Non-resident capital gains taxation on direct and indirect sales of UK property

July 2018 Draft Finance Bill clauses Non-resident capital gains taxation on direct and indirect sales of UK property Summary of proposals Gains on disposals of all UK property and certain UK property rich entities ( indirect disposals ) on or after 6 April 2019 will be subject to UK tax, regardless of the residence of the seller Where the gain was not taxable before this law change (e.g. commercial property) the allowable cost of property held at 5 April 2019 is its market value on that date, with a limited option to apply original cost An entity will be UK property rich if at least 75% of its gross asset value at the date of disposal derives from UK property, but only those with at least a 25% interest in the entity at any time within the 2 years prior to disposal (aggregating certain connected persons) will be subject to tax (unless held for an insignificant proportion of that period) Gains made by companies will be taxable at the main corporation tax rate, gains by individuals at up to 28% for residential property or up to 20% for commercial. The ATED related gains regime will be abolished Certain tax exempt persons such as registered pension schemes and overseas pension schemes will be exempt from the measures under existing exemptions There could be an elective regime for Collective Investment Vehicles which would move the incidence of tax from the fund to its investors with the 25% interest threshold not applying to disposals by investors Anti-avoidance and anti-forestalling rules aim to counteract arrangements seeking to avoid the tax charge

Background Following a consultation published with the November 2017 Budget, on 6 July 2018 the Government published draft Finance Bill clauses reflecting its proposals to extend the scope of taxation of gains from UK property. Currently, non-residents (other than non-close companies and certain widely marketed schemes) are taxed on gains on disposals of UK residential property. Additionally, companies, partnerships with a corporate member and certain collective investment schemes, wherever resident, are taxed on gains on disposals of UK residential property that is subject to ATED, the Annual Tax on Enveloped Dwellings (broadly where market value exceeds 500,000 though numerous reliefs and exemptions are available). Gains on investments in commercial property by non-residents are generally outside the scope of UK tax on gains. The consultation published in November 2017 proposed extending the taxing of property gains, with effect from April 2019, to encompass all nonresidents (with very limited exemptions), and extending the assets within scope to include: UK commercial property as well as residential, and Entities that, directly or indirectly, derive at least 75% of their value from UK property excluding real estate-rich trading entities (see further below) EY has been involved in working group meetings in relation to this consultation, as well as submitting our own representations. The consultation closed in February this year and 6 July 2018 saw the publication of the Government s consultation response document, together with the draft Finance Bill clauses to put its intended changes into effect. Draft clauses were also published on 6 July 2018 to bring non-resident corporate landlords within the scope of corporation tax, rather than income tax, on UK property income with effect from April 2020. This was subject to a separate consultation in 2017 and is primarily intended to bring such entities within the scope of corporation tax regimes such as loss relief, loan relationships, the corporate interest restrictions and anti-hybrid regime. General scope of measures There are a number of detailed aspects of the proposed new regime that will need to be considered, but a general overview is as follows. The extended regime will apply to direct and certain indirect disposals of UK property on or after 6 April 2019, whether the disposal is by a company or other person. The existing non-resident CGT regime for the sale of UK residential property will be subsumed into one overall regime for all disposals of interests in UK land and the ATED related gains regime will be abolished. This will be achieved through a consolidation re-write of the whole of Part 1 of the Taxation of Chargeable Gains Act, though current rules (other than putting the new regime into effect) are not intended to be changed as a result. Where the non-resident is a company (or other entity that would otherwise be in scope for corporation tax were they UK resident) then any gain will be chargeable to corporation tax. For other persons the charge will be to capital gains tax. This will result in a considerable simplification of the rates of tax applied to UK residents on the sale of UK property, and non-uk residents on the sale of UK residential property (where the current diversely held company or widely marketed scheme exemptions do not apply): The main corporation tax rate (currently 19%) will apply to companies on the sale of all UK property Individuals will pay CGT at 18% or 28% (depending on whether they are basic or higher rate taxpayers) on the sale of UK residential property, and 10%/20% on the sale of UK commercial property The 28% rate previously applied for ATED related gains will disappear as part of the abolition of that regime Non-resident capital gains taxation on direct and indirect sales of UK property 2

