A closer look - changes and proposals to the taxation of UK residential property

In this note, we review the Budget measures. We also outline the proposals for the taxation of gains made by non-residents disposing of UK residential property and consider how this new CGT charge may inter-relate with the ATED-related CGT charge introduced in April 2013.

Surprise measures to increase the scope of certain taxes on higher value residential property acquired by and/or held through corporate envelopes were announced by the Chancellor in the UK Budget on 19 March 2014. The draft Finance Bill 2014 has since been published and provides some clarification of these proposed changes.

In addition, at the end of March, the UK Treasury published its promised consultation on the introduction of a capital gains tax (CGT) charge on non-residents who dispose of UK residential property. This is to take effect from 1 April 2015.

Summary of Budget measures

• An extension of higher rate Stamp Duty Land Tax (SDLT) at 15% to apply to acquisitions of residential properties worth more than £500,000 by a company or other 'non-natural person' (NNP);
• An extension of the annual tax on enveloped dwellings (ATED) to apply to:
  • properties worth between £1,000,001 and £2 million with effect from 1 April 2015;
  • properties worth between £500,001 and £1 million with effect from 1 April 2016.
• An extension of the ATED-related CGT charge at 28% to apply to:
  • properties worth between £1,000,001 and £2 million on gains accruing on or after 6 April 2015; and
  • properties worth between £500,001 and £1 million on gains accruing on or after 6 April 2016.
• In addition, the rates of ATED for properties worth over £2 million have increased in line with the Consumer Prices Index (CPI), as expected.

Summary of consultation proposals

• The new CGT charge on non-residents will focus on "property used or suitable for use as a dwelling" and, unlike the ATED-related CGT charge, it will include residential property used for letting purposes.
• There will be exclusions for certain types of property in communal use, e.g. boarding schools and nursing homes.
• The charge will apply to individuals, partnerships, trustees and non-resident companies (to the extent they are not caught by the ATED-related CGT charge). Funds which are not closely-held will not be caught and neither will pension funds, REITs or their foreign equivalents.
• Principal private residence relief (PPR) will be available in appropriate circumstances. However, changes are proposed to remove the ability to elect one's main residence, in order to prevent non-residents always electing their UK property as their main residence. These changes will also affect UK residents.
• Under the new CGT charge, the rates for individuals will be either 18% or 28% according to their status as basic or higher/additional rate taxpayers.
• There will be a mechanism for declaring losses and offsetting them against gains from the sale of UK property, where appropriate.
• There is a proposal to introduce a withholding tax regime, similar to that for SDLT, ideally to sit alongside a self-assessment option.

Budget measures

SDLT - original rules for high value UK residential property

Under legislation introduced with effect from 21 March 2012, an acquisition of an interest (or interests) in a single residential property or dwelling (defined as a 'single dwelling interest') for chargeable consideration of more than £2 million by an NNP (broadly, companies, partnerships with at least one corporate partner and collective investment schemes), gives rise to an SDLT liability at the higher rate of 15% rather than the standard rate of 7% for residential property worth over £2,000,000.

There are a number of reliefs and exemptions from the higher rate SDLT charge. Amongst others, there are reliefs for property rental businesses letting to unconnected parties for rent on a commercial basis, property developers and property traders.

SDLT - new measures

Under the new Budget measure, the 15% rate has been extended to situations where a single dwelling interest is acquired for chargeable consideration of more than £500,000 by an NNP on or after 20 March 2014. As a result, instead of paying SDLT at 5% (for properties between £1,000,001 and £2 million) or 4% (for properties between £500,001 and £1 million), NNPs acquiring such an interest in property now pay SDLT at 15%.

As an example, for a property worth £1 million, this means SDLT of £150,000 rather than £40,000 (3.75 times more) and for a property worth £2 million, £300,000 rather than £100,000 (3 times more).

The 'effective date' of the transaction for these purposes will generally be the date of completion, but transitional rules will ensure that (with certain exceptions) the existing threshold (£2 million) will continue to apply to contracts that were entered into before 20 March 2014, but are completed on or after that date.

