One of the cornerstones of the UK tax system has been that assets owned by non-UK residents and not used for the purposes of a UK trade are outside the scope of UK capital gains tax. This has underpinned the structuring of the substantial flows into UK real property over past decades, both from overseas investors and UK institutional funds looking for a transparent holding structure. This has been demolished with the Budget announcement that gains on all UK real property will be taxable from April 2019. This will include gains from the disposal of holdings in 'property rich' companies, partnerships and other entities.
Not all non-residents in existing structures will be caught by the rules for disposals of interests in 'property rich' entities, because some double tax treaties will prevent the charge applying. However, an anti-forestalling provision prevents post-Budget structuring to take advantage of favourable treaties.
Non-UK residents owning commercial property which is not used for the purposes of a UK trade are not currently subject to UK tax on property disposals. They are also not usually subject to UK tax if they dispose of an interest in an entity, such as a company or a fund, which owns UK commercial property as an investment. The Transactions in Land (TIL) rules introduced in 2016 brought trading profits and certain gains on disposal of property and interests in property holding vehicles within the scope of UK tax where property was acquired or developed with a main purpose of realising a gain.
The position is different for UK residential property:
- In 2015 a charge was introduced for the disposal of non-resident owned UK residential property (the Non-Resident Capital Gains Tax or NRCGT). This charge does not apply to non-resident companies that would, if they were UK resident, not be close companies; and
- There is also a tax charge where there is a disposal of UK residential property that has been subject to the Annual Tax on Enveloped Dwellings (ATED).
Both these current charges apply only where the non-resident makes a direct disposal of the property, and not where the non-resident disposes of an interest in an entity, such as a company or fund, which owns UK residential property.
The main proposals from the consultation document are:
- From April 2019, gains made by non-residents from all UK land and buildings will be subject to UK tax;
- The rules will apply to residential property, as well as commercial property, and the existing regime for NRCGT and ATED related gains will be brought within a single regime for UK real property;
- For commercial property, only the gains attributable to changes in value will be chargeable, from 1 April 2019 for companies or 6 April 2019 for other persons
- Tax will be charged if a non-resident individual, company or other entity disposes directly of UK property, or if a non-resident disposes of an interest in a 'property rich' company or other entity
- The indirect charge will only apply if the investor has at least a 25% interest in the property owning entity (or had at any time in the prior 5 years) – ownership of related parties is aggregated
- The rules will be subject to the substantial shareholdings exemption and the terms of any applicable double tax treaty
- Advisers will be required to report indirect disposals to HMRC in some circumstances.
Direct disposals of property
There will be a single regime for disposals of both residential and commercial property by non residents. Companies will be subject to tax on gains arising from April 2019 at the UK corporation tax rate, which is currently 19%. Normal loss rules will apply. Individuals, trusts, and personal representatives will pay at the usual CGT rates for UK residents, including any personal allowances.
In relation to residential property, companies which would not be close if they were UK resident will be brought within the regime.
Indirect disposals of commercial or residential property
Disposals by non-residents of interests in companies or other entities will be within the new regime if:
- the entity being disposed of is 'property rich'; and
- the non-resident holds a 25% or greater interest in the entity, or has held such an interest at some point within the five years before the disposal.
An entity will be 'property rich' if at the time of the disposal, directly or indirectly, 75% or more of the value of the asset disposed of derives from UK land. This will be calculated by reference to the gross-asset value of the entity, not including liabilities such as loan finance. The test will use the market value of the assets at the time of disposal.
The 25% ownership test will take into account interests in the entity held by related parties as well as those held by the person making the disposal. The text will use the wide 'acting together’ rules used for the purposes of the corporate interest restriction designed to cover the situation where persons come together as a group with a common object in relation to the property holding entity.
Double tax treaties
The CGT charge will be subject to the terms of any double tax treaty between the UK and the company of residence of the non-resident. Treaties usually allow capital gains from immoveable property to be taxed in the country in which the property is situated.
In addition, most of the UK's treaties allow the UK to tax gains on disposals of shares in UK property rich companies. However:
- some treaties, such as the one with Luxembourg, will only allow the UK to tax direct disposals of UK property so will not catch the sale of entities which are property rich;
- some treaties, such as the one with China, will only allow the UK to tax indirect disposals where the asset being sold is shares, rather than, say an interest in a partnership;
- Some of the treaties which allow the UK to tax indirect disposals of property rich entities only apply where the entity being sold directly owns property so in applying the property rich test it will not be possible to take into account property owned by a subsidiary of the company or other entity;
It will therefore be necessary to consider the terms of the precise treaty to see whether indirect disposals of UK property can be subject to UK tax.
Note however that anti-forestalling arrangements apply from Budget day. These will prevent the restructuring of existing holdings or the structuring of new arrangements to take advantage of double tax treaties which do not allow the UK to tax the gains from direct or indirect holdings of UK property. They will allow HMRC to counteract any advantage obtained by relying on a double tax treaty where the tax advantage is "contrary to the object and purpose of those provisions".
Tax exemptions for gains made by UK funds such as real estate investment trusts (REITs), property authorised investment funds (PAIFs) and exempt unauthorised unit trusts on property disposals will continue, although the consultation notes that gains by non- resident members of REITs will be subject to tax in line with the position on non- resident disposals generally.
Funds which are exempt from tax currently by reason of non- UK residence, such as Channel Isles unit trusts such as Jersey property unit trusts (JPUTs), non–resident companies and trust structures, will become subject to tax in accordance with the main rules applying to non-resident disposals of property or interests in property rich entities.
There is no specific comment in relation to partnerships and it remains to be confirmed that the current "look through" treatment for capital gains of partnerships will continue to apply.
Non-residents will be subject to tax on the disposal of their interests in UK or non- UK resident funds and collective investment structures where the property rich test is met and the 25% ownership condition is also met.
It is not currently proposed that there will be any specific exemption applying to institutional or fund investors. However, there is nothing to suggest that tax exempt investors such as UK pension funds will lose the tax exemption on directly realised chargeable gains, though there may now be a taxable gain within fund vehicles in which such investors have invested where the new rules apply.
The consultation also notes that gains will be subject to the substantial shareholdings exemption (SSE) which may provide an exemption in relation to material investments by qualifying institutional investors in corporate holding structures where the underlying companies are not trading. The relevant provisions to extend the SSE are in the current Finance Bill.
The government accepts in the consultation document that there are some aspects in relation to REITS and other funds which will require further consideration.
Reporting and compliance
Sellers will be required to report a disposal within the new regime on an electronic form to HMRC within 30 days of completion of the disposal, in the same way as currently applies for NRCGT. For transactions subject to corporation tax, the non-resident will be required to register for corporation tax self assessment.
In a separate measure it was confirmed in the Budget that non-resident companies (which would apply to many non-UK property investment companies) will become subject to corporation tax rather than income tax from 6 April 2020.
In relation to indirect disposals, there will be a requirement for UK based advisors receiving fees in relation to a relevant transaction, to report the transaction to HMRC unless they can reasonably satisfy themselves that the transaction has already been reported to HMRC.
The consultation closes on 16 February 2018.
Non-residents owning UK real estate directly or through funds or other intermediate or collective structures will need to consider the impact of these proposals on both existing structures and proposed future investments.
Institutional investors will also need to review fund investment structures to identify in particular whether non- resident vehicles within the structure will become taxable under the new regime.
John Christian is a property tax expert at Pinsent Masons, the law firm behind Out-law.com