For disposals that would not have been within the charge to UK tax before this law change (for instance the disposal of a UK commercial property) the allowable cost will, for property owned as at 5 April 2019 be rebased by reference to the market value of the property on that date. A taxpayer can elect to use the property s original cost instead (for example where a loss or lower gain would arise commercially than the taxable gain if rebasing to market value). However any loss arising on an indirect disposal as a result of an original cost election will not be an allowable loss. For disposals already within the charge to UK tax the current basis of taxation will continue to apply so that, for instance, April 2015 will continue to be the rebasing point for disposals currently within the non-resident CGT regime. An original cost election is also possible for such disposals, furthermore it is possible to make a straight line time-apportionment of the gain (so that only the proportion of the gain arising after April 2015) is brought into charge. Where a company becomes UK tax resident after 5 April 2019 and makes a direct or indirect disposal of UK land after that date, the rebasing rules referred to above will also apply. Other aspects of the capital gains rules will apply, for example: The offset of losses on other disposals against gains (other than losses arising as a result of making an original cost election in respect of indirect disposals, which will not be allowable losses, as above) Certain reliefs such as replacement of business assets (rollover) relief or no gain/no loss relief on intra-group transfers Exemptions such as the Annual Exempt Amount or (for indirect disposals) the Substantial Shareholdings Exemption Existing anti-avoidance such as depreciatory transactions and value shifting The charge will apply to all non-residents other than those that are generally exempt from UK taxation, such as registered pension schemes and overseas pension schemes making disposals of UK property investments held for the purpose of their scheme. To qualify for the exemption for overseas pension schemes, a foreign pension fund must meet the existing narrow definition for capital gains purposes. This may cause problems for certain funds like Australian superannuation funds that do not qualify for a full tax exemption under their home country regime, but HMRC has stated in its response document that it would welcome submissions on circumstances where current definitions are insufficient, and is prepared to update the relevant definitions as appropriate. A targeted anti-avoidance rule will seek to counteract any arrangements entered into on or after 6 July 2018 that aim to circumvent the taxation charge, and for indirect disposals an antiforestalling rule aims to counteract certain arrangements entered into on or after 22 November 2017 that make use of treaties to avoid the charge (see below). Indirect disposals of UK property In addition to being subject to UK tax on gains on direct disposals of UK property, non-residents will also be taxed on gains on disposals of entities (regardless of where the entity is resident) that themselves, directly or indirectly, hold UK property, unless the entity uses the assets in its trade (or acquired them for such use). Such regimes for taxing real estate companies, can be found elsewhere in the world, but this will represent a considerable expansion of the UK CGT regime. The taxation charge will apply on the disposal of shareholdings and other interests in entities at least 75% of whose gross asset market value at the date of disposal is derived directly or indirectly from UK property. In particular, the charge will apply to disposals of interests in companies. Where the entity being disposed of itself holds other entities it will be necessary to trace through down to the level of the underlying property assets owned by the group to determine whether the 75% threshold has been met. Under the original consultation, indirect disposals would be subject to taxation regardless of whether the entity in question used the assets in its trade; however following representations the Government has amended its proposals so that gains on the disposal of shares in a company will now be exempt from charge under the regime where all (but an insignificant proportion by value) of the land held Non-resident capital gains taxation on direct and indirect sales of UK property 3

by the company is being used for the purposes of a trade (or was acquired for such use). This trade has to have been carried on commercially with a view to profit for at least one year prior to the disposal, and be expected to so continue after the disposal for more than an insignificant period of time. The charge will be calculated by reference to the actual shareholding (or other interest) sold, but will only apply to persons that held an interest of at least 25% in the entity at any time during the two years leading up to the date of the disposal (other than for an insignificant proportion of that period). This is a change from the original consultation which had proposed a lookback period of five, rather than two, years prior to the disposal. In assessing the percentage held, interests held by certain connected parties are aggregated. The definition of connected parties proposed does not include partners in a partnership, however it will include a situation where two or more persons are acting together to secure or exercise control of a company. EY and others had expressed concerns about the breadth of such a test which, under the original proposals, could for instance have potentially included certain minority investors that would otherwise be unrelated. The definition of acting together proposed in the draft Finance Bill is narrower in scope than the definition that was originally proposed in the consultation document (which referred to parties acting together with a common objective ). It should also be noted that disaggregation arrangements may come within the scope of the targeted anti-avoidance rule attached to the indirect disposal rules. gains charge may still be regarded as trading companies for the purposes of SSE (for example if not all the land held is used for trading purposes). In such cases the indirect disposal could be eligible for the general SSE exemption. In addition, where the entity in question is owned, directly or indirectly, at least 80% by Qualifying Institutional Investors (QIIs), for instance investment funds, life assurance businesses and pension funds, then the gain may qualify for SSE under the QII exemption even if the entity being sold is not a trading company (with a partial exemption being potentially available if owned less than 80% but at least 25% by QIIs). The taxation charge can potentially be overriden if the non-resident seller is resident in a tax treaty territory which restricts taxing rights for such disposals to the territory of residence of the seller. It should be noted, though, that many tax treaties contain securitised land provisions within their capital gains articles which, for disposals of real estate companies, allow the territory in which the property is situated to levy taxation, so it is becoming increasingly unlikely that residence in a tax treaty location will result in the gain being exempted. Additionally, an anti-forestalling rule within the draft legislation aims to counteract arrangements entered into on or after 22 November 2017 that make use of treaties to avoid the charge if any tax advantage obtained is contrary to the object and purpose of the relevant treaty. This is in addition to the targeted anti-avoidance rule that applies generally to these proposals and aims to counteract arrangements that seek to circumvent the charge. As for direct disposals, UK property held as at 5 April 2019 will be rebased for allowable cost purposes to its market value on that date, with an option to apply the original cost instead. Unlike direct disposals, though, any loss arising on an indirect disposal as a result of an original cost election is not an allowable loss. As mentioned above, exemptions such as the Substantial Shareholdings Exemption (SSE) can potentially apply to indirect disposals. It is possible that UK property rich companies that are not regarded as trading for the purposes of the capital Non-resident capital gains taxation on direct and indirect sales of UK property 4

