TAXING CAPITAL GAINS MADE BY NON- RESIDENTS DISPOSING OF UK COMMERCIAL AND RESIDENTIAL PROPERTY FROM APRIL FINANCE BILL UPDATE JULY 2018*

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1 * The Gvernment has annunced that frm April 2019 tax will be charged n gains made by nn-residents n the dispsal f all types f UK real estate, extending existing charges that apply t residential prperty and ablishing an exemptin fr cmmercial prperty that has been in existence since the intrductin f CGT in Investrs are likely t face cst and cmplexity as they try t get t grips with ne f the mst dramatic changes in the taxatin f UK real estate in living memry. BACKGROUND T put this change in cntext, the Gvernment says that ther majr jurisdictins apply CGT t nn-residents dispsing f lcal real estate and that there is unfairness between UK and nn-uk residents in giving nn-residents CGT exemptins. They say it drives the creatin f cmplex ffshre structures (ften in tax havens) t hld real estate which can facilitate avidance. Althugh the Gvernment recently intrduced CGT n dispsals f residential prperty by clsely-held nn-resident cmpanies and did nt apply that t indirect dispsals, they want t align the taxatin f cmmercial and residential prperty held by nn-residents as much as pssible s as t create a chesive framewrk, s existing charges fr residential prperty will expand in scpe t match the intended rules fr cmmercial real estate. KEY POINTS The new rules will create a single regime fr dispsals f interests in bth residential and cmmercial real estate under which: There will be a new CGT charge fr direct and indirect gains n dispsals f cmmercial prperty by mst nn-residents; The existing CGT charges fr residential prperty will be The new extended rules will t create indirect a single sales regime and dispsals fr dispsals made f by interests widelyheld cmmercial cmpanies; real estate under in bth residential and which: Changes at a glance The Gvernment has annunced that it will extend the UK tax base with regards t dispsals f UK real estate by nn-residents by bringing int the charge t UK tax: (i) all UK real estate capital gains they make frm direct dispsals; and (ii) any such gains made via indirect dispsals. The new rules will apply frm 1 April 2019 (fr cmpanies) r 6 April 2019 (fr ther persns) t gains attributable t increases in value frm thse dates. The Gvernment has published draft legislatin with mre detail n the prpsals in the Finance (N.3) Bill. Further wrk ver the summer is being undertaken in relatin t hw the rules will apply t cllective investment vehicles and exempt investrs. The key features are summarised in this briefing. The full cnsultatin dcument is available t read here, and the summary f respnses dated 6 th July 2018 is available t read here. * This is an update t ur client briefing riginally published n 22 nd Nvember 2017 t take accunt f develpments since the release f draft text in the Finance Bill n 6 th July July 2018 Cliffrd Chance 1

2 The "indirect dispsal" rule will apply where an entity is "prperty rich" which is bradly where 75% r mre f its grss asset value at dispsal is represented by UK real estate and the persn hlds, r has held at sme pint within the previus tw 1 years, a 25% r greater interest in the entity; Fr indirect dispsals it was riginally prpsed that there wuld be a reprting requirement n certain third-party advisrs wh have sufficient knwledge f the transactin. This prpsal has been shelved fr the time being. It shuld be nted that nn-resident wners f UK residential r cmmercial prperty wh acquire r develp the prperty fr sale i.e. "traders" in UK real estate are already subject t UK crpratin tax r incme tax depending n the precise facts and subject t the applicatin f any relevant duble tax treaty. An anti-frestalling rule currently applies t certain arrangements entered int n r after 22 Nvember 2017 t cunteract arrangements that seek t avid the new charge n nn-residents thrugh expliting tax treaties. The Gvernment is particularly cncerned with cuntries with treaties that wuld verride the intended "indirect dispsal" charge. The new rules will als be prtected by a targeted anti-avidance rule aimed at defeating all arrangements entered int the main r ne f the main purpses f which is t secure that gains are nt subject t the new tax. Hwever, the Gvernment say that thse wh are currently exempt frm all UK capital gains tax (fr example, verseas pensin funds) r therwise nt in the scpe f UK tax fr reasns ther than being nn-resident, will cntinue t be exempt r ut f scpe. The enabling legislatin giving effect t this is yet t be published. SCOPE The Direct Dispsal Charge Where the nn-resident is a bdy crprate r wuld therwise be in scpe fr crpratin tax were they UK resident, the gain will be chargeable t crpratin tax (expected t be 19% in 2019 reducing t 17% in 2020). Fr ther persns, the charge will be t capital gains tax (up t 28% fr gains frm residential prperty and 20% fr nn-residential prperty gains). Gains n indirect dispsals will be cmputed by reference t the gain n the interest in the entity that derives its value frm land, rather than by reference t any increase in value f the land itself. There will be n grandfathering fr existing wners f UK real estate wh cme within the scpe f the charge ther than CGT newly arising will nly apply t gains arising after the charge cmes in (April 2019). There are cmplex rebasing rules t deal with different scenaris such as lsses and thse already within the residential CGT charge. Nn-UK resident cmpanies that becme UK resident pst-april 2019 will als have the benefit f the April 2019 re-basing ptin s as nt t disincentivise n-shring. Rll-ver relief fr business real estate assets used fr trade purpses will be capable f applying. The Indirect Dispsal Charge Tw tests must be perfrmed at the date f dispsal t establish whether a dispsal is in scpe: Is the entity being dispsed f "prperty rich"? and Des the nn-resident (including related parties) hld a 25% r greater interest in the entity, r have they held 25% r mre at sme pint in the tw years ending n that date? 1 The riginal prpsal was fr this t be five years. The perid has been reduced t 2 years fllwing the cnsultatin exercise. 2 Cliffrd Chance July 2018

