by Cecil Bounsall
Many people buy property with the aid of loans raised outside the UK, but few of them have probably ever heard of sections 52, 53 and 54 of the Income and Corporation Taxes Act 1970 (as amended) (now consolidated as sections 347-350 of the Income and Corporation Taxes Act 1988). However, failure to observe the provisions of this and other associated tax law can have dire consequences, as the following story shows. The property concerned is in Spain, but the location is in fact immaterial — similar circumstances elsewhere would have had the same result.
The recently published McMillan Scott Report states that out of several hundred complaints investigated, some 90% related to properties purchased in Spain.
A few months ago it was reported that a British subject bought a villa in Spain in 1982, having financed the purchase with the help of a large loan which he obtained from a Spanish bank. Since then he has remained tax-resident in the UK, and about a year ago he was appalled to receive a letter from the British Inland Revenue telling him that he owed more than £11,000 in unpaid taxes, and warning him that the imposition of interest and penalties would be considered in addition. The letter pointed out that since 1982 he should have deducted tax at the basic rate from his payments of annual interest to the foreign bank, and then paid these tax deductions over to the Inland Revenue.
I gather that the borrower did not take professional advice before he signed the loan agreement, but he did so on receipt of the letter from the Inspector of Taxes; by then, sadly, it was too late. He found that he could not escape liability, innocent though his failure to deduct tax may have been. Nor could he reasonably hope for a retrospective application of the Anglo-Spanish double taxation agreement under which the Inland Revenue can agree to deduction of withholding tax at a rate substantially below the basic rate.
What it boiled down to was that he would have to pay whatever amount the Inland Revenue were entitled to demand in respect of the back taxes and any interest or penalties they might decide to impose. In future, of course, for the residue of the term of his bank loan, he would have to account to the Inland Revenue out of his own pocket for tax on the annual interest payments. It was up to him to seek whatever reimbursement he could from the lending bank under the terms of his loan agreement. In the event there was no such reimbursement; the agreement, which was written in Spanish, specified that the loan interest of 15% was to be paid clear of tax deductions!
It would be comforting to believe that cases such as this are rare — and possibly at present that may be so. However, from a number of inquiries which I have made, I suspect that there are many people who are already ensnared, although most are not yet aware of the fact. It seems that it took the Inland Revenue more than five years to find out that someone who raised his loan in 1982 had failed to disclose the interest payments, and one wonders how the discovery eventually came about. While this must be a matter of conjecture, there does appear to be a strong possibility that recent advances in computerisation, coupled with greater co-operation between the tax authorities in different countries, may be the answer. If so, it is to be expected that there will be an increasing number of such discoveries in future years.
Although current tax return forms and guidance notes point to the need to declare annual interest payments made direct to anyone who normally lives outside the UK, there are, of course, many people who do not receive these forms. In any event the information is less likely to register with a taxpayer before he starts to pay such interest, rather than afterwards. Afterwards will be too late if the loan agreement has been signed without a provision for tax deduction. Unless there is a great increase in public awareness it appears inevitable that many more people will find themselves in this trap in future. Professional advisers can, of course, assist considerably by warning their clients well before they commit themselves to buying a property with the aid of finance from outside the UK.
It is beyond the scope of this article to consider the detailed provisions of the 1970 Act and the associated tax law, or the effect of various double-taxation agreements. Even in the limited context of the tax deductions from annual interest payments there are a number of exceptions, reservations and other “ifs and buts” which in specific cases can qualify the application of the general principle. Where a borrower appoints an agent in the UK to remit interest payments abroad, for example, that agent himself becomes liable to account to the Inland Revenue for tax deductions. A further example relates to foreign banks: provided that such a bank carries on a bona fide banking business in the UK, and grants a loan, the interest on which is payable in the UK, the Inland Revenue can agree to regard the loan in the same way as if granted by a British bank.
It is a matter of individual circumstances as to whether a given loan falls within the tax deduction net and, if so, the tax rate at which deductions must be made. I suggest that readers, if in any doubt, should consult the Inland Revenue at the department of the Inspector of Foreign Dividends, Lynwood Road, Thames Ditton, Surrey, or alternatively should consult a specialist tax adviser.
In conclusion, I would mention a few general cautions. Clearly any foreign loan agreement should be scrutinised by an adviser who can understand legal documents in the language in which they are written, and the provision for withholding tax — or its absence — should be noted. Where an intending property purchaser contemplates taking over an existing foreign loan (for example, from a developer who has raised a mortgage on the land) it is most unlikely that there will be a provision for reducing the interest to allow for UK tax legislation. It should also be remembered that where a vendor/developer offers facilities for payment by instalments, these instalments may well include interest on the outstanding balances of the purchase price; here again it is unlikely that there will be a provision for withholding tax.
It will be appreciated that the question of whether the lender is a foreign person or company is not necessarily decisive; for example from the point of view of UK tax law a British subject may be regarded as “normally living” outside the UK — conversely, a foreign national may normally live in the UK. Caution is always to be recommended in treading the tax tightrope.
