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Gains by non-residents on UK land – special rules for property

Two elections will be available to prevent double taxation of fund investors or the loss of exemption for pension funds when non-UK residents become subject to UK capital gains tax on non-residential UK property and UK property-rich entities.08 Nov 2018

The details are set out in a technical note on collective investment vehicles (CIVs) published alongside the 2019 Finance Bill.  

"There is lots for the industry to work through in the proposed treatment of CIVs in the new regime. While most CIVs will be subject to the tax, the two promised exemptions will relieve the charge in limited cases," said Richard Croker, a property tax expert at Pinsent Masons, the law firm behind Out-law.com.

From April 2019 gains made by non residents on non-residential UK property will be brought within the scope of UK tax. Non-UK residents are not currently subject to UK tax on capital gains made from UK commercial property.

At present gains made by non residents in relation to disposals of interests in residential property are subject to UK tax, but diversely held companies, some widely held funds and life assurance companies can elect out of the charge. 

The new rules extend the charge on gains on disposals of interests in residential property to these entities and mean that all non-UK resident persons, whether liable to capital gains tax or corporation tax, will be taxable on gains on disposals of interests in any type of UK land, whether residential or non-residential. Only the gains attributable to changes in value from 1 April 2019 for companies or 6 April 2019 for other persons will be subject to the new regime.

The changes will also tax non-UK residents' gains on interests in UK 'property rich' entities. These indirect disposal rules will apply where a person makes a disposal of an entity that derives 75% or more of its gross asset value from UK land. This would catch for example, selling shares in a company that derives 75% or more of its value from UK land.

The default treatment of non-resident CIVs will be that they are companies for the purposes of the legislation on taxation of chargeable gains and so will be chargeable to corporation tax on their gains. For investors, interests in a CIV will be treated as shares and any disposal of the interest will be chargeable as a disposal of an interest in a UK property rich company.

Following the publication of the proposals there were concerns that investment in UK real estate would be impacted negatively if tax exempt investors such as pension funds were taxed or if investors in CIVs suffered multiple tax charges in respect of the same disposal.

The legislation now contains two possible elections for CIVs which are 'UK property rich'. This means that 75% or more of their gross asset value derives from UK land.

 A 'transparency election' is designed for smaller, joint-venture arrangements where the investors are predominantly or wholly exempt investors. This election would treat an offshore CIV as a partnership for capital gains purposes thereby ensuring that the investors are taxed on disposals of the underlying assets of the partnership. Transparency would mean that a tax exempt investor would be able to obtain the exemption on a disposal of assets by the CIV, as the CIV itself would not be a taxable person.

"The irrevocable transparency election option will work for Jersey Property Unit Trusts (JPUTs) where the investors are tax exempt and the structure will be retained by such investors until wound up, because the fund and its investors can effectively ignore changes to members, but as the election is irrevocable it will not suit some potential buyers of JPUT units," Richard Croker said.   

The other new election provided in the legislation is an 'election for exemption'. Under this election the CIV itself is exempted from the tax, but the investors remain chargeable on their gains on disposals of interests in the CIV. This election is likely to be used mainly by widely held funds with large structures, particularly where the investors are exempt and wish to prevent tax charges in the fund itself that will impact on their returns.

The election for exemption will only be available to collective investment schemes as defined in the Financial Services and Markets Act 2000 or to non-resident companies that are the equivalent of UK REITs.

Funds will be considered to have UK REIT equivalence if the company is not close, or is only close because of control by a 'qualifying investors', at least half of its income is property income from long term investments, it annually distributes all, or substantially all, of its property income from long term investments and it is not liable to tax on that income under the law of any territory in which it is resident.

"The exemption option - which shadows much of the UK REIT regime - is more complex, has more conditions and will only apply if the fund is diversely held, but will be available to non UK REIT equivalents and to partnerships and coownership authorised contractual schemes (CoACS) in respect of their underlying investments in property rich SPVs," Richard Croker said.

"Investors will be liable to tax on their disposal of interests in the exempt fund (even if below 25%). Logically - to shadow the REIT regime - there is proposed to be a tax clawback if exempt gains are distributed tax free to members as a dividend instead of being realised by the unitholder selling units," Croker said.

"The reporting requirements for exemption are considerable and the government proposes that an election - again like REIT status - can be revoked by HMRC if they consider it appropriate to protect the public revenue. An exemption election can also be revoked by the fund manager - in which case there will be a deemed disposal and reacquisition of investor interests at market value immediately before," he said. 

There is also a "very sensible rule" which will allow qualifying institutional investors to 'lend' their non taxable status to wholly owned intermediate entities, he added.

"Some funds will have the choice of either election or none - some investors will going forward have interests in both types of fund - and will have decisions to make when they invest," Croker said.

"Given the large number of assets in relevant structures it is to the credit of the authorities that they have proposed what appear to be workable solutions in this way - albeit at the cost of even greater complexity to the tax system," he said.