Tax and UK residential property - an introduction for foreign investors

14 July 2014


Prime residential property in the UK, and luxury London property in particular, remains a popular investment choice for many wealthy foreign individuals and their families.

Whether an individual wishes to buy a second (or third, etc.) home in Knightsbridge, or because they are in the process of changing their country of residence, or simply because they consider it to be a good investment, UK property remains very close to the hearts of such individuals.

Need for tax structuring

As with other types of assets, to maximize the return on an investment in UK property, it is essential to consider the acquisition structure for its tax efficiency at an early stage - certainly before exchange of contracts for the property purchase and preferably even before beginning the search for a property.

International investors, who may be from jurisdictions with relatively low rates of income and/or capital gains tax, may not attach great importance to tax planning or may think that the holding structure for a property acquisition can be revisited later without too much trouble.

Sadly, the UK tax environment is by no means as benign as some, and failure to adopt the right structure (at the outset or at all) can have costly tax consequences. This can in turn erode the investor's anticipated returns and the value of their children's inheritance.

It is important to get the structure right from the outset, as the penalty for changing one's mind after the property has been acquired is likely to be at least an additional Stamp Duty Land Tax (SDLT) charge of up to 15%.

Residence and domicile

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, very broadly (and subject to deeming rules for inheritance tax purposes), the place an individual regards as their permanent home.

In the majority of cases involving an acquisition of UK property by a wealthy foreign individual, he or she is likely to be non-UK domiciled. However, this should always be verified.

Taxation of UK property

In general, there are three main categories of direct UK taxes that are relevant in the context of ownership of UK residential property:

  • income tax on any rental income from the property;
  • capital gains tax (CGT) on a disposal of the property at a gain; and
  • inheritance tax (IHT) on transfers of value on death or, in specified circumstances, during an individual's lifetime.

For residential properties valued over £2 million 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 which applies where certain "non-natural persons" or "NNPs" - companies, partnerships which include one or more corporate partners and collective investment schemes - own a residential UK property with a value exceeding £2 million. This tax is due to be extended to properties worth over £1 million with effect from 1 April 2015 and those worth over £500,000 from 1 April 2016.

In addition, SDLT is payable by purchasers of UK property, at the rate of 5% where the purchase price exceeds £1 million or 7% where it exceeds £2 million. The rate increases to 15% 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 property developers or to be used in a rental business.

However, no SDLT is payable (i) on gifts of UK property unless the gift is to a connected company; or (ii) the transfer of shares in a company deriving its value from UK property (although in the case of a transfer of shares in a UK company, stamp duty at a rate of 0.5% may be payable).

Options for acquiring UK property

The principal options available for wealthy foreigners acquiring UK property are, as follows:

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

The form of ownership which will suit each individual investor will vary not only according to his or her 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

Income tax will be relevant if a UK 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 may vary according to the structure through which the property is held, and advice will be needed accordingly.

Inheritance tax

Even where an individual is domiciled outside the UK, inheritance tax will be applicable to his or her UK estate. Using an appropriate structure, IHT on a UK situate property may be avoided. However, many individuals would prefer to hold a property directly and, in many cases, for other tax reasons, this may be advisable.

In this situation, to mitigate IHT a property may be purchased 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. However, in such circumstances, other options for IHT mitigation, such as insurance, may still be available.

Capital gains tax

Existing position

Under the 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 UK property as their main residence worldwide and certain statutory conditions are met, no CGT is payable on a disposal of that property. Where the gain is taxable and not covered by the main residence exemption, the rate of tax is 18% for basic rate taxpayers and 28% 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 a disposal of the property, the company which owns it will also be liable to CGT at the rate of 28% on any ATED-related chargeable gains (which are those arising since acquisition or 6 April 2013 (whichever is later) unless an election is made to include all gains since acquisition). As the ATED-related CGT charge only applies to ATED-related gains, where a property is not liable to the ATED for a period of time, 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 a disposal of a property owned by an NNP but which is outside the scope of the ATED charge either because of its value or due to the existence of a relevant relief may still result in a charge 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 was published in March 2014 on the proposed introduction in April 2015 of a CGT charge on future gains made by non-UK residents disposing of UK residential property. This closed in June. HMRC are considering the responses they received and will report further as to how they intend to proceed, probably in the Autumn.

Once introduced, the proposed measures will represent a further and important consideration in terms of which is the most tax efficient structure for holding UK property. Non-UK residents holding or acquiring UK residential property now (whether directly or through a holding structure) 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 even if they would not be so liable under the existing law.

Conclusion

This note provides a very brief outline of the tax considerations which may be relevant in structuring an acquisition of UK property. Specific and detailed advice tailored to an individual's personal circumstances will be required in each case.

No single structure will be always right for acquiring and holding UK property. In each case, the appropriate solution will be determined by consideration of the investor's tax attributes and intentions for the future in terms of how the property will be used (for personal occupation, to generate rental income, for capital appreciation, for development or to quickly resell at a gain) and where individuals and their families will be living in the foreseeable future. With the world becoming a much smaller place and investments and lifestyles becoming progressively more international, to ensure continued tax efficiency, the holding of UK property should be revisited each time there is a material change in circumstances.

Importantly at the moment, given the recent proposals for the introduction of a CGT charge on gains made by non-UK residents disposing of UK residential property, any existing or proposed UK property-holding structure should be revisited regularly over the forthcoming months as the proposed provisions of the charge are developed to ensure that, as far as possible, the structure continues to achieve its aims.


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