Our tax partner Paul Belsman has written the following article which has been published in this month’s Taxation magazine.
Rarely is the term congestion used to describe taxation provisions but arguably it could be said to apply to the ownership of UK residential property by non residents given the influx of new legislation over the past three years.
The policy objective that appeared in the 2012 Budget proposals followed swiftly by a Consultative Document was fundamentally directed “to encourage the de-enveloping of residential property”.
Accordingly, the classic structure whereby foreign ownership is held through a non resident company (often owned by a non resident trust) so as to mitigate the impact of CGT and IHT charges is arguably no longer appropriate for new acquisitions and has a bearing on the sustainability of existing structures given these changes. The future IHT changes announced in the 2015 Summer Budget relating to ownership of foreign property which, although referred to in the Consultative Document on Domicile issued in September, bring no clarity to date so potentially bringing further challenge to the enveloped structure.
The impact of the continuing changes has made this area increasing problematic and in some sense presents a degree of overlap all round.
This new legislation needs to be considered, where relevant, as an adjunct to the general rules taxing gains made by non resident trustees on a UK beneficiary on receipts or capital payments (TCGA1992 S87) and modified where appropriate for a non domiciliary claiming the remittance basis. This will be important in any evaluation to dismantle or adjust an existing structure.
There are arguably 2 sets of provisions to consider which tax non residents directly on the disposal of residential property:
- Anti-enveloping Charges
Introduced by Finance Acts 2012 and 2013, these fall into 3 main categories, the Annual Tax on Enveloped property (the ATED) , CGT on ATED properties at 28% and the 15% SDLT charge.
These enveloped charges are in point where either a company, collective investment scheme or a partnership which includes a company (referred as non natural persons) acquires a chargeable interest (generally an estate interest or right or power over land) in a single dwelling(s). The important point here is there is broadly a uniform code applying for the application of ATED to residential property.
There are specific exclusions from these charges, the most significant categories being:-
- Property rental businesses
- Property development or trading
- Properties open to the public for more than 28 days
- Farmhouses occupied by a working farmer
- Dwellings used by employees (not connected with the acquiring entity)
These exclusions need to be claimed to avoid the charge. A single dwelling interest is a separate and distinct unit for the purposes of these provisions so a series of flats in an apartment block are looked at individually .
The ATED specifies an annual chargeable amount or assessment depending on the valuation band with such band charges increasing substantially in 2015/16 from their 2013/14 introductory levels. Moreover the entry value which was previously set at £2million has been reduced for 2015/16 to £1m (with a charge of £7,000) and will be reduced to £0.5m effective 1 April 2017. Adjustments are permitted where the property is not owned for the complete period.
The 2015/16 current rates of ATED charge are:
Value of Property £m Annual Charge
1 to 2 £7,000
2 to 5 £23,350
5 to 10 £54,450
10 to 20 £109,950
Payment is required on 30 April each year. Any property falling within the ATED regime needs to be reported within 30 days.
The chargeable period runs to the year ended 30 March and apportionments are permitted where the property is not occupied for the entire period.
The CGT ATED regime applies to disposals of any chargeable interest in a single dwelling. The vendor only needs to come within the regime for one day in the ownership period to fall within the charge. High value for this purpose is where proceeds exceed £1m for 2015/16 (reduced from £2m for the two previous years and to be reduced to £0.5m for 2016/17 onwards). Such gains are computed on accrued gains from 6 April 2013, adjusted for any period in which the exemptions prevail on a time apportioned basis. The market value of the property at 5 April 2013 would be taken where ownership preceded this date. However, an election can be made to dis-apply the rebasing if that is preferable, arguably, where market value at 5 April 2013 was lower.
The SDLT charge at 15% is applied on acquisitions in excess of value of £0.5M (previously £2m but reduced from 20 March 2014) unless the appropriate claims for excluded categories are claimed and such excluded activity must apply for 3 years with no non qualifying occupation in that time period.
- The Non Resident CGT (NRCGT) charge on Residential Property
In addition to the enveloped CGT charge for ATED properties from 6 April 2015, there is now a new general CGT charge introduced by Finance Act 2015 (s37 and Sch 7) with consequent amendments to TCGA 1992 applying to the disposals of residential property by all non resident persons to include individuals, companies trustees and personal representatives of deceased persons. Arguably, the NRCGT charge introduces yet another new regime with its own reporting structure and process which has a short reporting requirement.
The fundamental principle is to tax gains arising from the ownership of land used as a dwelling, no matter how short that period may be, over the relevant ownership period.
Dwelling is extended to mean land that is in the process of being constructed or adapted for such use. The provisions thus seek to include non resident individuals buying properties off plan. However, dwellings used generally for communal purposes are usefully excluded.
There is an exclusion for diversely owned non resident companies, particularly OEICS, authorised unit trusts, provided an appropriate claim is made as well as exemption by election for participants of “widely marketed schemes” (as defined in TCGA Sch C1).
The rate of CGT applied to such gains for individuals and trusts is 28% with normal annual exemptions. Gains accruing to companies will follow the normal corporation tax rates with the benefit of indexation.