The reliefs which apply to transactions caught by the original rules for higher-rate SDLT also apply to transactions caught by the extended measures.

ATED - existing measures

The ATED was introduced in April 2013, alongside higher rate SDLT and the ATED-related CGT charge, for residential properties owned by NNPs worth over £2 million. Such properties may be excluded from the charge as a result of one of a number of reliefs or exemptions, including those mentioned above in relation to higher rate SDLT.

ATED is charged at different rates according to which of four value bands the particular property, or 'single-dwelling interest' (defined as for higher rate SDLT) falls into. These bands and the applicable rates for the chargeable period from 1 April 2014 to 31 March 2015 are, as follows (increasing annually in line with the CPI):

• property valued over £5m and up to £10m - £35,900;
• property valued over £10m and up to £20m - £71,850; and
• property valued in excess of £20m - £143,750.

The rates increase annually in line with the CPI.

ATED - new measures

In addition to the extended SDLT measure, changes to the rules for the ATED and the ATED-related CGT charge will apply from 1 April 2015 to UK residential properties owned by an NNP that are worth over £1 million but less than £2 million, and from 1 April 2016 to such properties worth between £500,001 and £1 million.

The new ATED charge for interests between £1,000,001 and £2 million will be £7,000 for the chargeable period from 1 April 2015 to 31 March 2016. For interests between £500,001 and £1 million the charge will be £3,500 for the chargeable period from 1 April 2016 to 31 March 2017. First year returns for the higher of these two bands will be due by 1 October 2015 with payment required by 31 October 2015.

Under the existing rules, interests in properties will be re-valued every 5 years. For interests worth over £2 million, the charge is currently based on the value as at 1 April 2012. The first re-valuation date for such properties will be 1 April 2017, and will identify the band into which that interest will fall for the purposes of the ATED charge with effect from 1 April 2018 for the following five years.

These valuation dates will remain unchanged for the new extended bands. Thus, the initial charge for properties falling into the ATED with effect from either 1 April 2015 or 1 April 2016 by virtue of the expanded rules will be based on their valuation as at 1 April 2012 (the initial valuation date) or the date of acquisition, if later.

Accordingly, properties which would be within the new bands if valued now or as at 1 April 2015 or 2016, may not be caught based on their values as at 1 April 2012. Of course, they will be caught for chargeable periods from 1 April 2018 onwards once they have been re-valued as at 1 April 2017.

ATED-related CGT charge - existing measures

Under the existing legislation, properties which fall within the scope of the ATED are also potentially liable to CGT on 'relevant high-value disposals', the so-called 'ATED- related CGT charge'. Broadly, these are disposals of residential property or interests in residential property by NNPs where the consideration exceeds 'the threshold amount', generally £2 million. There is a tapering relief for gains where the property is worth just over £2 million.

The charge applies only to 'ATED-related gains' accruing after 6 April 2013, rather than the entire gain from acquisition, unless an election is made to the contrary. Broadly, an 'ATED-related gain' is calculated by reference to the number of days in the 'relevant ownership period' (the period between 6 April 2013 and the date of disposal, unless an election has been made) in respect of which an interest is within the ATED and not subject to an applicable relief.

The fact that the existing CGT charge is tied to the ATED limits it to NNPs comprising companies, partnerships where at least one member is a company, and collective investment schemes. Individuals, trustees of settlements and personal representatives are excluded from the ATED-related CGT charge.

The reliefs applicable to the ATED and higher-rate SDLT also apply to the ATED-related CGT charge. The rate of CGT is 28%, the rate applicable to higher/additional rate taxpayers.

ATED-related CGT charge - new measures

From 6 April 2015, the ATED-related CGT charge will also apply to properties worth between £1,000,001 and £2 million. It will only apply to that part of the gain accruing on or after that date. From 6 April 2016, the ATED-related CGT charge will apply to properties worth between £500,001 and £1 million, to the part of the gain accruing after that date. The rate will be 28% as for the existing charge.

