The government has introduced new rules aimed at protecting some investors in UK commercial property from proposed tax changes in its Finance Bill 2017-2019.
The Bill, published today (7 November), responds to the commercial property sector’s concerns that a planned overhaul of the system could unfairly penalise certain, currently exempt, investors and push them away from financing key UK development projects.
In the Autumn Budget in November 2017, Philip Hammond announced a change in capital gains tax rules for overseas investors buying UK property.
Traditionally, this tax was only charged on disposals of non-residential property by UK residents, but the government proposed extending the regime to non-residents from April 2019. In its draft Bill published in July, the government said the move “levels the playing field between UK residents and non-UK residents” on UK property disposals.
Threat to property investment
However, the property sector has raised concerns about the impact of the changes on the funds industry, which is a major contributor to the UK property market.
As a result, the government extended its consultation on the proposed tax change to consider areas specific to the funds industry. Initial responses to the consultation and draft legislation were published in July 2018.
The new regime could have sprung charges on traditionally tax-exempt investors, such as pension and sovereign wealth funds, many of which hold UK real estate assets in non-UK funds.
What HMRC didn’t understand
The senior property source said: “What HM Revenue & Customs didn’t understand is that exempt investors like pension funds can own UK real estate directly or indirectly. They didn’t know that pension funds can invest through other funds. If HMRC didn’t amend the proposal, they would suffer additional tax if they invested through a fund instead of investing directly.
“HMRC consulted with us and we have ended up with a UK tax transparency election and an exemption election in the Finance Bill 2019. It should mean that exempt investors don’t pay more tax if they invest via a fund instead of in a property directly.”
In contrast, other overseas property investors, such as family offices, will have to pay CGT from April 2019 regardless of whether they invest indirectly through a fund or not.
How funds can avoid CGT
To ensure institutional investors such as pension or sovereign wealth funds are not hit with CGT, the new Bill containts details allowing offshore funds to either elect for tax-transparent status or special treatment.
The senior property source explained: “Transparency election will basically treat the fund and any entities in the fund structure as not existing for tax purposes. This means that investors are only taxed once.
“Funds can also make an exemption election. This exempts the fund itself from tax as long as the fund managers are prepared to abide by certain rules, such as reporting information about who the investors are. HMRC wants to know more about who is investing in these funds.”
The move will offer some relief to the commercial property sector, which had raised concerns over a drop in overseas investment in regenerating the UK property market as a result of the tax changes.
Ion Fletcher, director of finance policy at the British Property Federation, commented: “When the new capital gains tax rules were first announced last year, we were very concerned that they would result in tax-exempt investors like overseas pension funds suffering tax just because they choose to invest through a fund rather than owning property directly. This could have pushed overseas pension funds away from fund investments and from financing much-needed, long-term regeneration projects across the UK.
“The BPF has, however, been working closely with the government to ensure better understanding of how funds work and why it was critical that there is no difference from a tax perspective between a pension fund owning a property directly and owning that property through a fund. Today’s Finance Bill recognises this, and its special rules for overseas fund investors is a positive outcome.”
Mark Watterson, a tax lawyer at Simmons & Simmons, added: “The availability of these exemptions is subject to detailed requirements and stakeholders need to start reviewing these as a matter of priority to understand their relevance to existing and proposed investments.”
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