The legislation seeks to tax gains accruing since 6 April 2015 and the default method brings into charge any gain arising since that date, restricted only by the proportion of days the property is not a dwelling as defined. This is probably the most straight forward methodology for the determination of the gain and requires the disposed interest to be valued at 5 April 2015.
By election, two further options for calculation of the gain are available. The first is a straight line calculation. The gain over the entire period of ownership is computed with a time apportioned adjustment for the period of ownership after 5 April 2015. Again, a further restriction for any period of time in which the property was not used as a dwelling after 5 April 2015 can be deducted, again, on a time apportioned basis. This might be preferable if the value at 5 April 2015 was depressed relative to the appreciation of the property over the period. The second is useful where the property was a dwelling for some of the period. Here the gain can be apportioned by reference to this use over the entire period of ownership excluding periods of ownership prior to 31 March 1982.
These 2015 Finance Act changes posed difficulties for policymakers having regard to the Principal Private Residence Exemption (PPRE) which has necessitated amendments.(FA2015 Scehdule 9) to avoid the NRCGT charge being easily circumvented. In short, for any given year of ownership, the exemption cannot be claimed by an individual making the disposal unless 90 days of UK residence in that year can be claimed. For this purpose, time spent by the spouse or a civil partner of the individual making the disposal may be claimed. This residence requirement could well influence the determination of whether an individual is resident or not under the Statutory Residence Test and therefore needs to considered carefully in any planning.
Given the two separate regimes for “ATED CGT” and NRCGT, there are complex provisions inserted in Finance Act 2015 to deal with mixed periods where the ATED is in point. This has bearing for companies given the varied rate of charge.
Both the ATED and NRCGT regimes include computational rules to determine part of the total gain realised on disposals of residential property that fall outside the charge to either of these taxes which will be relevant; for example, to the potential charges arising where benefits are enjoyed by beneficiaries of non resident trusts (TCGA1992 s87/87B).
The regime for reporting is extremely tight with a return and payment required within 30 days of the date of disposal. Guidance notes and the format of the return can be accessed (see https://online.hmrc.gov.uk/shortforms/form/NRCGT_Return). Claims for exemptions and elections must be made on this return and, as a practical point, if valuations are required, they obviously need to be considered during the process of sale given the tight reporting deadline. Whilst some computations may be straight forward, the complexities of the calculations may require some pre-planning ahead of the completion so that filing deadlines can be met.
The advent of both regimes has naturally caused a rethink of appropriate structures. Historically, most attention was paid to the potential saving for IHT and it is this factor that predominated. Typically, a more detailed plan is necessary to evaluate the cost of holding a property liable to ATED charges and the potential benefit of a corporate structure (notwithstanding the awaited IHT changes announced in the Summer Budget ) whereby the potential IHT charge can be avoided.
Watch the IHT Loan Traps
In addition to the ATED regime, the Finance Act 2013 introduced restrictions on the deductibility of loans for IHT purposes which will have a bearing on thinking here. Plainly, a loan taken to finance the acquisition for a UK property will generally be deductible for IHT purposes. However, loans raised on the security of UK property to finance the acquisition of excluded property (as defined for IHT purposes) are not deductible for IHT purposes (IHTA S162A).
Further, liabilities can only be deducted to the extent that they are discharged after death unless there is a strong commercial rationale for their retention and the securing of a tax advantage is not the main or one of the main objectives in retaining the liability. If connected parties are creditors here, this is likely to be problematic.
So How should Non Residents Acquire Property?
If a non resident individual or trust owns a property directly, the ATED charges are avoided. NRCGT will now be in point in the event of a disposal subject to potential relief for the PPRE. The crucial point for IHT will depend on the anticipated period of ownership, the use to which the property is to be put, and the nature of any funding.
Should the acquisition be made by the individual intending to make the acquisition or by a trust settled by a non resident and non domiciled settlor?
This may seem attractive in the first instance. The trust will be subject to a 10 year charge calculated with the deduction of any loan taken when the property is acquired. On the basis the settlor has no reservation of benefit, the 10 year charge may be considered palatable depending on the view that is taken on the value of then property at the relevant anniversary date. As ever, appropriate calculations should be prepared and liabilities calculated. In the event of the demise of the settlor, no IHT will potentially be payable and the 10 year charge as opposed to the ATED charge and the current IHT uncertainties over a corporate structure may seem attractive.
Alternatively, the simple approach of direct ownership is increasingly being considered, particularly, if the property is not let. Frequently, this is the easiest solution where there is likely to be the availability of the inter-spouse/civil partner exemption and the likelihood that on first death the property will be sold. This may bring some advantage as the base cost inherited by the surviving spouse will benefit from any appreciation in the value of the property from the date of acquisition. A joint life second death insurance policy could then be considered as supplementary protection which could be utilised to fund IHT liabilities in the event of the death of the surviving spouse on the basis the property is retained. Again, calculations need to be prepared to assess these benefits.
For more info, contact Paul on (0207 433 2478) or email Paul.Belsman@nlpca.co.uk