Non-resident companies subject to income tax

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1 Introduction 1. The BPF represents the UK real estate sector an industry with a market value of 1,662bn and that employs 1 million people. We promote the interests of those with a stake in the UK built environment, and our membership comprises a broad range of owners, managers and developers of real estate as well as those who support them. Their investments help drive the UK's economic success, provide essential infrastructure, and create great places where people can live, work and relax. 2. Around 28% of the UK's investment grade commercial real estate is owned by overseas investors; a share which has roughly doubled over the last 15 years and continues to grow rapidly. Indeed, the UK's commercial real estate market is one of the best in the world at attracting investment from overseas; investment that ultimately goes into upgrading our towns and cities. 3. Given the scale of such investors, any changes to their tax treatment should be considered carefully before implementation to minimise impact on investor sentiment. We therefore welcome the opportunity to comment on the government's proposals at an early stage in the tax policymaking process. Executive summary 4. We set out our key points below. More detailed responses to individual consultation questions can be found in Appendix Our overarching comment is that the proposals add to the more than sixty tax changes that have impacted on the real estate industry since Real estate - like all long term investments - thrives on certainty. Constant changes to the rules erode that certainty and ultimately lead to less money to fund the renewal of our towns and cities. While we appreciate the intention behind the proposals, we would very much welcome a period of stability in real estate tax It is not necessary to bring NRCGT within the scope of CT in order to deliver the government s objectives of applying the corporate interest restriction rules and loss reform to non-resident corporate landlords (NRCLs). NRCGT is a stand-alone regime and to incorporate it into CT would add unnecessary complexity. We recommend leaving NRCGT as it is It is not clear that the UK has taxing rights over all of the income you might expect to arise in an NRCL. Gains on the revaluation of derivatives (e.g. interest rate swaps) are not strictly speaking property rental income. There is therefore a need to consider whether the disregard regulations require adapting. In any case, we would suggest that the tax treatment of existing hedging arrangements should remain unchanged The consultation paper leaves several important practical questions unasked. Among other things, it is not clear what information NRCLs will be expected to supply to HMRC along with their CT returns and in what format this will need to be provided. It is also unclear how HMRC will categorise NRCLs for its own operational purposes and whether large groups of NRCLs will be allocated CRMs.

2 6. We look forward to discussing with you the contents of this response and the consultation paper more generally. Ion Fletcher Director of Policy (Finance) British Property Federation St Albans House Haymarket London SW1Y 4QX

3 Appendix 1 detailed responses to consultation questions Question 1: Do you agree that it is more appropriate to apply interest restriction and loss reform to UK real property income within the CT regime rather than the income tax regime? If you consider that they could be applied within income tax, how would the interest restriction and loss reforms be applied in a consistent manner to companies within CT? Bringing UK real property income within the scope of CT is probably the most straightforward way of applying interest restrictions and loss reform to non-resident companies owning UK real estate (henceforth, non-resident corporate landlords, or NRCLs). However, doing so would also subject such entities to a range of additional rules that exist in CT that have no equivalents in income tax and will most likely complicate the computation of taxable profits relative to the current position. It is therefore worth considering whether there is any way that NRCLs could be made subject only to certain elements of corporation tax (such as interest restrictions), as opposed to having to apply the rules in their entirety. For instance, it might be possible to introduce a separate income tax grouping system for NRCLs, which would allow interest restrictions to be applied to an income tax group as a whole, rather than treating each company separately as is currently the case for income tax. This could also facilitate the application of CT loss reform to NRCLs. If it is decided to subject NRCLs to the full CT regime, the transition would require them to come to terms with an enormous volume of legislation all at once. This contrasts with the position for existing CT payers, who have been on a tax journey and adapted to changes in legislation over a longer period, although even these are currently struggling with the implications of the interest restriction, loss reform and hybrid rules - aspects of which are still being finalised and clarified. It seems reasonable to wait until any teething problems with these rules have been resolved before extending their scope to a new universe of taxpayers. The transition from income tax to CT should therefore consider the need for taxpayers and HMRC to put in place the necessary systems to deal with it. We would suggest that transition should not occur before April Question 2: If non-resident companies liable to NRCGT are brought within CT, what features of the NRCGT provisions do you think may give rise to difficulties if adapted for CT? It is not entirely clear to us why it is necessary to bring non-resident companies subject to NRCGT within CT for recent CT changes like interest restrictions and loss reform to apply to NRCLs. While there is some logic in abolishing NRCGT and replacing it with chargeable gains under CT, this also entails additional complexity. For instance, the pooling arrangements that currently exist for income tax would need to be replaced with some sort of equivalent of sections 171, 171A and 179 of TCGA The existing NRCGT exemptions (e.g. for widely held companies) would also need to be transposed; this is particularly important because the exemptions are designed to encourage large scale institutional investment into new homes for rent. In addition, the knock-on impact on ATED would need to be considered and the value rebasing in the NRCGT provisions would need to be reflected in any replacement chargeable gains under CT. Ultimately, NRCGT is currently a standalone regime with its own rules and fundamentally taxes non-resident companies in a different way to resident companies. Bringing it within the charge to CT does not properly reflect the fundamental differences.