Legislation on the CGT elements of the high-value property measures will be introduced in Finance Bill 2015.

Consultation on implementing a CGT charge on non-residents

At the UK Autumn Statement in December 2013, the Chancellor announced that, with effect from 6 April 2015, non-UK residents will be liable to CGT on gains made on disposals of UK residential property. The consultation provides an outline of the proposed details of this new charge, but there are still many unanswered questions upon which the UK Government are seeking views. Accordingly, the tax may look very different from the existing proposals by the time it is introduced.

Briefly, the proposals are as follows:

• The new CGT charge on non-residents will be focussed 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 in the ATED-related CGT 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 which 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/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%.

Ownership of residential property

• Individuals - non-resident individuals who own and dispose of UK residential property directly will be liable to the new CGT charge.
• Partnerships - the new CGT charge will also apply to disposals of UK residential property made by partnerships so that non-resident partners will be taxable under the new CGT regime to the extent that gains are attributable to them, as is currently the case for UK resident partners.
• Trustees - it is proposed that non-resident trustees should be subject to CGT on any gains on disposals of UK residential property. How such a tax will interact with existing CGT anti-avoidance provisions, which seek to attribute trust gains to settlors and/or beneficiaries, remains to be seen.
• Funds - non-residents will not be taxed on disposals of shares or units in a collective investment scheme or fund, such as a Property Authorised Investment Fund. This is because it may be difficult to target disposals of units of investment in residential property in a fund which holds multiple investments for a wide group of investors. Instead, it is proposed to introduce a "genuine diversity of ownership" test to ensure that where funds are closely held they can be within the scope of the new CGT charge on non-residents to prevent avoidance of the tax by holding interests in property within closely-held funds.
• Pension funds - will be excluded from the scope of the new CGT regime.
• Foreign REITs - foreign real estate investment trusts (REITs) will not be taxable under the new CGT regime where they are equivalent to UK REITs. HMRC is currently drafting guidance on what constitutes a foreign-REIT equivalent.
• UK REITs - non-residents investing in UK residential property through UK REITs will also not be affected by the new CGT regime.
• Non-resident companies - it is proposed to extend CGT 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 the ATED charges each year.

At the moment, companies that own UK residential property and let it to unconnected third parties on a commercial basis would be within the relief for property rental businesses for ATED-related CGT. To avoid non-residents incorporating companies to hold their property in order to avoid CGT, the consultation indicates that the UK Government is considering options to bring such non-resident property investment companies into the UK tax system.

If enacted, the result of this will be that NNPs that are not genuine businesses disposing of higher value UK residential property will be subject to the ATED-related CGT charge at 28%. Other non-resident companies disposing of UK residential property will be subject to a new "tailored" charge within corporation tax or CGT, at a rate to be confirmed. Only losses that have been incurred by non-resident companies on disposals of UK property will be allowed against such gains.

Reliefs

PPR (principal private residence relief) is currently available where a property is an individual's main residence (this includes trust beneficiaries in appropriate circumstances). Whilst a UK property will not generally be the main residence of a non-resident individual, there will be exceptions to this and PPR will be available to non-residents in appropriate circumstances (e.g. when someone emigrates from the UK and then sells a property which was their main residence).

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

• 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.
• 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 regarding their residence than is presently the case for people who choose to make an election.

There are no proposals in the consultation to make changes to other relevant reliefs relating to a person's main property.

Tax rates

The rates of tax for the purposes of the new CGT charge on non-residents are to be the same for non-UK resident individuals as for UK residents. So for basic rate taxpayers, the rate would be 18% and for higher/additional rate taxpayers, it would be 28%. For non-residents, the rate will depend on their total UK income and gains. The annual exempt amount for gains (£11,000 for tax year 2014/15) will also be available to non-residents.

For trustees, funds and companies, rates of tax are to be confirmed, but the aim is to ensure that resident and non-resident entities are treated comparably.

There will also be a mechanism for the declaration of losses, where appropriate.