3 The "prperty rich" test will require 75% r mre f the value f the asset dispsed f t derive frm UK land. The test will be made n the grss-asset value f the entity, s nt including liabilities such as lan finance. It will take market value at the pint f dispsal. It will be necessary t trace value if a grup f cmpanies are invlved. The 25% "wnership test" will lk at the prprtin f interest a nn-resident (and related parties) have in a prperty rich entity at the pint f dispsal, and include a 2 year lk back rule. The amunt f the gain r lss will be calculated n the basis f the interest being dispsed f in the transactin. The nrmal rules fr dispsal f shares r ther interests will apply as apprpriate, including thse aimed at preventing depreciatry transactins and similar anti-abuse rules. A new exemptin has been intrduced t the indirect charge where the real estate in an entity being dispsed f is all r substantially all used fr trading purpses (e.g. a cmpany that wns and perates a htel). Rebasing f shares fr the purpses f the tax calculatin will apply as at April It will be pssible t elect t apply histric base cst if higher than the April 2019 value but nt s as t generate a tax lss. The UK Gvernment cnsultatin acknwledges that, fllwing the expansin in the UK's "substantial sharehlding exemptin" ("SSE") frm 1 April 2017, it may be pssible fr the SSE t apply, subject t strict cnditins, t dispsals f prperty rich cmpanies r grups f cmpanies by "qualifying institutinal investrs" (e.g. certain pensin schemes, life assurance businesses, svereign wealth funds, charities, investment trusts, authrised investment funds and exempt unauthrised unit trusts). The Gvernment acknwledges that certain f the UK's duble tax treaties include a capital gains article which allcates taxing rights t the share-seller's jurisdictin n a dispsal f shares, even if the shares dispsed f are in a cmpany which is "prperty rich". Subject t any future amendments, thse treaties shuld cntinue t perate t shelter investr share-sellers resident in ne f thse jurisdictins frm the new indirect charge n capital gains frm UK land. Respndents t the cnsultatin raised Luxemburg as a treaty jurisdictin which wuld verride this charge. The Gvernment has said it is in discussin with Luxemburg t get this changed. Hwever, in the meantime, this is subject t anti "tax treaty-shpping" avidance prvisins, and the UK Gvernment has indicated that it will seek t deny the benefit f any such treaty if the main purpse, r ne f the main purpses f implementing a structure was t be able t use it as a shield against the new indirect charge, where the btaining f such tax advantage wuld be cntrary t the bject and purpse f the relevant duble tax treaty. As an "anti-frestalling" measure, this rule was impsed with effect frm 22 Nvember Ownership by and thrugh Cllective Investment Vehicles Dispsals by nn-residents f interests in UK funds will be within scpe f the Indirect Dispsal charge. Hwever, the Finance Bill des nt cntain details n hw the rules will apply t ffshre cllective investment vehicles and exempt investrs. The Gvernment prpses further cnsultatin ver the summer. In the meantime, it is prpsing the fllwing features as a starting pint fr discussin: Offshre funds such as JPUTs will default t being paque fr tax frm the perspective f nn-uk resident investrs. Hwever, they will be able t elect t be treated as transparent. Nn-UK resident investrs wuld then be taxed r exempted in the nrmal way n gains frm dispsal f the underlying real estate by the JPUT r dispsal f units (akin t the treatment f partners in partnerships). The Gvernment has indicated that base cst fr the purpses f the CGT rules wuld be the base cst f the underlying prperty, nt the base cst in the units acquired if different. Transparent ffshre funds will als be eligible t elect fr the special tax treatment that exempts gains by the fund and taxes the investrs n dispsals f their interest in the fund using the value f the interest rather than the underlying asset (in return fr certain reprting requirements). July 2018 Cliffrd Chance 3