“Plus Valia”
This Spanish tax can involve purchasers in a substantial and often unexpected liability. It is a capital gains tax, payable on the sale of property, but it is assessed only on the deemed site value. One would expect it to be payable by the vendor, to whom the deemed profit accrues — and so it is in the first instance; however, it can, and often does, fall on the purchaser, for reasons which will be discussed later.
Although usually known as Plus Valia, the formal description of the tax is Impuesto Municipal Sobre el Incremento del Valor de los Terrenos, which can be summed up as “Municipal tax on land value increases”. Some municipalities do not charge Plus Valia; those which do so split their area into different land value zones, to each of which they attribute an “official” price per square metre. These prices depend on the specific location of the land, and vary enormously within the municipal boundaries; they are revised periodically.
When the sale of a property is registered the local tax authority looks at the price per square metre for the zone in which it is situated and multiplies this by the site area of the property (as recorded in the title deeds). The exercise is then repeated as at the date of the previous registered sale, and the increase in the “official” site value is the basis of assessment. However, the tax rate levied on the assessed figure varies in accordance with the percentage increase in the deemed site value and the number of years which have elapsed between the dates of sale. These complications are determined by use of an arbitrary formula.
From the foregoing it is apparent that the tax payable (which can range from modest amounts to thousands of pounds) is in no way related to open market property or site values, or to actual capital gains made by vendors. In consequence a modest villa set in, say, 2,000 m2 of unusable rocky scrubland can attract a far heavier charge than a neighbouring landscaped luxury villa which has a site area of say, 1,400 m2. Similarly, two identical villas, each with the same site area, can attract widely different charges if they are in different “official” zones.
We can now look at the problems faced by British purchasers in regard to Plus Valia. The first is that Plus Valia runs with the land, so that if the vendor fails to pay it, as happens frequently, then the purchaser becomes liable. The danger of this happening is increased by the fact that it often takes two or three years for the tax collector to send out the bill.
The second problem is that a vendor is not legally barred from transferring liability for Plus Valia to a purchaser in the initial sale contract for the property (the Contrato de Compra-Venta). Over the years it has become a fairly widespread practice for vendors to pass on the tax in this way. Originally, where there was an appropriate adjustment in the price of the property, the practice protected purchasers against the vendor’s failure to pay the tax, but over the years some vendors — property developers in particular — have found that they can get away with a transfer of liability without having to concede any price reduction. They simply draft sale contracts to include Plus Valia among those conveyancing costs which are normally to be paid by purchasers.
British and other foreign buyers often fail to realise that they are contracting to pay capital gains tax for which vendors are primarily responsible, and this occurs on such a wide scale in some areas of Spain that if challenged the vendors can reply — with ironic truth — that the contract has been drawn up in accordance with local custom!
What advice can readers give to their clients in this matter? Obviously the first thing is to find out from the municipality in which the property is situated whether they charge Plus Valia. If so the next move should be to seek an estimate of the potential amount, either from the town hall or from a local tax specialist. There are then two alternatives, neither entirely without risk. The purchaser can demand that the sale contract contains a specific provision that Plus Valia is to be paid by the vendor; if the latter subsequently fails to pay the purchaser will not escape liability to the tax authority, but at least he may be able to obtain some redress under the contract.
Alternatively, the purchaser can agree to pay Plus Valia in consideration of a reduced purchase price; the risk here is that when the tax is eventually assessed it may prove to be higher than expected, particularly if any lengthy delay occurs in the registration of legal title to the property. It may happen, of course, that where a property is in demand, the vendor will reject both alternatives and insist on the purchaser paying Plus Valia without a price adjustment, but in that event a prospective buyer will be in a position to take the extra cost into account in deciding whether to proceed with the purchase.
To conclude, it is worth noting a few general points which should be considered. As previously mentioned the tax is assessed only on deemed site values; bare sites will attract the same values per m2 as developed sites in the same zone, and in the latter case the quality and size of the buildings are of no account in the assessments. However, the nature of the buildings can sometimes be relevant to the tax payable by individual purchasers; in the case of a block of flats or apartments the site assessment is apportioned between all the dwellings in the block. The percentage increase in deemed site value is an important factor in determining the rate of tax payable on the assessment; this increase is likely to be well above average in locations which have developed rapidly in recent years.
Finally, it must be remembered that the tax rate also depends on the dates of registered sales. In Spain some sales are never registered, and others are registered only after a lapse of several years; it is unwise to rely on information which has not been verified at the local land registry(*).
(*) It was announced recently that the system of assessing municipal charges is to be standardised as from January 1 1990 by reference to what is called the Valor Catastral of properties. This is the present basis for rating assessments, and represents the deemed capital value of the individual sites with any buildings thereon. While it is not yet clear as to precisely how this will affect future computations of Plus Valia, it does seem probable that in the case of developed land the deemed value of the buildings will also have to be taken into account.
