Safe as houses: buying residential property in the UK

Prime residential property in
the UK, particularly in London, remains a popular investment choice for many wealthy foreign individuals and their families. Whether someone wishes to buy a second,
third or fourth home in Knightsbridge, or because they are in the process of changing their country of residence,
UK property is important.

To maximise the return on such an investment, it is vital to ensure the tax efficiency of the chosen acquisition structure, as far as this is possible while also achieving the client’s non-tax aims on cost, confidentiality and succession, for example.

Failure to adopt the right structure can have costly tax consequences, which can erode the investor’s anticipated returns and their children’s inheritance.

Aside from stamp duty land tax (SDLT) on acquiring a property, until recently non-UK resident property buyers, regardless of their domicile,
were principally concerned about a potential inheritance tax (IHT) liability on properties owned in the UK. Income tax could also be relevant for some but only in relation to rented properties.

Unfortunately, the UK tax landscape has become considerably more complicated for certain non-UK property owners and is set to be even more so for all non-UK owners in the coming year.

Direct taxation in the UK is effected by reference to the taxpayer’s residence and domicile. For tax years 2013/14 onwards, residence is determined by applying the new statutory residence test. Domicile is, broadly (and subject to deeming rules for IHT purposes), the place an individual regards as their permanent home.

Property taxation

Generally, in addition to SDLT, there are three main categories of direct UK taxes that are relevant in the context of UK property ownership:

• income tax on any rental income from the property

• capital gains tax (CGT) on a disposal of the property at a gain; and

• IHT on transfers of value on death or, in specified circumstances, during an individual’s lifetime.

For residential properties valued
over £2m and owned through a company or certain other non-natural persons, the new annual tax on enveloped dwellings (ATED), introduced in April 2013, may also be relevant. The ATED is an annual charge that applies where certain non-natural persons (NNPs) – companies, partnerships that include one or more corporate partners and collective investment schemes –
own a residential UK property with a value exceeding £2m.

This tax is due to be extended to properties worth over £1m with effect from 1 April 2015 and those worth over £500,000 from 1 April 2016.

In addition, SDLT is payable by
UK property buyers, at the rate of
5 per cent where the purchase price exceeds £1m or 7 per cent where it exceeds £2m. The rate increases to
15 per cent for residential property valued over £500,000 acquired by a company or other non-natural person, unless there is an applicable relief, e.g. for a property acquired by developers or to be used in
a rental business.

However, no SDLT is payable on (i) gifts of UK property unless the gift is to a connected company; or (ii) the transfer
of a company deriving its value from
UK property.

Acquiring options

The main options available for wealthy foreigners acquiring UK property are:

• direct ownership by an individual

• ownership through a single-purpose, foreign-registered holding company, the shares of that are owned by (an) individual(s); and

• ownership via a foreign-registered holding company, the shares of
  which are owned by non-UK resident trustees of a discretionary trust created by (a) non-UK resident and non-UK domiciled individual(s).

Each individual investor will prefer their own form of ownership according to their personal tax circumstances but also – and often more importantly – according to other factors such as privacy of ownership, or any applicable forced heirship rules, such as Sharia law or
those of many European and other
civil law countries.

Tax considerations

Income tax will be relevant if the property is rented out, in which case
the rental income will have a UK source and will be taxable in the UK, except to the extent of any allowable expenditure. The tax rates and other specific considerations that may be relevant, such as the application of the non-resident landlord scheme or possible shadow directorship issues, will vary depending on how the property is held; advice
will be needed accordingly.

Even where an individual is domiciled outside the UK, IHT will be applicable to their UK estate. Using an appropriate structure, e.g. ownership through a company or through a company owned by a trust, IHT on a UK situate property may be avoided. However, many individuals would prefer to hold a property directly and, in many cases, for tax and/or other reasons, this may be advisable.

In this situation, to mitigate IHT, a property may be bought with a mortgage to reduce its value in a non-domiciled individual’s estate. Legislation introduced in 2013, which restricts the deductibility of liabilities for IHT purposes in certain circumstances, may limit the effectiveness of such a strategy where it applies.