4 The Gvernment is t explre further any difficulties that arise frm the discnnect between applying CGT n the value f the interests and the value f the underlying UK prperty amngst ther issues. Widely held ffshre funds wh agree t reprting requirements will be eligible fr special exemptins. The fund itself culd be exempt frm gains frm direct and indirect dispsals f UK prperty as will any nn-resident entities within its structure that wuld be chargeable n such gains. Investrs will be charged t tax n the gain n their interests in the fund; this will be based n the value f the interests. In return the fund must reprt details f the investrs, dispsals f interests by the investrs and the value f interests. The Gvernment says it is als cnsidering the apprpriateness f withhlding tax n redemptins fr smaller retail investrs and what the cnsequences f withdrawal f the exemptin wuld be and hw t tax distributins upn wind dwn f an exempted fixed-term fund. The Gvernment is als still cnsidering hw t deal with entities which wuld nt qualify fr the abve 'ffshre fund' exemptin (e.g. nt widely held, say in a tw-party jint venture) but held by exempt investrs. REITs are exempt frm tax n capital gains n direct dispsals but REIT exempt capital gains cunt as Prperty Incme Distributins upn which 20% UK withhlding tax can apply depending n the identity f the sharehlder. REITs can be impacted by these changes if a nn-resident member dispses f shares in a prperty rich cmpany. Currently, any distributin f prceeds d nt cunt as a PID subject t ptential 20% withhlding tax. The technical effect f the new changes will be that the prceeds wuld cunt as such a PID distributin. Reprting and Cmpliance Where a nn-resident is chargeable t capital gains tax (whether n a direct r indirect, residential r nnresidential dispsal), they will need t reprt that dispsal t HMRC within 30 days f the dispsal and als make payment within that timeframe (subject t any deferment f payment permitted under the UK's Self Assessment (SA) regime). Where a nn-resident is chargeable t crpratin tax (whether n a direct r indirect, residential r nnresidential dispsal), they will need t register fr CT Self-Assessment with HMRC, and will need t return the gain r lss within that framewrk, and pay any tax t the crpratin tax timescales apprpriate fr the amunt. Since the new measures include the impsitin f a charge t capital gains frm UK land upn an indirect dispsal, this may be hard fr the UK tax authrities t detect and cllect as a matter f practice. The UK Gvernment therefre riginally prpsed a new reprting requirement t be impsed n UK-based third party advisers wh have sufficient knwledge f an indirect dispsal falling within the new charge, unless they culd satisfy themselves that the transactin has been reprted t HMRC. It was prpsed that the UK-based third party adviser wuld be required t reprt t HMRC within 60 days f the relevant dispsal taking place, unless they can satisfy themselves that the transactin has already been reprted t HMRC. Hwever, the Gvernment has nw drpped these prpsals. It is prpsed that, if necessary, HMRC will be able t recver the tax f a nn-resident cmpany frm its UK representative (if any), r frm a related cmpany. Existing penalties regimes are prpsed t be applied fr failure t ntify a transactin falling within the new rules, and als fr failure t cmply with the prpsed reprting requirement fr third party advisrs. ATED-related Gains The Gvernment nw intend t ablish the existing regime fr ATED-related CGT pst-april Cliffrd Chance July 2018

5 NEXT STEPS Draft legislatin n the cre prpsals has been published. A technical cnsultatin will take place ver the summer. The plicy will be finalised in Finance Bill fr the changes t cme int frce in April Guidance ntes are als prmised in due curse. July 2018 Cliffrd Chance 5

6 CONTACTS This publicatin des nt necessarily deal with every imprtant tpic r cver every aspect f the tpics with which it deals. It is nt designed t prvide legal r ther advice. David Saleh Partner UK Head f Real Estate Tax T E Edward Page Senir Assciate T E Cliffrd Chance, 10 Upper Bank Street, Lndn, E14 5JJ Cliffrd Chance 2017 Cliffrd Chance LLP is a limited liability partnership registered in England and Wales under number OC Registered ffice: 10 Upper Bank Street, Lndn, E14 5JJ We use the wrd 'partner' t refer t a member f Cliffrd Chance LLP, r an emplyee r cnsultant with equivalent standing and qualificatins If yu d nt wish t receive further infrmatin frm Cliffrd Chance abut events r legal develpments which we believe may be f interest t yu, please either send an t nmrecntact@cliffrdchance.cm r by pst at Cliffrd Chance LLP, 10 Upper Bank Street, Canary Wharf, Lndn E14 5JJ Abu Dhabi Amsterdam Bangkk Barcelna Beijing Brussels Bucharest Casablanca Dubai Düsseldrf Frankfurt Hng Kng Istanbul Lndn Luxemburg Madrid Milan Mscw Munich New Yrk Paris Perth Prague Rme Sã Paul Seul Shanghai Singapre Sydney Tky Warsaw Washingtn, D.C. Cliffrd Chance has a c-peratin agreement with Abuhimed Alsheikh Alhagbani Law Firm in Riyadh. Cliffrd Chance has a best friends relatinship with Redcliffe Partners in Ukraine. 6 Cliffrd Chance July 2018