CMS_LawTax_Negative_28-100.ep Tax guide Non-residents and real estate Budget 2017: Extension of tax on capital gains
Non-residents and UK property Budget 2017 included unexpected announcements in the context of real estate taxation. Summary The Government intends to tax capital gains realised by non-uk resident investors in UK property. This is scheduled to have effect from April 2019. Very broadly: Tax will be charged on gains made by non-residents on disposals of UK commercial property. Non-UK companies and other bodies corporate will become subject to corporation tax, individuals will become subject to capital gains tax. Tax will also apply to indirect disposals of interests in UK commercial or residential property. The charge will apply on the disposal of an interest in a 'property rich' vehicle, being an entity which derives, directly or indirectly, 75% or more of its value from UK land. The new indirect charge will not apply to investors which hold (when taken together with relevant persons) less than 25% of the vehicle. The 25% threshold will have regard to the period of five years prior to disposal. In the context of the existing charge to tax on UK residential property, the exemption for property held by widely-held companies will be removed. This is set to be a significant and dramatic change to the regime. Currently, only direct disposals of residential property are usually within scope. Outline Only gains attributable to changes in value from April 2019 are said to be chargeable. This will be achieved by rebasing commercial property (and residential property held by widely-held companies) to market value at April 2019 for the purposes of calculating the gain on disposal. Similarly, disposals of shares or other interests in property rich vehicles will be limited to growth in value from April 2019. These changes are set to have a major impact on existing ownership and financing structures, transaction steps and new investment. This Overview is intended to outline the current position, as well as set out some initial thoughts on impacts. We will supplement the commentary in this Overview over the coming weeks and months by way of specific topic updates. We caution against making immediate decisions based upon the consultation details released so far. Greater clarity should be obtained over the coming months. CMS will be responding to the Government consultation. The Government have stated that the decision to change the rules is not open for debate - the scope of the charge, commencement and core features are all fixed. There will, however, be detailed aspects which may benefit from refinement to ensure that the provisions are properly targeted and not burdensome. Please do share with us your concerns and suggestions for improvement.
The current position Most jurisdictions exercise taxing rights over their land. The existing rules of the UK are therefore unusual from an international tax perspective. Residential property UK residents are normally liable to tax on capital gains that derive from UK land, subject to exclusions for individuals in the context of their main residence. For non-residents the position is more complex. A non-resident is not normally subject to tax on capital gains, with the exception of residential property: ATED-related capital gains tax applies for properties above a financial threshold (now 500,000), wholly or partly owned by a company (directly or via a partnership) or a collective investment scheme. Non-resident capital gains tax normally applies to non-resident individuals, trustees, companies and funds (amongst others) without financial threshold. Certain companies and funds, which satisfy diversely-held ownership requirements, are exempted together with life assurance companies in specified circumstances. Commercial property A non-uk resident investor in commercial property will usually be outside the scope of tax on capital gains. This advantageous treatment for non-residents is subject to exceptions. Dealing in or development of land will usually attract tax. Also, where the property is a fixed asset of a business carried on in the UK through a permanent establishment, capital gains will fall within charge. This typically occurs in the context of property used by the owner as part of its operating business, common examples include hotels, golf-clubs and other leisure assets. There are separate rules for temporary non-uk residents, so as to reduce avoidance opportunities. Ownership trends Non-UK resident investors are normally subject to income tax on rents. This is the case whether the property is commercial or residential. In the context of commercial property the taxation treatment has tended to encourage geared investment. The aggregate return to investors comprises (i) an income element, against which interest and other debt expenses are set for income tax purposes, and (ii) a capital element outside the scope of charge to tax. From a tax perspective gains are preferred. A combination of low yields, with a mixture of third party and shareholder debt, may result in very low effective rates of UK tax. 3
2019: Direct disposals The general intent is that from April 2019 all gains accruing on disposals of UK real estate interests will be chargeable to tax, regardless of the residence status of the person disposing. The new charge will more closely align the tax treatments of non-uk residents and UK residents. As such, it is relatively advantageous to those investors whose treatment does not change. So for example: REITs, pension funds and charities will retain their existing exemptions. Life offices remain subject to their specific regimes. Sovereign immunities are not impacted. Indeed, for those investors whose position is unchanged the extension of tax may be helpful from a pricing/net returns perspective when compared to non-residents. Rebasing It is intended that only gains from increases in value from 1 April (companies) or 6 April (others) 2019 will be chargeable. This is to be achieved by way of a rebasing of property values for tax purposes. Rebasing can produce odd/unfair results. It is proposed that if the non-resident has made a loss overall, but a gain would accrue under rebasing, then there will be a computational option of using acquisition cost. This is helpful but would not appear to assist a tax payer in circumstances where there is a gain overall (no matter how small), but a temporarily low market value in April 2019. No specific valuation requirements are expected. The UK's emphasis on self-assessment means that taxpayers should consider what evidence is appropriate to support their views as to value. A full valuation exercise by an independent firm will not always be appropriate. The greater the value, or more complex the asset, as well as the longer the period after April 2019 to disposal, the more useful a contemporaneous valuation report will be. Residence For owners considering coming on-shore, it will be natural to wait until April 2019. There may be administrative and cost benefits to becoming resident in the UK. Non-UK resident companies currently subject to income tax on rents are now expected to be moved to a corporation tax basis in April 2020 (not 2019 as originally thought). More restrictive debt expense rules are expected as part of this change to the assessment basis. For companies impacted, continuing non-uk residence until 2020 may have attractions. 4 CMS Network Sharing 3.0