Such liabilities include those that are attributable to financing (directly or indirectly) the acquisition of, or maintenance or enhancement of, any excluded property. However, in these circumstances, other options for IHT mitigation, for example insurance, may still be available.

Existing position

• Under existing law, if a property is directly owned, non-UK resident individuals (other than temporary non-residents) are in most cases outside the scope of CGT. Equally, where a UK resident individual occupies a UK property as their main residence worldwide and certain statutory conditions are met, principal private residence relief (PPR) may apply so that no CGT is payable on a disposal of that property. Where the gain is not covered by PPR, the rate of tax is 18 per cent for basic rate taxpayers and 28 per cent in all other cases, subject to an annual tax-free allowance, where applicable.

• If a property is within the ATED charge, because it has a value exceeding the relevant threshold value and is owned through a company or other NNP, (whether held by a trust or not), on disposal, the company that owns it will also
  be liable to CGT at the rate of 28 per cent on any ATED-related chargeable gains (which are those arising since 6 April 2013 unless an election is made to include all gains since acquisition). As the CGT charge only applies to ATED-related gains, where a property is not liable to the ATED for a period, due to
  the application of a relief such as that for property rental businesses, any gain attributed to that same period will not be taxed.

• Gains on disposal of a property
  owned by an NNP but that is outside the scope of the ATED charge, either because of its value or because the existence of a relevant relief, may
  still be liable to CGT if certain
  anti-avoidance provisions apply. In certain circumstances, these may attribute a proportion of the
  
  
  
  
  
  
  
  
  gains of an offshore company to its UK resident shareholders or, in the case of companies held by offshore trustees, to UK resident and domiciled settlors, or UK resident beneficiaries of the trust.

Proposed changes

• A consultation, published in March 2014, on the introduction in April 2015 of a CGT charge on future gains made by non-UK residents disposing of UK residential property closed in June. HMRC is considering the responses it received and will report further as to how it intends to proceed, probably in the autumn.

• The new CGT charge on
  non-residents will focus on ‘property used or suitable for use as a dwelling, i.e. a place that currently is, or has the potential to be, used as a residence’. This will include property in the process of being constructed or adapted for such use, in line with
  the definition of a dwelling in the
  ATED regime.

• Residential property used for letting purposes will be included in the charge, as would be the case for
  UK residents. In this way, it will differ from the ATED-related CGT charge that provides a relief for property let to third parties on a commercial basis.

• There will be exclusions for residential property with a communal use, such as boarding schools, nursing homes, etc. Unlike the case for SDLT/ATED/the ATED-related CGT charge, residential accommodation for students will not be excluded for the purposes of the new CGT charge on non-residents, except as part of a hall of residence for an institution.

• Disposals of multiple dwellings in a single transaction will not be excluded from the new CGT charge on non-residents, unlike with SDLT where such transactions are treated as a non-residential transaction and charged to SDLT at 4 per cent.

• The charge will potentially
  apply to individuals, partnerships, trustees, closely held collective investment schemes and funds,
  and non-resident companies.

• Widely held collective investment schemes and funds, pension funds, UK real estate investment trusts (REITs) and their foreign
  equivalents should not be caught by the new rules.

The interplay

The existing proposals provide for ATED-related CGT to continue to apply to disposals of properties that fall within its parameters. It is proposed to extend the new CGT charge to gains
on UK residential property sold by
non-resident companies, so that all properties are within scope, including those valued at or below £500,000. The consultation states that the UK government will ensure that the
ATED-related CGT charge only
applies to those properties that are
also subject to ATED charges each year.

Non-resident companies holding property in the UK worth over £2m will already be potentially within the scope of the ATED-related CGT charge. Those with residential properties worth over £1m and worth over £500,000 will fall into its scope in respect of gains accruing on or after 6 April 2015 or
6 April 2016 respectively as the threshold value reduces accordingly.

