 2020, non-UK resident companies will be within the charge to Corporation Tax on their property income and capital gains. There is a ‘win’ in that the rate of tax is expected to be 17% by then. However, for larger property investors who finance their projects with borrowing, this exposes them to the new interest restriction, which is yet another factor to consider when calculating your investment's NPV.
It can also only be a matter of time before the government bring the value of company shares that hold UK non-residential property into the IHT net as well, as they did for UK residential property in April 2017. Any planning that you are considering in advance of the April 2019 change to the CGT charge should assume that the IHT change will also happen in the near future.
An example - paying IHT even if you have no UK assets?
You have never been to the UK and have no interest in coming. However, your daughter moves to the UK for a very good job. Unfortunately, her UK mortgage provider requires someone to provide security for her mortgage because she is not originally from the UK. She finds the perfect house for £3m and requires a £2m mortgage. You provide security to the mortgage provider over £2m of your investments. Your daughter has no problem paying her mortgage each month but if you, unfortunately, pass away 10 years later when the outstanding mortgage balance is still £1.325m. There is a potential IHT charge on your estate of £400,000 even though you do not have any UK assets.
Where does this leave property investors?
For the first time in a long time there is very little left to change so we can say there is, finally, some stability. However, the rules are exceptionally complex and will only become more so.
However you invest in UK property (e.g. directly or by helping someone else who does by providing either a loan or security), expect there to be UK tax charges on:
Potentially during ownership; and
Disposal (e.g. gift or sale).
You must also consider IHT at up to 40% when looking at all UK real estate acquisitions to make sure that you correctly evaluate your investment and also that you meet all compliance requirements.
What should you do if......
You own UK residential property?
If you already own UK residential property or have supported someone who does (e.g. providing a loan or security), ensure that you understand,
How the recent changes have affected you;
Whether there have been any missed compliance obligations; and
Whether there is anything that you can do to make your position more efficient.
You own UK non-residential property?
If you already own UK non-residential property, then you should seek advice because while the changes won’t take effect until April 2019, it is less than a year and a half away and the consultation will only result in minor tinkering and you need to now consider the IHT changes that will no doubt follow suit.
You are considering investing in UK property?
If you are considering buying UK property for any reason, you simply need to be fully aware of the potential UK taxes to consider when making your investment decision and be able to use the most appropriate structure.
For help, advice and guidance on the multitude of complicated tax rules surrounding UK property, please speak to your usual Buzzacott contact or James Walker.
Partner, Private Clients
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