2019: Indirect disposals Tax will also extend to indirect disposals, with a new 'property rich' entity concept. Outline The rules will apply where, at the time of disposal, directly or indirectly, 75% or more of the value of the asset disposed of derives from UK land. Typically, this will apply in the context of real estate owned by a company or unit trust, where the disposal is of the shares or units. Without a charge on indirect sales, it would be possible to defer tax on gains by selling the vehicle that owns the real estate. However, to prevent smaller investors falling within scope, there is a 25% threshold requirement. This in turn is subject to aggregation rules. It is proposed to include connected parties, as well as persons to which 'acting together' rules apply. To prevent avoidance, past holdings in the last five years are taken into account for the purposes of assessing whether the threshold is met. So for example, connected persons might have sold leaving an investor with less than 25%, but remaining within charge because of the proposed look-back test. Unlike the position for direct disposals, rebasing will only be by reference to market value in April 2019. Potential charges to tax upon a sale of shares or units (or other interests) are then subject to any relevant reliefs. Substantial shareholdings exemption may be relevant in limited circumstances, sovereign immunity and the impact of double tax treaties may also be in question. In circumstances where real estate is owned by a SPV, the impact of the charge should be easy to identify and take into account. However, the position becomes more difficult as ownership layers and ultimate owners multiply. Inherent gains In a simple case of a SPV sale, the new rules may give rise to double-taxation, at least economically. Leaving aside the impact of any special status (such as UK REITs), a purchaser of a target company with inherent gains will generally seek a discount for the tax in agreeing the net assets. So, in effect, the seller suffers this by way of a reduced purchase price for the shares. This purchase price is then subject to tax on the share sale capital gain. Whether this is acceptable to a seller may depend on a number of factors, including the stamp taxes position. Anti-forestalling Arrangements entered into on or after 22 November 2017 (Budget day) may be subject to counter-action. This applies where a UK tax advantage purpose test is satisfied in the context of double taxation advantages contrary to the effect and purpose of the relevant treaty. Third-party reporting To ensure that HMRC is made aware, reporting requirements are proposed for certain advisers in specified circumstances. In addition, HMRC will have the ability to recover tax from a UK representative or related company of the non-resident disposer. 5
How will the market develop? Offshore holding structures The changes are not immediately fatal to offshore holding structures. Material stamp tax benefits may continue to arise from the indirect sale of a property rich SPV. However, depending on the performance of the underlying asset, there may be a tipping point at which the capital gains tax cost outweighs the expected SDLT benefit. Going forward, onshore structures such as REITs, PAIFs and authorised contractual schemes are likely to become more popular. Luxembourg premium? Although the UK intends to tax indirect disposals, not all treaties give the UK taxing rights. Amongst common offshore holding jurisdictions, Luxembourg appears to be attractive. So for example, a property rich company would still be subject to tax on capital gains, but a Luxembourg shareholder might have treaty benefits in holding shares in their company. In practice, tax may be deferred by a series of SPV sales. Existing offshore holding structures are unlikely to be decamping to Luxembourg immediately. Anti-forestalling rules are proposed to prevent any move without a genuine commercial purpose. Also, the OECD s BEPS project should make the UK/Luxembourg double tax treaty harder to access. It is anticipated that a principal purpose test will soon apply to the treaty. Substance and genuine commercial reasons for investing through Luxembourg will therefore become increasingly important. Channel Islands unit trusts A Jersey or Guernsey unit trust has historically been an excellent holding structure for UK property. They are income transparent, currently outside the scope of capital gains tax when managed offshore and capable of being sold SDLT free. Income transparency makes them attractive vehicles for both taxable and exempt investors, with tax being payable according to an investor s specific tax profile. Going forward, unit trusts are likely to become less attractive. For a UK tax exempt investor the vehicle exposes the investor to UK tax on capital gains as the unit trust is a deemed company for these purposes. A structure that offers a tax treatment equivalent to a direct holding such as a REIT is likely to be preferred. Investors that continue to invest through an offshore holding structure may choose non-resident companies for simplicity. REITs The REIT structure is a potential winner from the changes. A REIT is tax exempt on its underlying property rental business and so, for an exempt investor, offers a tax profile equivalent to a direct holding. Income must be distributed under current rules. There is a prima facie withholding tax on distributions from the REIT. However, many investors such as UK pension schemes are exempt from withholding. In addition, tax treaties typically lower the rate of withholding to 15%. Further relief may be available for specific investors. For example, Dutch and US pensions schemes are fully exempt from withholding tax on distributions from a REIT. 6 CMS Network Sharing 3.0
Contacts Phil Anderson T T +44 20 7524 6048 phil.anderson@cms-cmno.com Anna Burchner (LL.M International Tax) T T +44 20 7367 3077 anna.burchner@cms-cmno.com Nick Burt T T +44 20 7524 6338 nick.burt@cms-cmno.com Graham Chase T T +44 20 7067 3387 graham.chase@cms-cmno.com Richard Croker T T +44 20 7367 2149 richard.croker@cms-cmno.com Jim Hillan T T +44 20 7367 3984 jim.hillan@cms-cmno.com Mark Joscelyne T T +44 20 7367 3390 mark.joscelyne@cms-cmno.com Clíona Kirby T T +44 20 7067 3386 cliona.kirby@cms-cmno.com 7
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