Collective investment vehicles Collective investment vehicles (CIVs) and their investors are in principle within the scope of the new charge to the same extent as other nonresidents. However the Government recognises that there is significant investment in UK property through CIVs and so is concerned to ensure the regime does not adversely impact non-resident investors by creating the potential for multiple levels of taxation and to take reasonable steps to protect investment in non-uk CIVs by tax exempt investors. The basic proposition outlined in the original consultation document was that, where a UK resident CIV is currently exempt from capital gains taxation on the basis that taxation is instead levied on its investors, then that would continue to be the case under the new regime. However, a CIV that is currently outside the scope of capital gains taxation purely because it is non-resident would come within the scope of the new regime. The draft Finance Bill provisions do not refer to the tax treatment of CIVs, however the explanatory notes confirm that specific provision will be made through additional legislation that will deal with the application of the rules to CIVs. Following the commentary in the consultation response document, we understand that the Government s current intention is as follows: Transparent offshore funds will be able to elect for transparency for the purpose of capital gains from the position of a non-uk resident investor, with UK investors retaining their current treatment Offshore funds that are not closely held will be able to elect for a special tax treatment whereby gains by the fund or within its structure will not be taxable, but the investor will be taxed on disposals of their interest in the fund. This treatment would apply whether the fund was transparent or opaque but it would be a requirement that the fund complies with certain investor reporting requirements represent functionally the same intended outcome of joint investment The 25% threshold test would not apply to disposals by investors of their fund interests where the fund meets the definition of a CIV (regardless of whether it has applied to make an election for transparency) The Government stated in its response document that it will continue to engage with stakeholders on this extremely complex area. Reporting and compliance As originally proposed, transactions within the scope of the new regime will need to be reported within 30 days of the transaction being completed, as is currently the case for disposals within the scope of non-resident CGT. Payments on account will be payable by nonresidents that would fall within the scope of capital gains tax or corporation tax on chargeable gains under the new regime. The third party advisor reporting requirement proposed in the original consultation has been dropped. What s next The final proposals are complex and so further aspects of the proposed new regime may become apparent following more detailed consideration of the draft legislation. The draft legislation itself is open (together with the rest of the draft Finance Bill) for consultation until 31 August 2018 and the Government has stated that, whilst the draft legislation represents its core proposals, it welcomes suggestions and recommendations in relation to the more detailed aspects. The official publication of the Finance Bill, of which these clauses will form part, is expected shortly after this year s Autumn Budget. Other solutions would be considered where exempt investors are involved in structures that do not fit within the definitions above but Non-resident capital gains taxation on direct and indirect sales of UK property 5

EY Assurance Tax Transactions Advisory Further information For further information, please contact one of the following or your usual EY contact: Russell Gardner rgardner1@uk.ey.com 020 7951 5947 Jane Scott jscott3@uk.ey.com 0121 535 2237 Claire Hooper chooper@uk.ey.com 020 7951 2486 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 OC300001 and is a member firm of Ernst & Young Global Limited. Ernst & Young LLP, 1 More London Place, London, SE1 2AF. 2017 Ernst & Young LLP. Published in the UK. All Rights Reserved. ED None In line with EY s commitment to minimise its impact on the environment, this document has been printed on paper with a high recycled content. 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 Non-resident capital gains taxation on direct and indirect sales of UK property 6