4 Accordingly, our view is that - despite its perceived faults - it would be simpler if NRCGT were retained separately from CT. Question 3: Is there an alternative approach that could be taken in calculating the taxable profits or losses of a UK property business carried on by a non-resident company? If they differ to those applied to a UK resident company carrying on a similar property business, please explain why different rules should apply. If it is decided to subject NRCLs to the full CT regime, it would seem reasonable for the taxable profits or losses of their UK property businesses to be calculated broadly in the same way as for UK resident companies. However, we see merit in taking the same approach with regards to interest payable as is applied in the UK REIT regime. In other words, interest payable should be treated as a deduction of the NRCL s property rental business rather than as a non-trade loan relationship. Alternatively, as suggested in our response to Question 1 above the interest and loss restriction rules could be applied to NRCLs within the context of income tax by creating the concept of an income tax group. Question 4: Irrespective of the tax regime, what would be the effect on non-resident companies from the application of corporate interest restriction? Please explain how any effect is different to the effect on UK resident companies. We remain concerned about the potential impact on real estate investment of the new interest restriction rules, regardless of whether they apply to UK resident companies or to NRCLs. That said, we welcome HMRC s confirmation that NRCLs would be treated in the same way as UK companies for the purposes of those rules and that subject to meeting the requisite conditions they would benefit from the de minimis and public infrastructure exemptions. We would not expect the application of the interest restriction rules to NRCLs to be significantly different from their application to UK companies. However, it is not clear how they may affect those (e.g. letting agents) that currently operate withholding tax for the non-resident landlord (NRL) scheme. It is very unlikely that letting agents will be able to correctly calculate allowable interest under the new rules, given their relative complexity and the potential dependence of allowable interest on the activities and performance of companies elsewhere in the corporate group. We would therefore recommend that letting agents be allowed to continue to use the existing method to estimate profits for the purposes of withholding tax under the NRL scheme. However, there is a more general point here in that real estate development is fundamentally a long-term business that thrives when the tax and regulatory environments are stable and predictable. This has been far from the case over the past five years and we fear that the continual tinkering with the tax rules has made the UK a riskier place in which to invest in real estate. Given the large number of jobs that the sector supports, this is ultimately to the detriment of the wider economy. Question 5: Do you agree that relief for management expenses for non-resident companies should be limited to those which are directly linked to the taxable UK sourced income? What are your views on the extinguishing of unused property losses at the point the UK property business has ceased? We broadly agree that relief for management expense for NRCLs should be limited to those linked to the taxable UK sourced income. However, we would additionally suggest that in cases where the only expenses of a company are of an administrative or legally required nature (e.g. audit fees) and the NRCL's business is principally UK property related, these should be deductible for tax purposes. In the case of a non-resident company whose only activity is a UK property business we would not expect there to be significant deductions

