Real estate structures in the United Kingdom
If a foreign resident, non-resident, or foreign domiciliary wants to purchase UK real estate, what are the applicable tax principles, and when is it advantageous to use a structure?
Bad advice can result in a negligence claim, and an inappropriate structure may result in unnecessary taxes.
Are there any takeaways for me?
It generally makes sense for a foreign subsidiary of a non-UK company to purchase and hold UK real estate when it is commercial. Using a company may make sense for residential properties, but only if they produce rental income commercially.
In recent years, ‘foreign’ ownership of UK real estate has become a sensitive political issue. There have been successive reforms to the tax treatment of UK land, including indirectly owned land, with much of the legislation directed, implicitly or expressly, at international residents or domiciles. Due to the piecemeal nature of these reforms, the legislative framework is highly complex.
How foreign domiciliaries should acquire/own UK land is essential to understand this framework and possible future changes.
This article discusses non-resident and UK resident non-UK domiciled individuals (‘RNDs’) and residential and commercial properties.
Homeownership structures under the hammer
Until now, the focus of this restless change has been residential property.
The first measure was introducing a 15% SDLT flat rate on corporate purchases of dwellings, subject to reliefs for (among other things) commercial properties. ATED, an annual wealth tax on homes held by companies, was introduced in 2013. Several exemptions apply to this tax, including those for properties rented on a commercial basis.
The burden of ATED has traditionally fallen on non-UK residents and foreign-domiciled individuals. Until recent reforms, they have typically used non-UK companies to acquire UK real estate to avoid IHT.
Eventually, ATED attracted ATED-related CGT and non-resident CGT (‘NRCGT’), taxes on the disposal of dwellings by companies in the scope of ATED.
In 2017, Schedule A1 to the IHTA 1984 was enacted, ending corporate structuring for UK dwellings. Foreign-domiciled individuals are subject to IHT on non-UK-situated assets derived from UK dwellings, such as shares in a non-UK incorporated property holding company. It does not matter how you use the property. Unlike ATED, IHTA 1984 Sch A1 does not differentiate between properties used by connected persons and those commercially let to third parties.
Where UK residential property is concerned, the scope to use a company or other entity as an IHT ‘blocker’ has largely been eliminated.
Gains tax tackled again.
Yet further changes are being made with effect from April 2019. The Finance Act 2019 has significantly extended the territorial reach of UK taxes on gains realised on, or in connection with, UK real estate.
There are two aspects to this:
Non-residents without a permanent establishment in the UK now pay taxes on gains realised on the disposal of UK commercial property. Until now, such tax exposure has only existed concerning UK residential property.
Non-residents will pay UK tax on assets derived from UK land even if they are not UK land. The targets are people holdings shares and securities issued by property holding companies.
Various rebasing dates exist depending on the nature of the dispone and asset. For companies currently subject to ATED-related CGT, the ability to rebase to April 2013 or 2014 is no longer an option.
The ‘all or most’ referred to above is shorthand for a more complex test set out in the legislation contained in a new Schedule 1A to TCGA 1992. Broadly, the requirement is for the asset to derive at least 75% of its value from UK land, directly or through acquisitions that derive their value from UK land. Non-residents should therefore pay tax on the disposal of an interest in a company whose value comes from assets other than UK land.
Moreover, the tax charge on indirect disposals will only apply if the person making the disposal has what the legislation calls a substantial indirect interest’ in the underlying UK land. Concerning a company, the requirement is broad that the person making the disposal has 25% or more of the voting rights or entitlement to 25% or more of the distribution or the proceeds of a liquidation. This requirement must be met at some point in two years running up to the date of the disposal.
It is easy to see the great uncertainty created by the sweeping and vague drafting.
There are two further points of note about indirect disposals:
The legislation provides no relief from double economic taxation. The same financial gain can be taxed twice if a non-resident shareholder disposes of his shares and realises a post-April 2019 gain taxable under TCGA 1992 Sch 1A.
The company then disposes of the property, realising a taxable gain on the company. Indeed, there is scope for the same economic gain to be taxed many times over, e.g. a simple multi-tiered corporate structure through the liquidation of holding companies.
