Capital gains for nonresidents. legislation released

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1 Finance Bill 2015 Capital gains for nonresidents - draft tax legislation released Introduction On 10 December 2014 the UK Government released draft legislation on the extended capital gains tax (CGT) charge for non-resident investors disposing of UK residential property. In particular, the draft legislation clarifies further the nature and scope of the charge and provides long-awaited detail on the specific exemptions for residential property held directly or indirectly by non-resident institutional investors. The changes are expected to come into force from 6 April 2015 and there is no minimum threshold. The Government has indicated that this measure brings the United Kingdom into alignment with most other countries who charge non-residents in relation to immovable property located in their country. This alert outlines the scope of the extended CGT regime in more detail and specifically from the perspective of institutional investors who are non-resident or hold UK residential property through non-resident vehicles. On balance, the new rules represent a significant move, however the effect on institutional investors should not be significant given the proposed exemptions for companies which are not closely held. We have considered these aspects in further detail in this alert.

2 Residential property: definition and exclusions Subject to certain exemptions, the extended CGT charge will apply to non-resident persons who dispose of UK residential property interests. A relevant property interest is defined as UK land (or an interest in land) which consisted of, or included, a dwelling at any time during the ownership period (or on/after 6 April 2015, if acquired before that date). Meaning of dwelling The definition of a dwelling includes a building at any time it is: used or suitable for use as a dwelling; or in the process of being constructed or adapted for such use. Land that is, or is intended to be, occupied or enjoyed with a dwelling at any time, such as a garden or grounds (including any building or structure on the land) will be taken to be a part of that dwelling at that time. A dwelling also includes a contract for the acquisition of land consisting of a building, or part of a building, to be constructed or adapted for use as a dwelling ( off plan purchases). Exemptions and conditions A building is not to be regarded as used (or suitable for use) as a dwelling if it is used as: a) residential accommodation for school pupils; b) residential accommodation for members of the armed forces; c) a home or other institution providing residential accommodation for children; d) a home or other institution that provides personal care and residential accommodation for the those of old age, disability, or past or present dependence on alcohol or drugs, or past or present, mental disorder e) a hospital or hospice f) a prison or similar establishment; g) a hotel or inn or similar establishment. A building is not used (or suitable for use) as a dwelling if it is an institution (not being within exclusions (c) (f) above) which is used, or suitable for use, as the sole or main residence of its residents. Furthermore, a building providing or forming part of student accommodation should not be considered to be used (or suitable for use) as a dwelling provided the building or accommodation (i) includes at least 15 bedrooms, (ii) is purpose built for occupation by students and (iii) is occupied exclusively or mainly by students for the purpose of undertaking a course of education for more than half of the relevant tax year. Temporary unsuitability A building which becomes temporarily unsuitable for use as a dwelling is to be treated as continuing to be suitable for use as a dwelling (and therefore potentially within the extended CGT charge). Damage to a dwelling An exemption from the extended CGT charge is available for a period of temporary unsuitability resulting from accidental damage to the building or damage caused by events outside the control of the person disposing the interest if the damage left the dwelling unsuitable for use for at least 90 consecutive days. This exemption does not apply where damage occurred during alteration work on a building which itself involved or could be expected to involve making the building unsuitable for use for 30 days or more. The draft legislation confirms that restoration works undertaken in the 90 day period do not count as construction or adaption of the building for use as a dwelling. Pre-disposal works A building will be considered to be unsuitable for use as a dwelling during any part of the relevant ownership period when works were in progress, where on or at any time before, the disposal of the building: it has ceased to exist, or has become unsuitable for use as a dwelling, as a result of works involving its complete or partial demolition, or any other works; planning permission or development consent for the works has been granted; and the works have been carried out in accordance with any relevant permission or consent.

3 This will include any period commencing before, and in connection with the works, that the building was not used as a dwelling. Who will fall within the scope of the extended CGT charge? The extended CGT charge is proposed to apply to any gains on the disposal of relevant property interests arising from 6 April 2015 to the following: Non-resident companies (save for those which are diversely owned or open-ended investment companies ( OEICs ) which meet the new widely-marketed fund condition) Non-UK resident individuals where that individual is not resident in the UK for the tax year (or where they are in the overseas part of a split year), and Non-UK resident trusts and partnerships (save for unit trusts which meet the new widelymarketed fund condition). There is an exemption from the charge for non-uk resident companies which carry on a trade in the UK through a permanent establishment, and the relevant property interests are used in or held for the purposes of the trade or permanent establishment. These companies will continue to be chargeable to UK corporation tax on chargeable gains on the disposal of relevant property interests so used or so held. Specific exemptions for diversely held companies and widely-marketed OEICs and unit trusts Importantly, the UK Government has introduced a number of exemptions for non-resident companies otherwise caught by the rules in order to encourage institutional investment in the development and supply of housing. In particular, the draft legislation states that the extended CGT charge for disposals of UK residential property will not apply to any of the following companies: any company which is a diversely-held company at the time of the disposal, any open-ended investment company which meets the widely-marketed fund condition. The second exemption also applies to a unit trust scheme which meets the widely-marketed fund condition. Meaning of diversely held company A diversely held company is one that is not closelyheld. A company is to be regarded as closely-held for these purposes if conditions A or B below are met. Condition A is that the company is under the control of five or fewer participators. Condition B is that five or fewer participators together possess or are entitled to acquire rights that would enable them to receive the greater part of the company s assets upon a winding up (disregarding any rights that any loan creditor has). A participator for these purposes takes the normal definition given to it under existing Corporation Tax legislation and includes: any person who possesses or is entitled to acquire share capital or voting rights in the company or a right to receive distributions of the company or any amounts payable by the company to loan creditors by way of premium or redemption a loan creditor, and any person entitled to secure that the company s income or assets will be applied for their benefit. Notwithstanding the above, a company will not be treated as closely held if it would not be treated as such except by taking as one of its participators, a diversely held company (that is, a company that is itself not close) or a qualifying institutional investor, or if reference to participator did not include loan creditors who are diversely held companies or qualifying institutional investors. Non-UK resident, Real Estate Investment Trusts in corporate form should fall outside the scope of the charge. Furthermore, the effect of the exemption is that any company, including a qualifying institutional investor that is itself diversely held, and any company that is controlled by one or more qualifying institutional investors, should fall outside the scope of the extended CGT charge. A qualifying institutional investor means any of the following: a unit trust scheme or open-ended investment company which meets the widely-marketed Capital gains for non-residents - draft tax legislation released 3