5 that would not already be deductible in computing the UK property business income following the changes introduced in Finance Act 1998 and Finance Act However, if non-resident companies are to be subject to CT instead of NRCGT management expenses should also be available if they can offset a capital gain. We would welcome clarification regarding the interaction of the scenarios described in paragraphs 3.14 and 3.18 of the consultation paper. In particular, the former suggests that UK property business losses may be extinguished but subsequently revived whereas the latter suggests they would just be extinguished. Or do these two paragraphs deal with different scenarios? In any case, we would expect that NRCLs would be subject to the same rules relating to losses as other CT payers. We would also suggest that in the scenario illustrated at paragraph 3.14 of the consultation paper, unused property losses of a UK property business should be eligible for group relief in the period when that business ceases. Question 6: Do you think that the suggested treatment of the unused income tax losses carried forward is reasonable? If you consider that there is an alternative approach, please explain what that would encompass. Yes, on the assumption that the unused income tax losses would be re-badged as pre-2017 losses and continue to be available for offset against future profits of the property rental business without the 50% restriction. Question 7: Are there other CT principles that you think would require transitional arrangements to be provided for? The consultation paper comments on a number of areas without then posing any questions. We comment on some of these below: Disregard regulations As a general point, we understand that most NRCLs are at present generally taxing or relieving fair value movements on derivatives - particularly as new UK GAAP requires FV adjustments to go through the income statement and there is no equivalent to the disregard regulations in the income tax rules. It could be argued that the UK may not have the right under double tax treaties to tax any non-property rental income of corporate NRLs. If this is correct, then it would follow that fair value movements on derivatives used to hedge property financing arrangements should not be subject to CT. If this were decided to be the most legally robust approach, it might be necessary for the disregard regulations to be made mandatory for NRCLs, on the basis that the UK has no taxing rights over related fair value movements. However, certain NRCLs could be worse off than at present under such a system (although perhaps not many in the short term, given the trajectory of interest rates over recent years). In addition, some NRCLs are comfortable with volatility in the fair value of their derivatives and would be unhappy with having to apply the disregard rules. In any case, to the extent that the disregard rules are not mandatory, HMRC must confirm at what point NRCLs need to elect into/out of the regime. We would also suggest that existing hedging arrangements in NRCLs should continue to be treated as they have historically any application or otherwise of the disregard rules should be prospective only.

6 Accounting period We agree that when an NRCL is brought with the scope of CT this should not trigger any balancing allowances or charges. It is also worth noting that NRCLs will generally have either a 31 st March or 31 st December financial year-end. In the former case, the accounting period implications of transitioning from income to corporation tax should be relatively straightforward. In the latter, NRCLs will be accustomed to calculating taxable profits for income tax by adjusting full year results for first quarter income and expenses. Other than in the case of abuse, we would suggest that HMRC should accept that the amounts brought into account for CT purposes in the year of transition is equal to the amount per the accounts less that already included in the income tax return to 5 April of the relevant year Group relief While the consultation paper states that the CT loss reform rules would apply to NRCLs as they would to UK companies, it is not clear whether the intention is for NRCLs to be able to surrender and receive group relief from other members of their group (be they UK companies or NRCLs). We assume that the intention would be to allow NRCLs the same access to group relief as for UK companies, but would welcome HMRC s clarification on this point. Practical challenges While the consultation paper addresses some of the main technical questions regarding a potential transition for NRCLs from income tax to CT, there are many practical considerations to bear in mind, including: What will be the future timing of tax payments for NRCLs? Will quarterly instalments apply? Will returns need to be accompanied by a set of accounts? What if the NRCL isn t legally required to prepare or file them? If accounts need to be filed, must they be tagged for ixbrl? This would seem unnecessary where no Companies House filing is made. How will Making Tax Digital proposals apply to NRCLs? We note the contents of a letter recently submitted to HMRC by the Chartered Institute of Taxation and would echo their comments. What team will take responsibility for NRCLs? Will large groups of corporate NRCLs benefit from a dedicated CRM at HMRC? How will HMRC transition taxpayers from their income tax to corporation tax systems? Will new UTRs be automatically issued? It will be critical that HMRC communicates widely any eventual changes to corporate NRL taxation. While many such landlords will be well advised, direct communication will also be needed. What will happen to concessionary treatment agreed by HMRC's NRL team (e.g. treating a (technically transparent) Jersey Property Unit Trust as the NRL for compliance purposes so that unitholders do not need to file individual returns in respect of the rental income)?