The ordinary taxation rates will apply to non-resident trustees and individuals realising gains related to indirectly owned residential property after April 2019.
And there’s more!
The process of any amendment will continue. From April 2020, any UK property income accruing to a company will be subject to corporation tax. Currently, the rental income of a non-UK resident company is subject to basic rate income tax in the company’s hands.
Additionally, the Government is consulting on a 1% SDLT surcharge for non-UK residents purchasing UK land in a future Finance Bill.
The future tense is often used instead of the conditional to describe consultations.
Suppose a company is not a UK resident for corporation tax purposes or a UK resident for such purposes but is closely held and controlled by a non-UK resident. It will be subject to the 1% SDLT surcharge in that case. Therefore, it is likely that a non-UK resident can only avoid the surcharge by creating a UK-resident company to purchase UK land.
Where will it end?
The regime for the taxation of UK land is clearly in a state of evolution. It is hard to know whether we are nearer the process’s beginning or end. The Finance Act 2019 may represent the first phase of a programme to align the tax treatment of UK residential and commercial property.
As matters stand, there are still some differences between the treatment of UK residential and commercial property and between direct and indirect holdings.
The IHT treatment differs significantly when UK residential or commercial property is held through a company whose shares are not in the UK. If the property is residential, the shares in the company are within the IHT net, under IHTA 1984 Sch A1.
That is not currently the case for non-UK situated shares in a company where the property is commercial; such shares still qualify as excluded property in the hands of a non-UK domiciled and non-deemed domiciled individual.
What structuring is still possible?
In light of current law and future measures that are in the pipeline, domiciliaries looking to acquire UK property must act sensibly. If a foreign domiciliary wants to acquire UK land, does it make sense to use an entity? If an entity already holds UK land, is there a benefit to retaining it in other situations?
As noted above, there are still significant differences between UK residential and commercial property treatment. IHT avoidance through a property holding company is still possible where the underlying property is commercial.
It is excluded property to own shares in such a company in the hands of a non-UK domiciled and non-deemed domiciled shareholder provided that, as a matter of general law, those shares are outside the UK (e.g. because they are registered outside the UK and their register is kept there).
In addition, the penal 15% SDLT rate for corporate purchasers of UK residential property is inapplicable to commercial property purchases.
These points mean that, under current law, there is a strong argument in favour of a non-UK domiciliary, who is not deemed domiciled, using a non-UK incorporated company to acquire UK commercial property so that the value of the property is shielded from IHT.
In the future, it will likely make little difference to the overall tax analysis whether the company is resident in the UK under the central management and control test. However, for an RND, it may be preferable for the company to be managed and controlled from the UK, so the company’s income/profits cannot be attributed to him under the transfer of assets abroad legislation.
By contrast, where UK residential property is concerned, the argument in favour of using a company to purchase the property is, at best, more subtle and, at worst non-existent. There may be an advantage where the property will be given to third parties on commercial terms or redeveloped so that the 15% SDLT charge will not apply to the purchase.
Relief will be available from ATED, and subsequent rental or redevelopment profits will benefit from the (currently) attractive UK corporation tax rate instead of personal income tax rates. But it is hard to make any case in favour of creating a company to buy and hold residential property used by the shareholder or connected persons. The 15% SDLT charge, ATED, and the absence of IHT protection make an expensive cocktail.
When it comes to UK residential property that a company already holds, the question of whether it is preferable to buy the property or the company can be complex. The scope to avoid SDLT on the purchase is attractive, despite the risks and extra transactional costs involved in buying a second-hand company.
Where the foreign-domiciled individual elects to buy the company, with the object of using the property personally, there are usually strong arguments in favour of collapsing the company after the purchase so that the property is held directly. These include eliminating ATED and avoiding possible benefit-in-kind charges if the individual is deemed a shadow director.
However, the tax and other considerations can also be complex and must be weighed carefully. For example, if an RND has purchased the company, could the company’s liquidation result in the remittance of funds used to make the purchase?
The article and the points above suggest hiring an adviser to set up the proper structure and do your homework.
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