4 fund condition in relation to the disposal the trustee or manager of a pension scheme that has been registered as such with HMRC, or a person who benefits from exemption from corporation tax or income tax on grounds of sovereign immunity. Meaning of widely-marketed fund condition Open-ended investment companies (which will include Property Authorised Investment Funds) and unit trusts will be exempt from the extended CGT charge if they meet the widely-marketed fund condition. This is similar to the Genuine Diversity of Ownership condition which applies to certain authorised investment funds. In essence, provided the unit trust or OEIC scheme actively markets itself sufficiently widely to reach the intended categories of investors (and does not put any undue constraints or limitations on the intended investors), the fund should satisfy the widely-marketed fund exemption. Rate of tax The UK Government has indicated an intent to ensure fairness between UK residents and non-uk residents. Therefore, where non-resident individuals are subject to the extended CGT charge, they will be chargeable to CGT at 18% or 28%, the rates that currently apply for UK resident individuals. They will also be able to benefit from the annual exempt amount. Non-UK resident companies subject to the extended CGT charge will be chargeable at corporation tax rates (20% from 1 April 2015). As with UK partnerships, any gains arising to non- UK resident partnerships will be taxed on the members of the partnerships and the partners will, therefore, be chargeable to CGT or corporation tax at the appropriate rate subject to their tax status. Calculating the chargeable amount The extended CGT charge will only apply to gains realised on or after 6 April Where a property was acquired after 5 April, a proportion of the gain will be chargeable by reference to the number of days in the period of ownership in which the residential property interest consisted solely or partly of a dwelling (calculated on a time apportionment basis). The draft legislation provides for alternative apportionment methods to apply to the calculation of the chargeable gain for assets held on 6 April The default position is that the chargeable gain is calculated by reference to the value of the residential property on 5 April 2015 with only the proportion of the gain chargeable by reference to the number of days in the period commencing 6 April 2015 in which the residential property interest consisted solely or partly of a dwelling (the proportion being calculated on a time apportionment basis). However, non-residents will have the ability to submit one of two types of elections and once an election has been made, it cannot be revoked: u u An election for straight-line time apportionment of the gain arising over the whole period of ownership (or from 31 March 1982 if acquired before that date) between the period ending before and the period commencing 6 April Only a proportion of the gain apportioned to the latter period will be brought into charge by reference to the number of days in that period in which the residential property interest consisted solely or partly of a dwelling. An election for the proportion of the gain arising over the whole period of ownership calculated by reference to the number of days in the entire ownership period in which the residential property interest consisted solely or partly of a dwelling. Where a property was only partially used as a dwelling (for example the taxpayer purchased a warehouse and converted it into a home), the proportion of gain attributable to the dwellings shall be calculated on a just and reasonable apportionment. Interaction with ATED and other charges The Annual Tax on Enveloped Dwellings (ATED) and ATED-related CGT were introduced from April Subject to available reliefs, the two charges apply to non-natural persons (broadly corporates or partnerships with one or more corporate partners) holding high value residential property. High value residential property is property worth more than Capital gains for non-residents - draft tax legislation released 4

5 EY Assurance Tax Transactions Advisory 2mn (or more than 1mn with effect from 1 April 2015 and more than 500,000 with effect from 1 April 2016 respectively). Where the ATED-related CGT charge applies, this will apply in priority to the extended CGT charge for non-resident non-natural persons and at a higher rate of 28%. Where a property is exempt from ATED (and therefore, ATED-related CGT), the extended CGT charge will be applicable. The draft legislation contains provisions governing the apportionment of gains when residential property interests come within ATED related CGT during the period of ownership. The UK currently imposes anti-avoidance legislation which attributes gains arising in non-resident close companies to UK resident participators (the section 13 charge). The extended CGT charge will apply in priority to this existing anti-avoidance legislation. Further information For further information, please contact one of the following or your usual EY contact: Marion Cane mcane@uk.ey.com Russell Gardner rgardner1@uk.ey.com Matt Maltz mmaltz@uk.ey.com Claire Hooper chooper@uk.ey.com Maheshi Ratnasekera mratnasekera@uk.ey.com About EY EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organization and may refer to one or more of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com. Ernst & Young LLP The UK firm Ernst & Young LLP is a limited liability partnership registered in England and Wales with registered number OC and is a member firm of Ernst & Young Global Limited. Ernst & Young LLP, 1 More London Place, London, SE1 2AF Ernst & Young LLP. Published in the UK. All Rights Reserved. ED None Information in this publication is intended to provide only a general outline of the subjects covered. It should neither be regarded as comprehensive nor sufficient for making decisions, nor should it be used in place of professional advice. Ernst & Young LLP accepts no responsibility for any loss arising from any action taken or not taken by anyone using this material. ey.com/uk 5