There have been some recent changes in relation to the taxation of commercial property interests held by non residents that are of interest to investors including non-resident corporates and individuals, offshore funds, REITs and institutions who currently hold interests in UK commercial property.
From 6 April 2019, gains arising on both the direct and indirect disposals of UK commercial property by non-residents are brought within the scope of UK tax. Prior to this, only gains relating to the sale of residential property would have been chargeable to UK tax with some exceptions (although recent changes in law means the exception is no longer available from 6 April 2019). New reliefs for non-residents that satisfy certain conditions have also been introduced as part of these legislative changes.
With the rules now in full force, existing funds and new set ups should consider their structures carefully to understand the impact of the changes and options available to retain returns for investors.
Disposal of commercial investment property by a non-UK resident investor
From 6 April 2019, any gain arising from the direct or indirect disposal of commercial investment property by a non-UK resident investor will be subject to corporation tax for corporate entities and capital gains tax for non-resident individuals or trusts.
With an indirect disposal, tax will apply on a gain where the disposal of shares is in an entity that derives 75% or more of its gross asset value from UK land and the non-resident holds at least a 25% interest in the entity at the time of disposal or at some point within the two years prior to the disposal.
Disposals by a non-UK resident in a collective investment scheme
There has been much debate in the industry on the application of the rules to funds. After a lengthy consultation process, HMRC introduced special elections for collective investment schemes (CIVs), which includes various fund structures, including partnerships invested in companies and Jersey property unit trusts (JPUTs).
The elections – transparency or exemption – can be accessed subject to certain conditions being met. The effect of the election is broadly to ease the impact of the new tax charge by shifting the tax to the investor. This allows certain institutional investors to continue to benefit from their tax-exempt status. However, under these rules, all investors in a CIV are within the scope of UK tax regardless of the percentage of their interest.
Transparency election (irrevocable) – CIVs that are transparent for income tax purposes but not for gains will be able to elect to be treated as transparent for capital gains tax subject to the agreement of all investors. This means that the investor will then be taxed in accordance with their own tax profile.
Exemption election (revocable) – Non-resident CIVs (and entities in which the CIV has an interest of at least 40% or more) should not be taxed on gains arising on direct and indirect disposals of the property. A key benefit to this election is the ability to roll up gains tax free with tax only payable at the point gains are extracted from the CIV structure. Again, investors will then be taxed in accordance with their own tax profile.
Fund managers should seek to understand the strict set of conditions that need to be met – similar to a REIT – before making an exemption election and take steps to comply with various reporting requirements.
UK real estate investment trusts
REITs should continue to benefit from HMRC’s approved REIT regime, whereby the disposal of UK commercial property is treated as exempt from corporation tax. Under the new rules, gains on the sale of shares in property companies that form part of the REIT group are also exempt from corporation tax. This means that gains may roll up or be reinvested tax free, with tax payable when the gains are distributed
However, a REIT is treated as a CIV for UK capital gains tax purposes and, as such, any shares held by a non-UK shareholder, however small, is potentially caught by the rules and subject to tax. Non-UK shareholders have the choice of using original cost or market value as at 5 April 2019 as their tax basis. It is only the amount of the gain that is in excess of this amount that would be subject to tax on disposal. Certain investor types may be able to benefit from an exemption or election to mitigate some or all of the capital gains tax.
Any historic gains pre-5 April 2019 should not come within the scope of UK tax as a result of these changes. HMRC has stated that the taxable gain arising on or after 6 April 2019 can be calculated either by rebasing the property to its value on 5 April 2019 or using the original base cost, although in the case of an indirect disposal a loss arising as a result of using the original base cost would not be allowable.
Non-residents subject to capital gains tax will need to comply with new compliance requirements on disposals by submitting a return to HMRC within 30 days of making a disposal from 6 April 2019. Those not registered with HMRC under self assessment are also required to pay any tax due within 30 days of the disposal. If registered under self assessment, payment of tax on disposals can be deferred in line with normal self assessment payment dates until April 2020 only.
Non-resident companies and those treated as companies under the CIV rules will be required to register with HMRC for corporation tax in the year of disposal, and should report the disposal through the annual corporation tax return. Any tax due on the disposal will be payable in accordance with the normal corporation tax deadlines. Penalties may apply for noncompliance.
What do you need to do now?
While the elections are certainly helpful, the rules are very complex and likely to impact a wide range of UK property investment structures. It is likely that certain decisions will need to be made to retain an effective tax position. In our experience, some of the key points to think about include:
Carefully consider the effect of the new rules on structures and potential impact on exit. Understand the investor profile to accurately assess the changes and plan accordingly. Exempt investors may need to reassess structures
For existing CIV structures, assess the impact and opportunity of making a transparency and an exemption election or a combination in accordance with the tax profile of investors. This may result in lower taxation
Managers need to consider the impact of any additional tax leakage on promote/carry arrangements
Plan for rebasing property values at April 2019 and consider seeking an independent valuation to support future disposal tax calculations and due diligence in the event of a share disposal
Understand and prepare for new record keeping requirements, tax filings and revised tax payment deadlines
Consider whether further exemptions may apply where properties are used for trading purposes, for example hotels and retailers
Assess whether other exemptions may be available to exempt part or all of the gain on share disposals where investors are qualifying institutional investors
Non-resident corporate landlords should start considering the impact of the change of tax regime from income tax to corporation tax from 6 April 2020, with particular focus on whether any restrictions to interest deductions will apply under the corporate interest restriction rules
An evaluation of new and existing structures for future acquisitions is essential to ensure that available exemptions are accessible and the tax position of ultimate investors is optimised. Our real estate team has significant expertise in this area and can help with your specific requirements.