As such, the principal impact will
be that the new legislation will catch
any gains that are not covered by the existing charge. For example, gains in relation to periods when the property was exempt from the ATED-related CGT charge under the property rental business exemption.

This will be quite complex in terms of calculation and administration, as a company caught by both charges will need to report and pay the relevant tax for the different periods separately following a disposal of a single property, effectively claiming a relief from ATED-related CGT for one period only to become subject to the new charge to CGT for any gains excluded from ATED-related CGT as
a result of the relief.

Ideally, the ATED-related CGT charge would be abolished in favour
of UK corporation tax for UK companies disposing of residential
UK property, and the new CGT charge for non-resident companies in the
same position. Doing so might raise a
number of issues that would require consideration by the government but would be hugely beneficial in terms
of reducing complexity.

Principal relief

PPR is available where a property is an individual’s main residence (this includes trust beneficiaries in appropriate circumstances). While a UK property
will not generally be the main residence of a non-resident individual, there
will be exceptions to this and the consultation indicates that PPR will be available to non-residents in appropriate circumstances (e.g. when someone emigrates from the UK then sells
a property that was their main residence).

However, to prevent non-residents being able to always elect their UK property as the main residence for
CGT purposes, the consultation
proposes a change to the election rules. The two alternatives are:

• to remove the ability for a person to elect their main residence for PPR. Instead, PPR would apply to whichever property is demonstrably their main residence on an evidential basis, e.g. the address where the spouse or family lives, where mail is sent, where the person is on the electoral roll, etc; and/or

• to replace the ability to elect with
  a fixed rule to identify a person’s main residence, e.g. that in which
  the person has been present the
  most for any given tax year.

If introduced, either option would require taxpayers, both UK resident and otherwise, to keep significantly more detailed records about their residence than is currently the case for people who choose to make an election. Although, from a fairness viewpoint and reflecting reality, the first option seems preferable.

A number of respondents to the consultation have pointed out that such a fundamental change to an important and broad-based relief should not be reviewed in the context of a narrow consultation about a CGT charge for non-residents. If PPR is perceived to require reform, this should be the subject of a specific and separate consultation.

No changes to other relevant reliefs relating to a person’s main property have been proposed.

Essential rebase

According to the consultation,
the proposed new CGT charge on
non-residents will come into effect
in April 2015 and ‘apply only to gains arising from that date’. The meaning of this is unclear, and we understand that the government may be considering a form of time apportionment of gains rather than a straightforward value rebasing as at 6 April 2015.

Respondents to the consultation, including our firm, have indicated that the option to rebase is essential to avoid effective retrospective taxation but that an option to elect for time apportionment might also be offered.

A form of withholding tax was proposed in the consultation and views canvassed on who should have responsibility for its collection.

However, we understand that the government has changed its view subsequently and is now proposing that taxpayers should have the option to choose within 30 days of a disposal to:
(i) make a payment on account, (ii) submit a computation of the actual tax due or (iii) indicate that they report the tax on a tax return in the usual way, where this is possible.

Once introduced, the proposed new CGT measures for non-residents disposing of UK residential property, together with the extension of
ATED-related CGT to lower-value properties, will be additional and important considerations in determining the most tax efficient structure for holding UK property.

Non-UK residents holding or acquiring UK residential property
and not already within the scope of
ATED-related CGT should take into account that, unless they intend to dispose of the property prior to 6 April 2015, they may be liable to a CGT charge on any gains after that date.

Furthermore, any existing or proposed UK property-holding structure should be revisited regularly as the proposed provisions of the charge are developed to ensure that such a structure would or
will continue to achieve its aims.

In certain situations, there may continue to be advantages to holding UK residential property through a corporate envelope rather than by an individual or trustees, even after the various changes come into effect. Careful consideration of all the relevant circumstances will be required in each case.

Anthony Thompson is a partner and head of the private capital team and Nicole Aubin-Parvu is a senior associate at Wragge Lawrence Graham & Co