Delivery mechanism

For the purposes of ensuring compliance with the new CGT charge on non-residents in a situation where HMRC has very little information about the likely taxpayer, the introduction of a withholding tax regime is proposed, ideally to operate alongside a self-assessment option.

The aim would be for the tax to be withheld and transferred to HMRC within 30 days of completion of the sale as is currently the case for SDLT. The consultation requests views as to how this process should be introduced and who should have responsibility for the identification of the seller and the collection of withholding tax - solicitors, accountants etc.

Consultation timeline

The consultation closes on 20 June 2014 and we will be submitting our views. As the proposals develop and draft legislation is published, we will report further.

Planning points

• In our experience, the driver for corporate-holding structures for property ownership by wealthy non-UK domiciled individuals and families tends to be either inheritance tax (IHT) planning or for reasons of privacy of property ownership.
• For UK residents, CGT has always been an issue and since the introduction of the ATED-related CGT charge it has also become a consideration for non-residents, albeit until now limited to non-resident NNPs.
• With the introduction of the proposed general CGT charge for non-residents with effect from 6 April 2015, it will become much harder for non-resident individuals or entities to avoid a potential CGT charge on a disposal of UK residential property, except where such property may qualify as the main residence of an individual for the purposes of PPR.
• If the UK Government replaces the ability to elect one's main residence with an objective test for qualification for PPR along the lines of those proposed, it would be difficult for someone to satisfy these requirements and continue to be non-resident, given the criteria of the new statutory residence test. Accordingly, it is likely that only individuals who are leaving or have recently left the UK to become non-resident would be able to claim PPR in respect of a previous UK home.
• However, if a property is likely to qualify for PPR for whatever reason, it may be preferable for an individual (or trustees) to hold it directly. On an acquisition of a property directly by an individual or trustees, SDLT will be at standard rates. ATED will not be an issue. However, the property will be within the IHT net unless other forms of IHT mitigation are put in place.
• For lower value properties, either under the new higher-rate SDLT/ATED/ATED-related CGT charge threshold of £500,000 or not far above it, the property may fall within a couple's joint nil rate bands (currently £325,000 each or £650,000 jointly). If there are no other significant UK assets to consider, no additional IHT planning may be necessary and such a property could be held directly unless there are other considerations.
• For IHT mitigation purposes, a property may be purchased with a mortgage to reduce its value in a non-domiciled individual's estate. Legislation introduced last year, which restricts the deductibility of liabilities for IHT purposes in certain circumstances, may limit the effectiveness of such a strategy where it applies. However, in such circumstances, other options for IHT mitigation, such as insurance, may still be available.
• For an individual wishing to invest in UK residential property generally rather than in any specific property, investing in a UK REIT or foreign REIT-equivalent may be an alternative tax-friendly option. Equally, a fund already investing in UK residential property might consider converting to a REIT (whether UK or a foreign-REIT equivalent) which is and, under the current proposals, will continue to be exempt from CGT on property gains.

Conclusion

The expansion of the existing tax regime for UK residential property held by NNPs was unexpected. For new acquisitions of UK property where there is no available relief, the increased SDLT cost is likely to be a significant deterrent to such structures for properties worth £2 million or less. On the other hand, the expansion of ATED may in some cases simply be regarded as an additional cost of maintaining such a holding structure, albeit an unwelcome one.

Although the extended ATED-related CGT charge will be an issue for many, the introduction of a new CGT charge for non-residents disposing of UK residential property with effect from 6 April 2015 is much further reaching and, subject to the application of a relief where available, will catch gains on disposals of UK residential property of any value by individuals and most other entities.

Nevertheless, there may continue to be situations in which, on balance, there are advantages to holding UK residential property through a corporate envelope rather than by an individual or trustees directly. However, careful consideration of all the relevant circumstances will be required to determine whether this may be the case.

Accordingly, any non-UK resident who owns or is considering acquiring UK residential property through a holding structure or otherwise, may wish to review the position as the details of the proposed new CGT charge for non-residents become clearer, in order to determine what may be the best way to hold such property for the future.